It’s difficult in 2023 to avoid trendy topics, regardless of their validity or sanity (I do my best but a part of me is always plugged in). A topic in recent years that’s garnered some attention on social media is the FIRE movement, or “financial independence, retire early” movement. The acronym is self-explanatory, but maybe what’s not so self-evident is what it costs to pursue.
When we think about money and our expenses, our brains jump to what our actual expenses are: rent, groceries, daily living, etc. Natural, right? But there are also expenses in our life that are intangible, but calculable: the cost of not doing something.
In economics and even everyday life, this is known as “opportunity cost.” It’s the value of what you give up when you choose to do something else.
For example, if it takes me 1 hour to drive to work or 2 hours to take public transit and I choose the public transit, I save money on gas, but I double my travel time. Therefore, my opportunity cost is 1 hour plus the things I could’ve done during that hour instead of being on the bus.
So, how does all of this relate to the FIRE movement?
- What is the FIRE Movement?
- FIRE Movement Implications: An Example
What is the FIRE Movement?
Proponents of the FIRE movement advocate for living below our means today and paying down debts to achieve “financial independence”, which theoretically allows us to retire “10-30 years earlier than normal”. The “retire early” component has probably the widest variations in definition, but most proponents of the movement do not believe it means laying on a beach sipping a cocktail every day at age 45.
Rather, they argue that an early retirement allows people to pursue their passions they had to put off during their working years or to spend more time raising their children and being “financially independent” allows them to achieve this lifestyle.
The “FI” Ain’t So Easy
The FIRE movement sounds great on the surface, right? It’s no wonder it’s become so popular amongst the Millennial and Gen Z generations in blogs, social media posts, and podcasts. Paying down debt is almost always a sound financial choice and living below our means is a definitive key to long-term financial prosperity.
To me, “financial independence” means that I have enough money attached to my name that I no longer need additional income to support myself. This means that I have enough cash on hand for the “(bleep), now what?” moments that will inevitably happen, enough cash for daily living, and the ability to tap my investment accounts if I need to. From my experience, the people who can actually do this are extremely few and far between.
The “RE” Ain’t So Easy, Either
Remember when we got to college, and we were given the triangle of choices? Sleep, grades, and social life? We could have any two we wanted, but not all three. Some of us tried valiantly to obtain all three but, as it turns out, the human body actually needs sleep in order to function coherently. Who knew?
In my experience talking to clients who are thinking about retirement, a similar triangle of choices is present, but it looks a little different (shocker: partying til 3am isn’t on the triangle). Their triangle tends to have “where, when, and how much” on it and most commonly, retirees choose where they want to retire and how much money they need to sustain them, and those two choices determine the age they can call it quits.
The FIRE movement is backwards: it targets the “when” but downplays the “how much” portion and doesn’t even consider the “where.”
Retiring many years before a “traditional” retirement age has pretty serious implications on many aspects of financial life, such as savings in qualified accounts (refer to a prior post if you don’t know what these are), health insurance, and Social Security earnings history, which we are about to explore. I’m going to assume I’ve achieved “financial independence” in the following example and will focus on the “retire early” implications, as I feel they are more dire.
FIRE Movement Implications: An Example
Let’s say I turned 50 today and retired from my career as a CFP® professional and I pursue an amateur golf career while giving golf lessons part-time for a little income. We’re really entering fantasy land here folks, but it’ll serve its purpose as an example.
We will use age 67 as my retirement age to compare, which is defined by the Social Security Administration (or SSA) as my “Full Retirement Age” (or FRA; this is true for everyone born 1960 or after). A spouse and kids will complicate things so for purposes of this example, those situations are not considered.
All the assumptions used are based on Social Security numbers and are in a table below, and all calculations were done in an Excel file which can be made available upon request.
|“Normal” retirement age||67|
|1994 salary (using SSA avg wage index)||$23,754|
|2022 salary (using SSA avg wage index)||$59,003|
|COLA for PIA (avg % 1975-2022)||4%|
|Annual salary increase||3.3%|
|File for Social Security||Age 67, FRA|
|Investment growth rate||6%|
Who Cares If I Retire At 50?
Well, as it turns out, the U.S. government and the SSA care when I retire. There are magical ages in the tax code that determine eligibility for things like tapping our retirement accounts, Medicare, and Social Security and if we don’t meet these requirements, we get a very costly slap on the wrist.
For example, we are not allowed to tap our qualified accounts (401ks and IRAs) before age 59.5 without paying income taxes and a 10% penalty (there are always exceptions, but this is a broad point). This is the first slap.
