The most accepted rule of thumb for cashing out your retirement stash is to take 4% of your stash’s beginning balance each year and withdraw that to cover that year’s expenses. That means basically that for every $1000 of your annual expenses you need to have $25,000 socked away. And it is that little formula that holds the “secret” to my earlier retirement.
At age 42, when I first seriously looked at my future retirement, my basic living expenses were running around $26,000 a year. So the little formula said that I would need $650,000 to cover those annual costs in retirement. With about $100,000 in my IRA at the time, and a savings rate of $5000 a year, it looked like retirement would not be possible at all without Social Security. At best, I would be able to retire at 62, when I could start withdrawing from my Social Security account to help cover my expenses. Which meant I had a 20-year wait ahead of me. Okay, not a catastrophe. Lots of people have to wait that long – or longer – to retire. But the little formula pointed the way to how I could do better.
I saw that the result would be mind-boggling if I looked at the formula “backwards.” Because what the formula then told me was that for every $1000 I could cut from my basic living expenses I could reduce my required retirement stash by $25,000. And, at my $5000-a-year savings rate, that $25,000 stash reduction would bring my retirement date at least 4 years closer – even factoring in growth in the value of my investments. Whoa, Nellie!
This revelation was HUGE to me. Every $1000 reduction in my annual basic living expenses would buy me four more years of job-free life! So I carefully went to work with sharp “budget scalpel.”
Gradually, I managed to reduce my yearly basic living expenses from $26,000 to $16,000 (and, surprisingly to me, without giving up anything that mattered or feeling deprived). This reduced my target retirement stash by $250,000. A quarter-million bucks. AND the cost reductions tripled my annual savings rate because those cost reductions freed an extra $10,000 a year that went right into additional retirement investments. The end result was a major (MAJOR!) financial breakthrough for me that bought me nine more years of life in financial freedom. Because I was able to retire – without having to wait for the Social Security money – at 53 instead of 62!
How much time you can buy for $1000 in reduced annual expenses depends on how much you are saving now. If, like I was, you are putting away $5000 a year then you can buy yourself 4 more years of job-free life with that $1000 cost reduction. If you are saving $10,000 a year, then that $1000 in reduced expenses will buy you 2 more years of retirement. And so on. The point is: however much you are saving, there’s a BIG sale on freedom time going on. And you can get in on it.
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