As expats living in Portugal who are in their mid-40’s with three kids, I would be lying if I didn’t tell you that an early retirement was on our minds when we made the decision to leave America. And any discussion of early retirement has to include an answer to the question, “how much is enough money”?
UPDATE: After 15 months in Portugal, we decided to move back to the United States in October 2023.
(For those of you that are wondering, you do NOT need a financial advisor to amass enough wealth to bypass a traditional retirement age, attain financial freedom, and retire early.)
Right now there is an extremely popular idea circulating with pretty much anyone over college age. And that’s the idea that you can reach financial independence and retire early as soon as you have amassed a nest egg big enough to allow you to do so.
This movement is called FIRE and it stands for Financial Independence Retire Early.
In today’s post I will review the different types of FIRE, what a FIRE number actually is, how to determine your FIRE number, and what my FIRE number is.
Table of Contents
The Different Categories of FIRE
As you contemplate an early retirement, you must give a lot of thought to the type of lifestyle you want to lead. Do you want to travel on a budget? Live lavishly? Are you worried about your health and potential medical expenses? Maybe you just want to get out of corporate America as quickly as possible. To accomplish any of these goals you must understand how to calculate your FIRE number.
Depending your specific situation, the amount of money you will need to attain FIRE will vary greatly.
Keep that in mind when you read the definition of what your FIRE number actually is:
Your FIRE number is the amount of retirement savings you must have invested so that you can comfortably live off of the investment returns from your portfolio such that work becomes optional.
As you can imagine, there are a wide variety of people and net worths that can lead to a FIRE-type retirement. Here are three primary categories for you to think about:
Lean FIRE
Lean FIRE is an individual or family who is prepared to retire while living off of less than $40,000 per year and has a net worth of up to $1M. Mr. Money Mustache (aka Peter Adeney) is the poster-child for the Lean FIRE movement. Adeney retired in 2005 at the age of 30 after amassing approximately $600,000 in investments as well as paying off his home valued at $200,000.
If you are considering a “Lean FIRE” lifestyle, you must be willing to live minimally in a lower cost-of-living (LCOL) area. This could be a good choice for expats who can use “geo-arbitrage” to live on a lower budget overseas than is possible in the United States. But be careful and do your research. Although many places seem less expensive, looks can be deceiving.
Regular FIRE
If you can live comfortably on a safe withdrawal rate of 4% (i.e. between $40-$100k per year), than regular FIRE might be for you. To achieve this level of fire, you will need to amass between $1M and $2.5M in assets. Aman and Christina Browning were able to retire at ages 39 and 41 with a portfolio of approximately $2.5 million in assets. Neither Aman nor Christina ever earned more than $100,000 per year as they were striving for FIRE, and they were able to achieve this accomplishment in about 8 years.
Fat FIRE
Fat FIRE is someone who intends to retire on more than $100,000 per year with a net-worth of more than $2.5 million. These are typically people who have done well in real estate, were high-income earners or are entrepreneurs who built and sold their business for a large cash payment.
My FIRE Number
When I originally wrote this post in 2023, my FIRE number was $3,000,000 in net worth while living off of $100,000 to $120,000 per year. This will be a combination of retirement accounts and pre-tax investment accounts. I say “was”, because I will be going through some life changes later this year, namely separating from my spouse. This will cut in half my current assets and require some adjustments to my fire number.
This number is likely high, but I’m trying to be conservative. If I could live off of $60,000 per year and have a nest egg of $1.5M, that may be sufficient.
So before I go any further, I think it is important to discuss how to calculate your FIRE number.
How to Calculate your FIRE Number
Everything changes when you look at your numbers, including your current expenses and savings rate, and decide what your FIRE number should be.
Your FIRE number, as mentioned before, is the amount of money you must have saved in active investments such that you can live off the passive investment returns of your financial portfolio after you quit working.
Most FIRE evangelists will tell you to take your annual expenses and multiply them by 25 to attain your FIRE number. This is a rough and dirty FIRE calculator.
Annual Living Expenses x 25 = FIRE Number
This formula became widely used after a publication out of Trinity University in 1998, (commonly called the “Trinity Study”) which popularized the “4% Rule”. The 4% rules states that you should be able to withdraw 4% of a fully invested financial portfolio each year and never run out of money.
A subsequent study was conducted by Philip Cooley and published in April 2011. That study found that for portfolio’s which were 100% invested in stocks, there was a 98% chance you would not run out of money after 30 years if you withdrew 4% per year, but a 2% chance that you would. However, there was a 100% chance that you would not run out of money if you only pulled 3% of the portfolio each year.
However, if you have an asset allocation of 75% stocks and 25% bonds, there was a 100% chance that you would not run out of money regardless if you pulled out 3% or 4%.
I was 46 years old when I originally wrote this, and intended to hit my FIRE number by age 50 (in 4 years). If I live to the age of 90, a 3-4% withdrawal rate per year should allow me and my wife to live comfortably for the rest of our lives with a net worth of $3M.
