The Secret Math Behind Early Retirement

Rob Berger, US News & World Report, 24 Dec, 2013

Early retirement often seems impossible. It's difficult enough these days to retire at age 65, so the thought of retiring early is a pipe dream for most people. Yet somehow this dream has become a reality for some diligent savers. In extreme cases, a few people have retired at an age when most of us are just getting started.

One well-known example is the man behind MrMoneyMustache.com, who retired at age 30 after just nine years of working. While he is the exception to the rule, he thinks that should change. He views early retirement as something most people can attain.

To understand how it works, let's take a look at the math behind early retirement. These numbers have implications for all retirees, not just those looking for an early exit. So even if you think you're too late for early retirement, these strategies will still improve your retirement finances.

The math. How quickly you can retire depends on how much you can save. If you are able to save the often-recommended 15 percent of your take home pay, it will take about 45 years to retire. This conclusion assumes investments earn a real return (after inflation) of 5 percent, and that you live off of 4 percent of your nest egg once you do retire.

Now let's say you are a frugal and committed saver. If you are able to save 30 percent of your take home pay, your working years fall to about 30. At 40 percent the necessary work years before retirement falls further to about 20. And if you are able to save 50 percent of your take home pay, you'll begin enjoying your golden years in less than 20 years. As my mom would say, now we're cooking with gas.

The magic behind this math is the result of three related factors. First, as the saving rate increases, the amount saved increases more quickly. Second, with the passage of time, the nest egg benefits from compounding of investment returns. Finally, as the savings rate rises, the amount of money needed for living expenses goes down.

Let's get real. I know what you're thinking. The math may be accurate, but saving 30 percent or more of take home pay is impossible. Don't tell Mr. Money Mustache or the bloggers at "Early Retirement Extreme" and "Can I Retire Yet?". The fact is that early retirement is a reality for many people, including those who earned an average income during their working years.

While each early retirement story is unique, many share several common themes. Early retirees shun certain expenses many of us take for granted, such as expensive cable and cell phone packages. They tend to spend less on cars and transportation, often living close enough to work to either bike or walk. They also spend less on food, eating out less frequently than most. Finally, they are often more self-sufficient, choosing to handle home and car maintenance and repairs on their own, rather than paying others for these services.

Implications for baby boomers. For those already approaching retirement, stories of early retirement may at first blush seem unhelpful. After all, baby boomers are long past retiring at age 30. However, study after study reveals that many older Americans are not prepared financially to retire. The principles behind extreme early retirement may be the answer. If extreme saving can enable some people to retire at age 30, the same methods can help prepare those in their fifties toretire by age 65.

Rob Berger is an attorney and founder of the popular personal finance and investing blog,doughroller.net. He is also the editor of the Dough Roller Weekly Newsletter, a free newsletter covering all aspects of personal finance and investing, and a weekly podcast.

This Is How Your Pension Will Probably Change

Kevin Press, BrighterLife.ca

The debate about Canada’s pension system comes down to four key ideas. Here’s what you need to know about each of them.

A report on the National Summit on Pension Reform landed Friday. Organized by Canada’s Public Policy Forum, the event provided an opportunity for industry leaders to assemble and talk about what comes next for Canada’s pension system. (The Province of New Brunswick, Sun Life Financial and Morneau Shepell contributed to the event as Summit Partners.)

Two things stand out from the report:

First, despite what you may have read, our national pension system is not in crisis. It could be better, certainly. But Canadians can rest easy knowing that a basic level of retirement income is provided for by the very well-managed Canada Pension Plan (CPP) and Old Age Security (OAS) program. Our system is admired around the world.

Second, there is political momentum behind efforts to improve the pension system. This is driven largely by recognition that Canada’s baby boom generation, as it enters retirement, will place a heavy burden on the system. This (along with volatile capital markets and low interest rates) has contributed to fears of a looming disaster.

Leaders at the summit discussed four big ideas. The event’s report provides a useful summary of how pensions across Canada — those provided by government, employers and via personal savings — are likely to change.

1. Risk is going to be shared differently

The goal is sustainability of the system, according to the report. That means you and I are going to be required to take on greater risk (we will have to save and invest more), and our employers and governments will lessen their exposure. This probably doesn’t mean lower CPP and OAS payments. But it will mean that both private and public sector employees will get less from their workplace plans than previous generations have. Many of us will retire later.

2. Pension plan design changes will grow more common

Pensions have not been known for flexibility in the past. Expect plan design changes on a more frequent basis as boomers move through the retirement income system. And watch for greater transparency in that process. For this to be successful there will have to be real balance between the interests of management and labour. Brush up on your financial literacy skills so that you understand what these changes mean to you and your family.

3. There will be more ways to save at work

This aspect of Canada’s system was headed in the wrong direction. According to the report, about 39% of the country’s paid workforce has an employer-sponsored pension plan. And that national average overstates the reality among private sector workers by a wide margin. “Overall saving rates in Canada are low, and there is a definite need to facilitate growth in Canadians’ workplace savings if we are to sustain an acceptable standard of living for the growing ranks of retirees,” reads the report. The recently introduced Pooled Registered Pension Plan is designed to address this. Ottawa created a regulatory framework for the new plans, and has left it to the provinces to decide how (and if) they want to implement. Quebec was the first to step forward with what that province calls the Voluntary Retirement Savings Plan.

4. CPP coverage could expand

We could see higher CPP payments and/or a new way for Canadians to top up their payout with individual contributions. There’s considerable debate on expanding CPP. Those for it point to the strength of CPP and ask why we wouldn’t want to rely on it more heavily. Those against it say it’ll increase taxes for consumers and businesses (because the money has to come from somewhere). Could go either way.

I would call it a safe bet that Canadians will have to save more personally if they hope to see the kind of retirement income previous generations have earned thanks to government- and employer-sponsored plans. The question for policy makers will be how to cushion that blow in the form of creative plan design and saver-friendly tax incentives.

I’m optimistic.