Everyone knows they should start saving for retirement as soon as possible. What people know they “should” do and what people actually do is not the same thing. According to AARP, nearly half of American households headed by someone age 55 or older have no retirement savings.
What is someone far behind on retirement savings to do? Can they learn anything from the FIRE (financial independence, retire early) community?
The “simple math” of FIRE allows people who start saving aggressively in their 20s to achieve financial independence in 10-15 years and be financially independent by their 30s to early 40s. The math is identical if you start saving in your 50s to reach financial independence at traditional retirement age.
It’s hard to drastically change decades old behaviors if you haven’t saved earlier in adulthood. That’s fair.
I want to share a counterpoint to give hope if you’re getting a late start saving for retirement. It is possible to apply these FIRE principles later in life. In fact, late savers have several key advantages that early savers do not.
Dissecting the simple math
Achieving financial independence quickly is primarily a function of your savings rate. The greater your savings rate, the faster you become financially independent.
Many people erroneously think achieving financial independence requires great investing prowess. The shorter your journey to financial independence is, the less time investments have to compound during this process.
This is not to trivialize investing. It will play a vital role in making your money last while supporting spending needs after achieving financial independence. Investing just needs to be placed in its proper place.
Savings rate is what you must focus on if you want to achieve financial independence quickly. Your savings rate is simply the amount of money you save divided by the amount you earn.
In equation form this looks like:
Savings rate = Savings/Earnings
Or:
Savings rate = (Earnings – Spending)/Earnings
Only two things really matter if you want to achieve financial independence quickly… how much you earn and how much you spend. Many people who begin saving later in life have several big advantages over younger savers in these two domains
1. Saving during your prime earning years
One of the two factors that go into creating a high savings rate is your income. So it should be easier to save when you earn more. Earnings peak for most workers in their 40s and 50s. This creates a clear advantage for people who are saving for retirement later in life.
In our household, we reached financial independence quickly by saving roughly 50% of our household income. We lived on Kim’s income. My income was used to pay off debt quickly. Then we invested it.
The simple math worked, but it wasn’t easy. We started this system of paying off debt when Kim was starting out with a salary of about $35,000. I was earning $10-$12/hour working part-time while in graduate school. This required a frugal lifestyle.
Things got much easier when I began collecting a professional salary as a physical therapist. It became easier still when we both grew our salaries over the ensuing decade.
Still, we started cutting back our income just as we were approaching our peak earning years. Kim cut back to part-time work when she was in her mid-30s after our daughter was born. I completely left my career at the age of 41.
Applying FIRE principles early in life means saving a large percentage of your income before reaching your peak earning years. Early retirement results in leaving a lot of career earnings on the table. Late savers, on average, have a clear advantage of saving during higher-earning years.
Earning is only half of the savings rate equation. Spending is the other key factor. Late savers may have key advantages here as well.
2. Empty nests
One of the biggest expenses many of us have is raising children. Younger savers have to figure out how to save for their own financial independence while also figuring out how to support children — from buying diapers and safety accessories in the early years, to supporting expensive hobbies and filling bottomless stomachs that characterize the teen years, to preparing for the massive expense of college education.
For many people in their 50s, their children are out of the house. For others, kids are in their teen years. Many expenses are in the rearview mirror, and there is some certainty on what the next phase of life looks like. As your children get older, this creates several advantages to earn more and spend less.
As children become adults, the expenses of their food, utilities, and clothing go away. Some parents save for their children’s college education over many years . Others cash-flow it from income when the time comes. In either case, once that phase ends it frees up substantial cash flow that can be redirected to your own retirement savings without sacrificing lifestyle.
Children growing up does more than free up cash flow. It frees up time. Tim Urban’s blog post The Tail End points out that by the time a child graduates high school, they’ve spent 93% of the in person time that they will ever spend with their parents in their lifetime.
The Tail End is a powerful read. It provides a graphic reminder to be careful how you spend your precious time.
