Your FIRE number (aka your financial independence number) is the amount of money you need to have saved and invested to sustain your desired lifestyle during your retirement years without the need for traditional employment. Calculating your FIRE number involves a few key steps:
Determine Your Annual Expenses: Start by estimating your annual expenses in retirement. This includes all your essential living costs such as housing, food, healthcare, transportation, utilities, and any discretionary expenses like travel or entertainment. Be thorough in this process to ensure you're accounting for all possible expenses. Knowing your current budget can give you a good starting point on this.
Consider Inflation: Project your expenses into the future by factoring in inflation. Inflation causes prices to rise over time, so you'll need more money in the future to maintain the same purchasing power.
Factor in Taxes: Consider any potential taxes on your withdrawals from retirement accounts. This can vary based on the type of accounts you have (e.g., traditional IRAs, Roth IRAs), the tax laws in effect during your retirement, what state you live in, etc.
Account for Extraordinary Expenses: Think about any one-time or occasional expenses you might incur during retirement, such as major healthcare costs or home repairs. You might even think about long-term expenses, such as the cost of staying in an assisted living facility. While these may not occur every year, it's wise to include them in your planning.
Calculate Your Withdrawal Rate: The 4% rule is a common starting point. Divide your estimated annual expenses by 0.04 (or 4%) to get your rough FIRE number. For example, if your annual expenses are $50,000, your initial FIRE number would be $50,000 / 0.04 = $1,250,000. (Alternatively, multiple by 25: $50,000 * 25 = $1,250,000.)
Adjust for Personal Factors: The 4% rule is a guideline and might not fit everyone's situation. You may want to adjust your withdrawal rate based on your risk tolerance, expected market returns, and other personal factors. A lower withdrawal rate could provide more security if you're concerned about market volatility or longer life expectancy.
Factor in Other Income Sources: Consider any other sources of income you might have in retirement, such as Social Security benefits, rental income, or part-time work. Subtract these income sources from your annual expenses to reduce the amount you need to withdraw from your portfolio.
Regularly Review and Adjust: As you approach retirement and throughout your retirement years, regularly review your financial situation and adjust your FIRE number based on changes in expenses, market conditions, and your personal circumstances.
Remember that calculating your FIRE number is not an exact science. It involves making assumptions about future expenses, returns on investments, and market conditions. It's a good idea to consult with a financial advisor/coach to help you create a comprehensive plan tailored to your specific situation, goals, and risk tolerance.