To access my personal FIRE Calculator, click here.
How Taxes Work in Calculating FIRE
Before you get all excited about your FIRE number, you must remember that taxes will likely play a role in your calculation.
Your withdrawals from your portfolio will largely come from your pre-retirement assets before you turn age 59 ½, and then from a combination of your retirement and non-retirement assets after you reach that age.
Note: There are entire strategies that have been developed about how and when to draw down your retirement assets between ages 60 and 70 so that you are able to minimize the effect of your required minimum distributions on your taxes. But we will save that for another post.
Assuming all of your income comes from dividends and capital gains, in 2024 you will pay 0% Federal tax on your first $94,050 in dividends and your first $94,050 in long-term capital gains as a married couple filing jointly. That’s $188,100 of income that you can earn completely tax free. If you tack on the standard deduction of $29,200 for joint filers, then that means you can earn up to $217,300 in dividend and capital gain income completely tax free.
However, if you earn more than that amount, but only take out $100,000 in dividend/capital gain income, you will still be required to pay tax on all of the additional capital gains and dividend income you earn.
In addition, as an expat living abroad, the first $253,000 ($126,500 per person) of income is excluded from Federal income tax in 2024 under the Foreign Earned Income Exclusion. While we lived in Portugal, we also qualified for a favorable tax program for new residents that excludes many types of income from tax for the first 10 years of your residency (but this could be going away in 2024).
With regards to state income taxes, it would be smart to move to a state that has a lower cost of living and/or has no state income tax. By living abroad, we did not have to pay state income tax in North Carolina (our current home state) while we were out of the United States.
So if I were to retire today, assuming a dividend rate of 3% on my $3M hypothetical portfolio, I would earn $90,000 of dividends tax free, and could remove the remaining $30,000 (to get to a 4% safe withdrawal rate) from my portfolio of stocks and/or mutual funds without ever coming close to the capital gains and dividends exclusion. Basically, I would be living tax free!
This is why I say that you should not worry too much about taxes once you decide to retire using the 4% rule.
What Types of Investment Retirement Plans Should You Use?
Many people are nervous about putting all of their savings into retirement plans, such as Roth IRAs and 401(k) Accounts because, logically, they won’t be able to pull from those accounts penalty free until they reach age 59 1/2. But you shouldn’t be. These are great vehicles to grow your wealth tax free alongside your pre-tax investment assets.
Generally speaking, you should use a combination of retirement and pre-tax investment accounts to grow your wealth. This way, you can pull from your investment accounts (as mentioned above, both dividends and long term capital gains are currently not subject to Federal tax until you reach very high threshold – likely higher than you will withdraw from your portfolio anyway).
But I will dig deeper into the best strategy for saving your money in future posts.
I do not recommend savings accounts or CD’s as a long term investment vehicle. These should only be used for short term (i.e. 6-12 months) spending.
What Should Your Savings Rate Be?
As mentioned before, those who are most successful at achieving FIRE have either a very high annual income (such that they can save more), or they live very frugally, allowing them to save more money event though their income is not as high.
What your savings rate should be will depend in large part on your time horizon (when you intend to achieve FIRE) as well as the growth rate on your money. The fastest way to achieve FIRE is to save nearly 100% of your yearly income, achieve a large growth rate, and work like crazy until you hit your FIRE goals. Unfortunately, this strategy is not practical to most people, nor is it a good idea if you have a family that you have to support. It is a quick way to find yourself in divorce court.
The best way to achieve FIRE is to determine what your bare minimum monthly expenses are, annualize those expenses, and then save every dollar you earn over the amount you spend each month. This is what is called your savings rate. By saving in this fashion, you will have enough money for your annual spending and can acquire enough savings to achieve your FIRE goal in 8-10 years.
For example, if you saved 50% of your income, you should be able to reach FI (assuming a 8% real rate of return) within 14 years. But if you saved 75% of your income, you should be able to hit FI at just 6 years.
The reason for this is that, no matter your income, if you reduce your expenses not only are you saving more on an annual basis, but you are also decreasing the amount that you will need to live off of from your portfolio. (If you plan to save a bunch and live off of more later, then you may need to run a different calculation).
Passive Income (i.e. Cash Flow) vs. Net Worth Investment Income
There is a large debate in the FIRE community about the difference between “cash flow” and net worth. For example, let’s say on the one hand, you have a portfolio of $1,000,000 which generates $40,000 per year in investment income. On the other, let’s say you have zero investments, but you have a YouTube channel, website or business that generates $40,000 in revenue per month without you doing much, if any work.
The debate here is whether you have achieved true FIRE solely by building an asset that generates enough cash flow for you to live off of with very little work on your part?
Most in the FIRE community would say that no, having an income producing asset such as a website or social media channel does not constitute true FIRE. And the reason for this is fairly obvious – this asset could go away AND there is still some amount of work that goes into maintaining that asset. If you rely on Adsense revenue from Youtube, if you stop making videos your income could go away (this happened to me as I stopped creating content for about 6 months while we moved back to the United States. My Adsense Revenue dropped by 60%). Or if you are relying solely on a website for your income, you can’t stop working on the site or updating it or else you risk losing your web traffic and as such, your income.