This idea can be a little depressing. But it highlights a key advantage that allows late savers to catch up. You can use that freed-up time to increase your earnings.
3. The ability to downsize
The biggest monthly expense for many households is the rent or mortgage payment. Related to your kids growing up and moving out, this could be a great time to downsize your housing.
The idea that we “needed” bigger houses in the first place is mostly a function of marketing. Many households could downsize at any time and still live comfortably.
Dave at Accidental FIRE analyzed housing trends. He found that in 1951 the average American household contained 3.34 people and the average new home construction was 874 square feet. By 2017 the average household size decreased to 2.54 people while the average new construction size increased to 2,660 square feet. Over the past 70 years, we have more than tripled the square footage per person in the average American household!
Downsizing housing expenses is one of the most impactful levers we can pull to drastically reduce spending. All things being equal, smaller houses tend to be less expensive, have lower property taxes, and cost less to heat and cool.
As our children get older and move out, it provides a great opportunity to downsize. That is another advantage for those who need to catch up on retirement savings compared to younger savers whose household size is stable or growing.
4. Catch-up contributions
We all realize that housing is a big expense. A rent or mortgage payment leaving your checking account every month is a stark reminder.
For many households, an even bigger expense is income taxes. This is easier not to notice for most of us because we don’t write this check every month. It is automatically deducted from our paycheck before we receive it.
Many people don’t even think about income taxes because they think they are inevitable and out of their control. In reality, we have a lot of control over how much income tax we pay.
Traditional retirement accounts
Most people who are saving aggressively for retirement can use simple timing strategies to decrease your tax burden. You can defer taxes that would be paid in higher-income tax brackets in your peak earning years. Instead, pay the taxes in lower tax brackets after retirement when income is generally lower. This is done by using tax deferred retirement accounts such as a 401(k) or traditional IRA.
The Roth option
Some people are confident that they will pay more income tax in retirement. For them, Roth versions of these retirement accounts make more sense. With Roth accounts, you pay income tax in the year of the contribution, but distributions are not taxed.
Tax-free growth
Both tax-deferred and Roth accounts allow your investments to grow tax free between when the money is deposited and withdrawn. This saves capital-gains taxes that would be paid annually on a taxable investment account.
Tax advantages for older savers
Regardless of whether tax-deferred or Roth accounts make more sense for you, it is wise to put as much money into these tax-advantaged retirement accounts as possible. This is true even if you want to retire early. But early retirees have to devise a strategy to create enough income to live in retirement without incurring early withdrawal penalties. Late savers who will retire at a standard retirement age don’t face this challenge.
The IRS allows “catch up” contributions to be made by those age 50 or older. In 2020 and 2021, individual contribution limits to 401(k), 403(b), and 457(b) accounts are $19,500. The catch up contribution for those 50 and older is an additional $6,500 for a total contribution limit of $26,000 per person.
Traditional and Roth IRA contributions limits are $6,000 per person. The catch up contribution for those 50 and older is an additional $1,000, for a total limit of $7,000 per person.
Individuals who can max out contributions to both work and personal retirement accounts can contribute $7,500 per year more than younger individuals. Households with married couples could potentially contribute up to $15,000 more than younger couples. This is a massive advantage to those who are starting to save for retirement late.
5. Decreased longevity risk
We almost always think of having more life left to live as a good thing. Retirement math is the exception. In retirement planning, the term longevity risk means your life may last longer than the money you have to support living expenses.
We certainly want to live long healthy lives, but we must acknowledge that doing so presents a challenge. We need to make our money last longer.
The late saver who cannot retire until the traditional ages of 60 to 70 should still plan on a retirement that can last 30 years or longer. The FIRE practitioner, like myself, who starts saving aggressively in their 20s and leaves their career in their early 40s essentially must plan for two consecutive 30-year retirements.
Early FIRE bloggers took retirement research that looked at the 30-year retirement assumption and extrapolated out that this could be applied to an indefinite retirement period. “Big ERN” at Early Retirement Now pushed back on this assumption with his Safe Withdrawal Rate Series. He found that early retirees should probably assume they can start retirement taking closer to 3% from their portfolio annually than the “4% rule” that is the starting point for traditional retirement planning.