According to the Bureau of Labor Statistics, only 44% of Americans actually have work retirement plans, and for the vast majority of these people, that will be their largest accumulating asset during their working years. Not having the ability to access our largest asset forces us to: have access to large amounts of cash on hand for emergencies and daily living (which inflation erodes over time), keep our debt balances to only necessary and manageable entities (autos and mortgage), and not withdraw money from any taxable investments we may have, as this severely hinders their ability to compound growth.
But don’t take my word for it: let’s see what the numbers say.
What Happens to My Retirement Accounts?
Retiring at age 50 as opposed to age 67 means I miss out on 17 years of not only higher wages, but also retirement plan contributions. This is related to the first slap, but it might not be on my wrist: it might be in my face.
For example, at age 50, if I contribute 10% of my salary per year into a Roth 401k then I miss out on over $141,000 of completely tax-free money in retirement, not including growth on those dollars.
The story gets worse if my employer offers a match.
A common thing for employers to do is match half of our contribution up to 6% of our salary. Think of it as them basically saying, “You’re smart and a good employee, and we want to keep you, so here’s a little Scooby Snack,” and they kick in a little money in an effort to retain us. This money has never been taxed so it goes into a pre-tax Regular 401k and we have to pay taxes when we eventually withdraw it after age 59.5.
The employer 401k match is essentially “free money” that I leave on the table. In total, retiring 17 years early means I miss out on $184,000 of tax-advantaged dollars, and when the investment growth is factored in…
What Happens to My Health Insurance?
Now, when we’re employed, we don’t really care about health insurance costs because our employers cover them (thanks team!). Once we turn 65, the government provides our health insurance through Medicare. But if there’s a gap when we are not employed and are not yet age 65 (like in our example), then we are on the hook for private insurance. This is the second slap.
According to ValuePenguin, the average cost of private health insurance for a 50-year-old individual in 2022 was $734/month, or $8,808/year. Health insurance premiums have also increased 3.7% per year over the last 15 years, on average. In our example, if I retire at 50 and am on the hook for private insurance until Medicare at 65, it will cost me over $187,080. Ouch!
However, if I stayed employed and instead took that $734 per month and invested it at the same 6% growth as my Roth 401k, I would have roughly $213,461 at age 65. I have healthcare in both instances, but my opportunity cost of retiring at 50 is the delta between the two scenarios…a whopping $400,541.
What Happens to My Social Security Benefits?
I’m kind of tired of getting slapped, but here comes a third one.
We pay into Social Security out of every one of our paychecks so that when we reach a certain age, we receive a paycheck back for the rest of our lives (yes, it will still be there for us when we retire). The SSA uses our 35 highest earning years to calculate our monthly benefit for life. If we don’t work at least 35 years, then they use $0 to average in for the years we did not work.
Let’s say for purposes of our hypothetical, when I retire at 50 and give golf lessons on the side, I earn 30% of what I was making as a CFP® professional. I’ll project this out until age 67 to determine my monthly benefit, and then compare it to what it would have been had I stayed in my career until age 67. Then I project that out until age 92 to determine a lifetime Social Security benefit in each scenario.
I’m using age 92 because a general prophylactic in the financial planning world is to plan to live much longer than you might expect to, even though the SSA has a male life expectancy at birth of 76 years old. It’s better to have money when you die than to not have it while you’re alive.
The popular financial modeling software MoneyGuidePro uses the Society of Actuaries mortality tables to determine planning ages, and they recommend to plan to age 92 for a male, non-smoker, in good health with about average family longevity. So, what happens to my lifetime benefits if I miss out on 17 years of higher earnings?
Yeah, Yeah, Cut To The Chase…
If all that slapping didn’t wake up my hypothetical 50-year-old self, then I’ll break it down further so it will.
This example shows how easy it is to miss out on over three quarters of a million dollars by retiring from a full-time career 17 years early. It’s also self-evident to see how this number would be exacerbated if a spouse and kids are in the picture.
Paying this opportunity cost affects not only “future me” but also my family members or other heirs who may need an inheritance. I think it’s important to most of us that we financially support not only ourselves but also people we love and care about.
I didn’t create this example to say that no one can retire at 50, or 55, or any age that’s considered “early.” If the earnings history is large enough and the debt management is supreme, then it may be possible for a minority of people to enjoy an early retirement.
The example simply uses average United States statistics for investment growth, health insurance, and Social Security to show what’s given up by retiring from a full-time career at an early age. As it turns out, that number being left on the table is pretty large and can make or break a lot of financial plans.
If you’re considering pursuing FIRE, weigh the pros and cons of both financial and non-financial aspects of the decision. Use this example if it helps to understand the financial impacts of an early retirement and determine if the opportunity cost is worth paying.