Early retirement isn’t exclusively for the rich. Many people, particularly followers of the FIRE movement — short for financial independence / retire early — use a couple key calculations to determine how much money they need to sustain an extended stay in retirement, which can begin years or even decades earlier than the standard retirement age.

In this article, we break down how to calculate your FIRE number, along with other considerations, including how to estimate your annual expenses in retirement and the best ways to invest your money so it grows over time.

Here’s what you need to know.

How to calculate your FIRE number

The FIRE movement has gained popularity as a goal for people seeking to break free from the traditional retirement age. The standard retirement age is 67 for people born after 1960, but FIRE followers hope to exit the workforce well ahead of schedule by boosting their income and aggressively cutting expenses.

The first step in achieving FIRE is determining your FIRE number, or the amount of money you need to have saved to support your desired lifestyle without relying on traditional employment.

At the core of FIRE calculations is the rule of 25. It states that you should multiply your anticipated annual expenses in retirement by 25 to arrive at your target savings goal.

FIRE Number = Annual expenses in retirement x 25

For example, if you anticipate needing $40,000 per year to cover your living expenses in retirement, your FIRE number would be $1 million ($40,000 x 25).

The rule of 25 is built on the assumption that you can safely withdraw 4 percent of your savings annually in retirement without depleting your nest egg too quickly. This is known as the 4 percent rule.

The 4 percent rule was popularized in a landmark 1998 research report known as the “Trinity study,” which analyzed past market performance to determine a safe withdrawal rate in retirement.

The paper found that in 99 percent of cases, retirees could withdraw 4 percent per year, adjusted for inflation, from a portfolio of stocks and bonds without depleting their nest egg.

The rule of 25 and the 4 percent rule complement each other: While the 4 percent rule focuses on a safe rate to withdraw funds, the rule of 25 provides a quick estimate of how much you need to accumulate before exiting the workforce.

Planning your retirement budget

Before using the rule of 25 to calculate your FIRE number, it’s crucial to have a clear understanding of your anticipated retirement spending.

While some expenses may decrease in retirement, others may increase. And for early retirees, especially those retiring in their 40s or even 30s, there are numerous other costs to consider, such as paying for health insurance or funding a child’s future college expenses.

Here’s a broad overview of what to consider when mapping out your annual estimated expenses in retirement.

  • Housing: Will you still have a mortgage after retirement? Mortgage payments may decrease if you downsize, move to a lower cost-of-living area or make extra mortgage payments before reaching financial independence.
  • Health care: Health expenses tend to increase with age so learning how to manage health care costs in retirement is essential. Finding affordable health insurance as an early retiree is particularly challenging. You might enroll in an insurance plan on the federal Health Care Marketplace, get added to your spouse’s workplace plan or self-pay for expenses by withdrawing from a well-funded health savings account (HSA).
  • Transportation: Work-related commuting costs may decrease, but leisure travel expenses might increase.
  • Food: Dining out and grocery expenses will vary based on your lifestyle choices.
  • Leisure activities: Many early retirees dream of indulging in travel, entertainment and hobbies, but you’ll need to factor these costs into your estimated budget.

Your spending in retirement is the key variable in calculating your FIRE number. If you have Ferrari taste, living on a Ford budget probably isn’t realistic. Here’s how much you’d need to save to afford different spending lifestyles:

  • $30,000 a year: $750,000
  • $40,000 a year: $1 million
  • $50,000 a year: $1.25 million
  • $60,000 a year: $1.5 million
  • $70,000 a year: $1.75 million
  • $80,000 a year: $2 million
  • $90,000 a year: $2.25 million

Pick the right savings rate

After you’ve calculated your FIRE number, the next step is figuring out what age you want to reach financial independence. Then, you can determine how much you need to save and invest each year to reach that goal.

Here’s an example.

Marcos is 25 years old. He wants to retire by 45. His estimated spending in retirement is $50,000. Applying the rule of 25, his FIRE number is $1.25 million.

To amass $1.25 million in 20 years, Marcos will need to invest about $2,255 a month, assuming an 8% return, to reach his goal.

The road to financial independence may seem daunting, especially if your FIRE number is large. However, with strategic planning, high earnings and disciplined savings, it’s achievable.

Invest so your money grows

Investing is crucial to achieving FIRE. While savings accounts offer minimal interest rates, investments have the potential to generate significant returns over time. You’ll need that extra money if you plan to live off your nest egg for decades.

Investing allows your money to grow exponentially, since you earn returns not only on your initial investment but also on the returns and dividends those investments generate. In contrast, relying solely on savings won’t keep pace with inflation, and your purchasing power will erode over time.

Picking the right type of investment account is also important. While traditional 401(k)s and IRAs are the preferred way to save for a standard retirement, they impose early withdrawal penalties if you want to access your money prior to age 59 ½.

Here are some options to consider:

  • Roth IRA: A Roth IRA offers tax-free growth and contributions can be withdrawn penalty-free at any time. Earnings can be withdrawn penalty-free after age 59½.
  • Taxable brokerage account: There are no income restrictions or contribution limits for taxable brokerage accounts, making them ideal for high-income earners who have maxed out other tax-advantaged accounts. There’s also no early withdrawal penalties, though you’ll face taxes on capital gains. Still, this flexibility can be appealing for early retirees.
  • Traditional 401(k) and IRA: You could utilize a Roth conversion ladder to convert traditional IRA funds to a Roth account gradually, paying taxes in the process. After five years, you can withdraw contributions penalty-free.

As for what to invest in, the S&P 500 index has historically netted a 10 percent annual return over time, so low-cost index funds or exchange-traded funds that track the S&P 500 can be a good option.

At the end of the day, your personal risk tolerance will determine your investment strategy. Speaking to a fee-only financial advisor can help you flush out your plan and pick an appropriate mix of investments for your portfolio.

Bottom line

Calculating your FIRE number and achieving financial independence is a journey that requires ample planning, discipline and a commitment to long-term goals. Just keep in mind that preparing for life beyond work requires more nuanced planning than one simple calculation can provide.

By understanding the power of investing and taking practical steps to increase your income and reduce your expenses, you can turn a seemingly unrealistic number into an achievable reality. For FIRE followers, the pay-off is unparalleled: Working out of choice, not necessity.