When it comes to the Financial Independence Retire Early (FIRE) movement, one of the key concepts is that of a safe withdrawal rate.
Traditionally, FIRE adherents have listed 4% as the best balance between sufficient retirement funding and risk when it comes to the rate at which you should withdraw from your savings. At 4%, one of the key assumptions is that the balance of your savings will continue to earn an annual return of 5% or more. Certainly it makes mathematical sense that if you withdraw at a rate lower than the rate at which you earn, year over year your savings will actually grow, not shrink.
However, 4% is a very restrictive amount, and demands either a significant amount of savings or a willingness to live on less in retirement. For example, the average American worker earns $928.74 per week or $48,294.48 per year. After taxes, that leaves about $38,635.58 per year in take-home pay. By saving 25% of take-home pay for retirement, then the amount needed as income in retirement is $28,976.69 (once retired, there is no reason to continue saving for retirement).
In order to live on $28,976.69 per year in retirement while withdrawing from savings at a 4% annual rate means the balance of savings at retirement must be $724,417.20. Acquiring $724,417.20 with an annual gross income of $48,294.48 would take nearly 32 years at a savings rate of 25% of take home pay. So much for the E of FIRE.
Because a 4% withdrawal rate coupled with a 5% earnings rate will ensure a perpetual savings balance in retirement, the first consideration in getting back to early retirement is evaluating how much less one can live on in retirement. Assuming that retirement income must equal 75% of pre-retirement income is akin to assuming retirement income must be 100% of living pay, because pre-retirement 25% of take-home pay is devoted to retirement savings and thus not available for other forms of spending.
Instead, to advance retirement the candidate must consider a living pay in retirement of less than 75% of their pre-retirement income. In the example from above, the living pay was $28,976.69. If retirement is important, it may be worth making sacrifices in other spending areas. Some considerations should be made regarding current spending that can reasonably be eliminated such at living pay can be reduced. For example, owning a car has an average cost of $10,410.96 per year, when totaling ownership, insurance and fuel costs. In retirement, can you get rid of your car? By replacing your transportation needs with public transportation, services like Uber or Lyft, and even car rentals when required, you may be able to save $8,000.00 of that $10,410.96 in car ownership cost.
At that level of income requirement, the retirement date advances significantly. By reducing retirement income from $28,976.69 to $20,976.69, the effect this has on retirement is to advance the date by which a 4% withdrawal rate can match that amount by 6 years, or a total of 26 years of savings. 26 years of savings is an improvement over 32, however it is still a long time to be saving for retirement. An individual who enters the workforce at age 25 would not be able to retire until age 51, and even at that point, the lifestyle in retirement must be compromised. The notion of compromising your retirement make less sense as you age, because your ability to engage and be active in retirement diminishes as your health declines. If you are to compromise your retirement is makes more logical sense to do so while you are young. Should you erroneously deplete your savings while young, you will have time to recover.
Changing your withdrawal rate is a compromise that adds risk to your ability to sustain your retirement long term. However, there is little reason to grow your savings in retirement. If you can sequence your retirement in an ideal way, your savings balance will diminish until age 62 at which point you are entitled to social security benefits. Granted, social security will be unlikely to provide a complete living wage, but it can help fill a gap in your retirement income.
By increasing the withdrawal rate to 9%, while maintaining the earning rate of 5%, retirement can commence after 16 years of savings. The consequence of a 9% withdrawal rate is that each subsequent year's withdrawal will be less than the prior year. Although that may align to decreasing spending needs as the years advance, it poses problems should health concerns surface later in life. In looking forward, withdrawing from savings at a 9% rate while earning 5% means that at year 20 in retirement, the income that must be lived on is $9,055.03.
While $9.055.03 is likely unreasonable to live on in retirement, a 42 year old can retire anticipating that income at age 62 by planning to fill the gap with social security payments. A 25 year old could retire after working for 17 years by saving 25% of take home pay and withdrawing at rate of 9%. 17 years is a compromise for retirement that may make sense for you, as it results in a retirement age young enough to remain active and reasonably healthy.
Rather than using a percentage based withdrawal rate, another option is to annually withdraw a fixed amount based on a predetermined requirement. For example, the living pay determined earlier was $20,976.69. That amount can be withdrawn each year safely, so long as the number of years spent savings is 18 instead of 16. After saving at a 25% rate for 18 years, the principal saved will be $284,207.22. Drawing down that balance by $20,976.69 each year while continuing to earn 5% on the balance will mean that by age 63, the savings will be depleted - just in time to transition to social security.
In reality, it is always best to discuss your retirement planning with a certified professional. In all cases, you may have experiences that differ from these scenarios, and any time averages are used in financial equations, they typically do not relate exactly to anyone. You may experience better or worse rates of return, you may experience different demands on your spending, and we all may experience unforeseen impacts such as interest rate hikes or runaway inflation.
Summary
In evaluating your FIRE, understanding the safe withdrawal rate that makes sense for your risk tolerance is a key consideration for determining when you can retire. Compromises are almost never a good idea when it comes to retirement planning, particularly when an extra 2 years of savings may mean the difference between stretching your savings until social security kicks in versus finding yourself in your sixties with no savings and no means to earn a living. Retirement planning should always focus on safety and therefore you should consult with professional before making any consequential decisions about your retirement.
Do you have any techniques to best optimize how to withdraw from your savings in order to preserve it for the duration of your retirement? Do you have experience with failing for plan sufficiently in retirement?