Why Your FIRE Number Is All Wrong

Is your FIRE number wrong?

At first glance, it seems easy enough.

Figure out your spending needs. Divide by the safe withdrawal rate (SWR).

Done – your FIRE number is staring you in the face.

But is it?

Inspired by a couple of reader comments on this post, let’s have a look at seven classic mistakes many people make when figuring out their FIRE number.

Mistake #1: Miscalculating Spending Needs

A lot of folks get hung up on the safe withdrawal rate (we will get to it later).

But what about your actual spending needs in “retirement”?

If there’s one sure thing in life, it’s that your spending patterns in retirement will not be the same as today.

That being said, your current expenditures can be a very helpful starting point to help answer the question.

Have a look at where your money is going today – and then ask yourself:

How will my lifestyle change in retirement?

For example:

  • Will you still have mortgage payments to make, or will your house be fully paid off by then?
  • Alternatively, are you / will you be renting your primary residence?
  • Will you continue living where you currently do, or will you move elsewhere?
  • Is that new location cheaper or more expensive versus where you live today?
  • If you have kids, will they still be living with you?
  • If not, will you be providing them with any financial support?
  • What will your lifestyle look like once you hit financial independence?
  • Will you ditch an expensive commute? Is there more travel on the cards?
  • Are you planning to take up any (expensive) hobbies?
  • Will you need to pay for your own health insurance?

We are just scratching the surface here and there are lots of questions to answer.

But it is exactly this kind of detailed thinking that will allow you to come up with an accurate starting point for your FIRE number.

Mistake #2: Forgetting About Inflation

Let’s say you’ve figured out that you need $50k to support your desired lifestyle once you retire.

The challenge, of course, is that it’s $50k in today’s money. And thanks to inflation, that same lifestyle will end up costing more with every year that passes.

I’ve previously covered inflation in detail.

That being said, here’s a handy illustration of what a “$50k lifestyle” costs, adjusted for various rates of inflation:

FIRE number illustration

In 20 years, depending on the inflation rate, that same $50k lifestyle will cost anywhere from $74k to $110k per year.

For those more mathematically inclined, the calculation is:

Estimated spending needs today * (1 + inflation rate) ^ number of years to FI = Spending needs in the future

For example, if you need $50k in today’s money to retire, plan to retire in ten years, and expect inflation of 2%, you will need:

$50,000 * (1 + 0.02) ^ 10 = $60,950.

If that’s too complicated, just use excel – or refer to the graph above.

Mistake #3: Not Including Additional Sources Of Income

Being the skeptic that I am, I don’t include any governmental pension income in my estimates.

I’m decades away from “official” retirement, the retirement age keeps moving further out, and with the government finances the way they are, I’m just not confident I’ll ever get a return on those taxes I am paying.

That being said, if you are closer to retirement (or have a higher degree of confidence in your government), you should account for your pension income as part of the calculation.

The way to do it is to subtract it from your future spending needs.

That is, if you think you’ll need $61k/year in ten years – but your pension will be $10k/year, then you only need your investments to provide $51k of income.

That being said, you don’t want to make mistake #4 below:

Mistake #4: Ignoring Taxes

Sad but true. Once you achieve financial independence, taxes will still be a part of your life.

Everyone has a very unique tax situation, depending on a multitude of factors.

In addition, tax rules change all the time (and are bound to change yet again in light of the Covid pandemic).

Hence, it’s tough to provide generic advice on how to approach your taxes in retirement.

That being said, here are some general principles to follow:

First of all, make the effort to understand your taxes today.

It’s a boring, but also a highly effective way to get rich. Trust me, it’s worth the effort.

Secondly, estimate your sources of income in retirement.

Is it drawing down on tax-advantaged accounts (i.e. ISAs)? If so, that money is tax-free.

Is it income from dividends or capital gains? Then it will be taxed at the respective tax rates, unless you hold the investments in your tax-advantaged accounts (which is why I bang on about ISAs and Lifetime ISAs all the time here).