One percent seems insignificant at first glance. A person who is taking 4% from their portfolio would need to save 25 times their annual spending. Someone taking only 3% would need to save 33 times their annual spending.
If you spend $50,000 a year, this is a difference of $400,000 less someone with a traditional retirement time frame needs to save compared to someone saving for FIRE. This is an advantage for the late saver. A shorter retirement time span requires a smaller portfolio to support it.
6. Social Security fills the gap
Once you determine how much you want to spend in retirement, you need to find a way to produce income to cover those needs. Someone pursuing FIRE needs to save enough money so their portfolio covers all of their spending needs. Alternatively, they can fill the gap between spending needs and income produced by their portfolio with income from other sources such as rental real estate, royalties or part-time work.
If you are getting a late start saving and won’t be able to retire until traditional retirement age, your portfolio doesn’t need to support all of your spending needs in retirement. You only need to save enough to fill any gap between your spending and the income Social Security provides.
You can still apply the principles of FIRE to develop a high savings rate later in your career. Working longer provides two advantage over someone pursuing early retirement. Social Security will be available sooner in your retirement. Your benefits will also be greater than if you retire early.
Social Security benefits decrease the amount a traditional retiree needs to save in order to retire securely. This provides a great advantage for the person who starts saving late over someone saving to retire early.
7. More certainty with health insurance
In writing this early retirement blog, rarely a week goes by that I don’t get the question, “How do you afford health insurance if you’re not working?” I share resources including a
- comprehensive overview of early retirement health insurance options,
- detailed review of health care sharing ministries, and
- deep dive into how Affordable Care Act subsidies work.
Invariably, the question comes back to, “No, what are YOU doing about health insurance?” I have to admit, I haven’t found a satisfactory solution for medical insurance that I’m confident will work for the next 20+ years until we reach Medicare eligibility. We’re winging it, planning one year at a time.
An early retiree must save tens to hundreds of thousands of dollars extra to be able to pay full unsubsidized insurance premiums until they reach Medicare eligibility. Alternatively, we could take on the political risk of relying on ACA subsidies.
Those with pre-existing conditions must also take on the risk of financial ruin if they can’t buy insurance at all if the law changes. All of these are reasonable possibilities for people bridging the gap between employer-provided health insurance and Medicare in America.
Medicare is not free. Medicare is not perfect. But it provides certainty and stability for someone who is saving for retirement at a traditional age. Neither is available to someone working toward FIRE.
A traditional retiree can get a reasonable estimate of how much you need to save to pay premiums. You have assurance you will have quality insurance that will prevent financial ruin in a worst-case scenario. These are big advantages for someone who starts saving late for a traditional retirement over someone who is saving to achieve financial independence and retire early.
You can do it
Summing up, achieving financial independence and obtaining a secure retirement isn’t easy. If it was, the FIRE community would not be a tiny subset of the population. The numbers for those approaching traditional retirement age I shared in the introduction wouldn’t look so grim.
Saving early and often is the best approach of achieving financial independence and a secure retirement. The FIRE movement is full of people who do this.
However, our stories are often presented in an extreme way that obscures solid principles that can be applied at any age. FIRE principles boil down to simple math and common sense.
Grow the gap between what you earn and what you spend to get your savings rate as high as possible. Do this by focusing on the big things that actually move the needle: increasing income and decreasing your biggest expenses including housing, transportation, food, taxes and child care.
Most people who have not established a consistent habit of saving during their early working years will have difficulty changing decades-old behaviors. It will take a change of mindset that results in taking new actions. That’s hard, but it is possible.
The person who starts saving later in life has some major advantages over someone like me who applied FIRE principles early in adulthood to radically change my financial future. If we can do it, more people can use the advantages described above to achieve a secure retirement … even if you’re getting a late start.