How to Retire by 40? Financial planning tips & tricks

Posted by: TheGuarantors on January 13, 2022

The Coronavirus pandemic has pushed many Americans to retire young. For some, it is a result of unpredicted layoffs or job eliminations. For others, it's due to staggering levels of burnout and career anxiety. So, the idea of leaving the workforce behind to retire by 40 sounds ideal. So how does one retire by 40, anyway? Well, this blog aims to do just that and more. We’ll cover the financial and saving tips you need to retire early and answer the most commonly asked questions to help you prepare for this exciting journey.

So, is it possible to retire by 40?

The good news is, it is possible. Although early retirement is made more accessible today than in the 90s, it's still not "easy." If you want to retire by 40, you need to plan and prepare. The many ways to retire early can be tricky. It will require you to make sacrifices today to afford your future. And even then, that future likely won't be cloaked in luxury.

The path to retirement

7 tips on how to retire by 40

The FIRE 🔥 ("financial independence, retire early") has redefined early retirement. It's less about leaving work and more about having financial independence. This is to decide when, how, and for whom you work.

1. Choose between LeanFIRE or FatFIRE

The first step to retiring by 40 is choosing your FIRE style. There are two approaches to FIRE early retirement:

  • LeanFIRE: It focuses on keeping retirement expenses low. According to the LeanFIRE Reddit community, you can retire with lower expenses (under $40,000 per year). "LeanFIRE types would benefit more from setting up side hustle income streams before retirement," says LeanFIRE-ee Steve Adcock. He retired at 35 and started Think Save Retire and now writes about personal finance and lifestyle on Steve
  • FatFIRE: is for those who retire young and want a more cushy retirement lifestyle (annual expense budget of $150,000 and up). They are also willing to save up to provide for it. While the financial cushion of FatFIRE means you're less likely to need supplemental income in retirement, you may have to build up your savings pre-retirement.

2. Calculate how much you need to retire by 40

calculate and retire early

Two factors go into how much you need to retire young:

  1. Your estimated annual retirement expenses.
  2. The percentage of your portfolio those expenses make up.

According to the Trinity Study, retirees can withdraw up to 4 percent (adjusted for inflation) each year in retirement without reducing their portfolio over 30 years. If you're planning to retire by 40, however, you may be looking at a lot more than 30 years of retirement.

Some early retirees target a 3% withdrawal rate to compensate for a longer retirement. A wealth strategist at PNC Wealth Management, Erin Brand, suggests going even more conservative with a 2 percent annual withdrawal rate.

To estimate how much you need to retire, take your expected annual expenses and divide them by your target withdrawal rate. Put another way, the 4% rule requires you to save 25 times your yearly expenses before retirement. So for a $50,000 annual budget, you'd need to have $1.25 million saved; for $100,000 in spending, you'd need $2.5 million.

3. Save 50% of your salary

The average savings by age 40 is more than 50 percent of your salary each year. "It sounds hard, and initially it is," Adcock says, "but when you look at what you're spending on, so much of it is stuff you either don't need or don't use."

Save half of your salary to retire early

To ramp up your savings, "attack the biggest expenses first: housing, cars, and food," says Chris Mamula. He retired at age 41 after burning out in his career as a physical therapist. He now shares his FIRE retirement wisdom on Can I Retire Yet? "By optimizing those areas (of your budget), you can develop a high savings rate."

4. Calculate how much you should have in your 401(k) at 40?

The most you can invest in your 401(k) account depends on your plan, salary, and government guidelines. Your annual salary-deferral limit is set by the IRS. This limit is $19,500 in 2021 and $20,500 in 2022. Let's say you make $50,000 a year and start saving at age 25. If you put $19,500 of your income—into your 401(k). And if your employer matched 50% of the first 6% of your contributions, by 40, you'd have $509,000. This is assuming a 7% annual rate of return. This calculation doesn't account for any raises you might receive between 25 and 40; if your salary does rise, a $19,500 contribution will be less of a burden. That $509,000 is only about halfway to your $1 million goal (and bear in mind that you'll owe income tax on your withdrawals from a traditional 401(k) account).

✏️ You can find a wealth of info on the Retirement Plans FAQ page of the U.S. Department of Labor website.

5. Lead a simple life

Your cost of living during your working years must be a good fit for your desired retirement lifestyle. Minimalism and careful living concepts are popular with people interested in accumulating meaningful life experiences than stuff. If you can reach big life goals while burning through a smaller amount of your earnings while working. In that case, you will be prepared to maintain that same enjoyable lifestyle in retirement. These economic choices include living in small spaces and buying used clothing, furniture, and cars. Leading a simple life will help you save more and reach your goal of retiring by 40.

6. Make investments

Your cost of living during your working years must be a good fit for your desired retirement lifestyle. The key is to start investing as early as possible. The longer you give your investments to grow, the more likely they are to match the stock market's long-term average return.

Related: How to Invest with Robo Advisors

7. Create passive income

If you want to retire early, you should look for ways to receive passive income streams. This is money that works for you. One common source of passive income is the stock of companies that have a long history of paying dividends. After you have collected large shares in these companies, you can choose to receive the bonuses in cash rather than reinvest them into more companies' shares.

create passive income for early retirement

Passive income could also come from an investment in a business you don't run or from rental properties you pay someone else to manage. Or it could come from some other creation for which you receive royalty payments.

Related: A Beginner's guide to Investment

To sum up

Retiring early demands careful planning and making the right investments. Starting early is the key as it helps you make changes mid-way should the need arise. TheGuarantors will ensure smarter solutions for you to take control of your financial future.

Want to retire by 40? Here’s the financial advice you’ve been looking for! Read how it works, 401(k) plans, and how to achieve financial independence.