Is it your UK workplace pension? Then you get 25% in a tax-free lump sum, and everything else is taxed at your marginal tax rate in the year of withdrawal.

Is it the state pension income? Once again, this gets taxed at your marginal tax rate.

Finally, you need to take a view on how the tax rates will evolve going forward.

Will capital gains taxes go up? Will income tax rates change?

You don’t need a complicated model and hundreds of scenarios.

Equally, you don’t want your ignorance of taxes to torpedo your dream of financial independence.

Mistake #5: Including House Equity In Your Net Worth

What I have seen many people do is take their net worth number, multiply it by 4% (or any other SWR), and assume this is their projected income in retirement.

Which is totally fine, of course, assuming your net worth number excludes the equity in your home.

Think about it this way: if you have a $1m net worth BUT $300k of that is your paid-off home, you only have $700k of accessible investments.

That is, unless you plan to move out and sell your home.

Now, downsizing and moving away may well be the plan in retirement. But if you do that, you also need to account for the cost of housing wherever it is that you move to.

And if you are planning to stay put, you can only count on your investment pot as a source of income (unless you plan to tap the equity in your home with a reverse mortgage).

Mistake #6: Forgetting Some Of Your Investments Are Not Accessible (Yet)

This is a simple one.

You can be a pension millionaire, or have a ton of money in your 401(k), but that money may be out of your reach for years, if not decades.

In that case, no early retirement for you – unless you’ve got other sources of capital you can tap.

Which doesn’t necessarily leave you in a bad place. Just make sure you plan accordingly.

Mistake #7: Assuming A Far Too Low SWR Rate

Historically, the working assumption for the safe withdrawal rate has been to use 4%.

More recently, there’s been a chorus of voices arguing for a much lower rate, on account of lower growth, zero yields, and a variety of other factors.

It’s good to be conservative. That being said, don’t forget that even a 4% withdrawal rate implies your money will last for 25 years – assuming zero returns on your investment portfolio.

Alternatively, taking 2% out of your investment pot every year means your money will last 50 years.

In other words, make an assumption you are comfortable with – but don’t end up in a place where even having millions isn’t enough.

The above list is by no means comprehensive.

There are many other considerations related to nailing down your FIRE number with greater precision (and you are welcome to add your own in the comments).

That being said, avoiding the seven mistakes above will take you 95% of the way to getting as accurate a FIRE number as possible.

And for most of us, that might well be enough.

Thank you for reading!

PS: You may also want to check out the posts below:

How To Lose Your Job In 10 Years

Three Changes In Attitude On The Road To Financial Independence

Higher Taxes Are Coming – Here’s What To Do About It

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Banker On FIRE is a London-based M&A (mergers and acquisitions) investment banker.  I am passionate about capital markets, behavioural economics, financial independence and living the best life possible.

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22 Comments

    • “Asset Rich” … mortgage free house with the Equity as you describe is “lost money” and leaves you ‘cash poor’ in a long retirement……

    • Thanks BF. I think including pension is fine – as long as you’re cognizant you’ve got to “bridge the gap” somehow.

      The hosue equity is a no go unless there’s an alternative plan in place (and reflected in one’s annual spending)

  1. I wonder if BF meant including state pension rather than private?

    Do enjoy your articles and site, many thanks.

    • Thank you!

      I think including the state pension is fine – as long as you’ve got reasonable conviction that you’ll receive it and have a decent handle on how much it will be.

      For me, it’s quite risky given that I’m about 30 years away from retiring (and also because I moved around a few countries, which reduces my qualifying earnings for a state pension)

      Others who are closer to retirement may be in a different place.

  2. You can view the house as an investment, that provides a source of income that almost matches open market rent ( almost, because you will need to insure and maintain it yourself) but it will of course raise your target income needs.

  3. Great points. I also find that people just use their current expenses to calculate their FI number and completely ignore future changes to their finances.