The bottom line is that these assets, while nice to have and which surely can contribute to your FIRE lifestyle once you attain your FIRE number, are not in and of themselves sufficient to allow you to retire early.
The reason I raise this issue is that I am at a place with my investments and passive income where I am close to achieving enough passive income to support our lifestyle. But to rely so heavily on passive income while I stop working towards building my net worth is a scary proposition in the long term.
This is why the best way (and the most popular way) to reach FIRE is to rely on investment assets alone.
What is Your Life Expectancy?
Another consideration you should be thinking about when calculating your FIRE number is how long you anticipate living. If you are retiring in your 20’s vs retiring in your 40’s or 50’s (as I plan to do), then your fire number may be drastically different. You must consider increases in cost of living and the type of lifestyle you plan to lead later in life.
As a 20-something with no spouse and no kids, your lifestyle will be drastically different than when you do have a partner and children. I know for me personally, I could live on very little money each month. But when you have 3 kids and a spouse to feed, clothe, put a roof over their head, send to school, etc., your budget starts to creep up. Not to mention that I want to travel and show my kids the world. If we are on a tight budget because of a restrictive FIRE number from retiring too early, that could have a negative impact on those plans.
Your Net Worth Will Continue to Grow… Hopefully
Historically, the stock market has grown at an annual return of almost 12% per year since 1975, when the first index fund was created by the late, great Jack Bogle. If you are only pulling out 4% of your portfolio per year, then you should have a real rate of return on your investments of 3-6% per year. This means that each year you are earning compound interest on your money and re-investing that growth into your stock portfolio.
Yes, there will be up years and down years, but by limiting the amount you are willing to take out of your portfolio, especially in the first few years of retirement, you should continue to enjoy growth in your portfolio and increase the likelihood that you will never run out of money.
What is Your Cost of Living?
The cost of living in the United States is growing at an astronomical clip right now. This is one of the many reasons we originally decided to move overseas to Portugal where the cost of living was (theoretically) much lower. Aside from putting our children in an American Private School for their first year (we anticipated moving them to a Portuguese Private or Public School during their second year, but instead moved them back to an American public school in North Carolina!), our expenses are minimal.
As an example, yesterday I woke up in the middle of the night with extreme pain in my abdomen. We didn’t know what to do or where to go. So we called the Portuguese equivalent of 9-1-1.
Within 10 minutes an ambulance was at our door and transported me to a public hospital. They gave me pain killers to alleviate my pain, ran bloodwork, performed an Ultrasound on my abdomen and back, gave me more medicine, and sent me home with some prescriptions. Turns out I had a kidney stone.
My total out of pocket expense was €13! And that was for the prescriptions! Everything related to the hospital visit, ambulance, testing, medication, etc. was 100% free.
In the United States I shudder to think what this bill would have been. We likely would have avoided the ambulance because there was an emergency room across the street from our house, but in another month or two I probably would have received multiple bills from everyone that worked on me in the hospital.
More on health insurance in a bit.
My point here is that if you want to retire sooner, and on a financial portfolio, you may have to take a close look at where you live and whether your cost of living is sustainable. The same dollar will go a lot farther in Portugal or some other lost cost of living states than it will in California (or even North Carolina where we moved from).
Tax Planning is Important
Now is a good time to start thinking about taxes. Do you live somewhere with a state income tax or no? That 5-10% per year can make a big difference in your budget. Are you taxed on passive income where you live vs. earned income? Will your real estate income be taxed? All of these little things make a huge difference.
Health Insurance
In addition to the favorable tax system, health insurance was a main driver for why we chose to live in Portugal. In the states, we were paying $800 per month for health insurance, and that was for a good plan through the State of North Carolina (my wife worked as an attorney at the Department of Justice).
If she stopped working, then our cost for insurance skyrocketed to $1,500 – $2,000 per month for a high deductible plan for our family of 5. That means that we would have been paying $18,000-$24,000 per year for a crappy insurance plan with a $10,000 deductible.
In Portugal, we paid €2,000 per year for our family plan. That bought us access to a network of private hospitals and care centers where our out of pocket expenses were minimal. In addition, in an extreme emergency, we also had access to the public health care system which was free. And if you were wondering about prescriptions, they are subsidized by the government, so there is no fear that you need to spend hundreds of euros per month on expensive medication.
If you want to retire early, health insurance will likely be one of your biggest expenses if you choose to stay in the United States. And you need it to protect yourselves from bankruptcy in the event of a catastrophic health event such as a car accident or cancer diagnosis.
So What is Your FIRE Goal?
So now you now how to calculate your FIRE number, so what is it? Take some time to sit down and try to calculate what you will need financially to reach your fire number within the next 5-10 years. How will you do it? How much will you save each year?
Post below in the comments to let me know how you intend to reach FIRE!
