Salary vs. Retirement Age

I used to have the assumption that the higher a person’s salary was, the earlier they could retire. I always imagined rich, not-so-old people frolicking around where ever it is that rich, not-so-old people frolic. I thought that the key to retirement, and early retirement, was to just make as much money as possible. I think that this is a common misunderstanding, and I think it can be a dangerous way to approach your financial future.

As I progressed through life and met “rich” people, I realized I was wrong. People with high salaries often have proportionally high spending (usually because they’ve become a victim of </span>lifestyle inflation). Great, I thought, these people making piles of money don’t appear at all ready to retire. 

So if not salary, then what?

I (and plenty of others) came to the realization that it was savings. Specifically, your saving rate. It’s your savings rate, the amount you save relative to your take home pay[^1], expressed as a percentage, will effect your time to retirement to a greater degree than your annual salary.

This is primarily a change from thinking about wealth (and retirement) in absolute terms and instead thinking about it relative to your own lifestyle. What I mean is, whether you make $30,000 a year or $100,000 a year, if you save 50% of your income for one year, then you have essentially saved enough money for one year of retirement. It really doesn’t matter what your salary is. I think this is a powerful idea.

Some math

An example, imagine two friends, John and Tim. John makes $100,000/yr but he doesn’t save any of it. Obviously he’ll never retire since he’s saving no money. He has a 0% savings rate. Tim only makes $50,000/yr but he saves all of it. He could retire today if he wanted. He has a savings rate of 100%.

This is fairly obvious, but it sets the scene nicely. We’ll all agree that if you spend everything you make, you’ll never retire and if you save everything you make, then your living costs must be $0/yr and you could retire today.

The interesting, “math-y” stuff happens in between these two extremes.

As one begins to establish and invest savings, those savings will begin to produce investment return. As the saving continues, the amount of annual investment returns also grows. Eventually, the amount of annual investment return will be larger than annual spending (plus expected annual inflation). When this happens it’s time to retire. See how we’re still thinking about wealth in relative terms here?

OK, now let’s relate this all back to savings rate. Take a look at this chart, it shows your projected time until retirement based on your savings rate. The various lines show how average market return effects time until retirement. Remember, we’re now defining retirement as the point at which the expected annual investment return on your investments will exceed your living cost.[^3]

Time to retirement vs. savings rate.

So, let’s assume that you save 30% of your net salary and live off 70%. According to this chart, if the market returns 5% on average each year, you’ll be ready to retire in 28 years. Doesn’t matter what your salary is, as long as you are saving 30%, you can retire in 28 years. Pretty cool huh?

The equation graphed here is a powerful one. It really shows how much your savings rate effects your retirement date and how truly expensive luxury items are, in terms of years of your life.

For example, let’s say you bring home $36,000 a year and save 10% of that for retirement. Getting rid of your smartphone cell plan, that costs your family $2,400 a year, would be a 6% increase in your savings rate. An increase in savings of this size would allow you to retire 9.9 years earlier.[^2]

Once you start to look at stuff as costing you in terms of time you will need to work before retirement instead of in terms of just money, you realize how expensive “stuff” truly is. It is really shocking.

Of course the other way to look at this graph is to approach it from the number of years you want to work and see what you’ll need to save to get there. For example, if I want to retire in 12 years, I need to be saving 61% of my take home pay. That’s a lot, but it’s far from impossible.

Back to salary

And here’s were we come full circle. Hopefully you’ll see now that cutting your spending, not raising your income, will have the larger effect on your retirement date. This is because saving more has two effects, it’s increases what you are saving now and it reduces the cost of your lifestyle now as well as in the future. This effectively speeds up the growth of your nest egg as well as lowering the amount at which the nest egg needs to reach in order to allow you to retire.


[^1] Take home pay is defined as your gross income minus any/all taxes you pay. It also includes all retirement contributions you make, matches to retirement accounts from an employer, etc. [^2}] Assuming a 5% average annualized market return. [^3] My graph assumes a safe withdrawal rate of 4%. [^4] The main ideas in this post are far from being original to me. It is my understanding that they were originally published in Jacob Lund Fisker’s Early Retirement Extreme and is discussed widely across the internet.

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