    Our finances change significantly as we make our way through life. Kids, mortgages, medical expenses, inflation. I also wrote about this recently: https://www.moneyfi.app/blog/how-long-will-it-take-reach-financial-independence/

    Someone who is in their late 20’s using their current finances and lifestyle as a benchmark as their FIRE number for the rest of their life is likely to be way off. Sure they might be lucky and have strong investment returns on their portfolio but that’s quite a long term gamble they’re taking.

  4. Lots to think about here and my FIRE number is probably what makes the whole thing such a big leap of faith since there is no way to be 100% certain about anything.

    To try to err on the side of caution, my estimated spending in retirement is more than what I currently spend but I still don’t know if this buffer will be enough. I guess I’ll have fun (or not) finding out!

    Interesting links from Al Cam and I can see their findings reflect my own parents spending in retirement – their spending overall has dropped as they’ve gotten older, and the ratio being spent on health now higher than that spent on travelling.

    • This is why I think having a “fall-back” part-time gig post RE is so valuable.

      Not only it allows you to slowly dial back (personally I cannot imagine doing nothing), but it also gives you an incremental safety net.

  5. I am a few years into my slightly ER journey. Currently I am about half way through bridging the Gap until I plan to take my DB pension. My state pension should follow some years later. I did quite a lot of planning / reading prior to pulling the plug and settled on a Floor and Upside approach – as opposed to the, so called, SWR approach. Having said that and to pick up on what FS/BoF mentioned/asked above: to date, it is clear that my planning a) over-estimated spending need; b) over-estimated inflation; c) under-estimated Other income(s); and d) although I always found it more convenient to work net of taxes I did over-estimate said taxes. The upshot of which is I am somewhat ahead of where my plan forecast I would be by now.

    This is undoubtedly a good thing – but some folks may frown at the foregone opportunity cost. However, who knows what is just around the corner and I do value liquidity and reversibility too.

    FWIW, personally I have no regrets about taking a conservative approach but happily acknowledge that this may not be the way for all folks.

    • Helpful perspective – thank you. Am sure others will find informative and reassuring.

      The challenge with inflation in particular is that it impacts many other pieces such as real returns and spending.

      I am in the same boat as you. Would much rather work longer but have an incremental margin of safety than pull the plug early and worry about whether I’ve got enough to sustain my lifestyle.

      Suspect most FIRE folks are in the same boat as we tend to solve for safety.

  6. It feels like these factors make it easy to err on the side that you feel most inclined to: if you’re in a hurry to retire, you can massage the number to arrive early, and if you are nervous about not having enough, you put off retiring. I do like the idea of factoring in some kind of income for at least the first few years after hitting “your number,” a graduated form of retiring where you don’t go from 40 hours a week of work to 0, so that you can get more information about what your post-retirement life will cost.

    • I think going from hero to zero (as far as working hours are concerned) is just a bit too drastic, especially if you are still in your 40s or early 50s.

      Much better to gradually slow down on the way to finding a “sweet spot” as opposed to stop dead in your tracks.

      For me, the ideal next step is a 40-hour a week job with 5 weeks of holidays I can actually take (and not be disturbed). It would be a massive improvement on my current lifestyle and so I can definitely see myself doing that for a few years before thinking of next steps.

      • My current life involves about 20-25 hours a week of paid work and a lot of hours a week caring for an infant… not exactly a relaxing lifestyle, haha, but a very rewarding one. 🙂 It does make me see how life without a 40 hour commitment every week can be very positive. Thanks for responding!

  7. I’m guilty of making a few of the mistakes you’ve listed above!
    I do include my home equity in my figures as I have a definite plan to downsize and use the equity in my home. Even if I did not, I have modelled my figures so that I would not need to tap into that capital in any case.
    I include the state pension as I can’t see it being taken away before I can access it in 15 years, but hopefully I can build a buffer in the next few years so that I’m covered in that event.
    Not including the above in my net worth would probably entail me working far too long for no reason.

    • Would hardly characterize them as mistakes based on what you are saying above.

      On the pension point specifically, think you are safe being 15 years out. I’m about 30 years out, so far less confidence on this end.

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