February 15, 2020
We all love the idea of complete Financial Independence (FI).
Abundant free time, and passive income covering all our expenses. The only issue is, building this level of wealth and financial strength can be a long road.
And even though 10-20 years of full-time work for a lifetime of freedom sounds like a great trade-off, there are many people who find this hard to stomach. I totally understand this feeling!
So if you find yourself feeling impatient about the journey ahead, there is another life-enhancing option to consider: semi-retirement.
I simply think of semi-retirement as being half-retired, or half-FI – however you’d like to think of it.
It’s where, instead of waiting until you have enough investments to live off completely, you retire earlier and live partly off your investments. At this stage, you either have a home paid-off, or a decent amount of investments providing you with some income, but not enough to live off.
And you typically do some part-time work on the side, to cover the gap between your current spending and your passive income from investments.
So, why would someone choose to ‘only’ semi-retire? Lots of reasons! Let’s take a look.
Here’s a list of the key points behind the case for semi-retirement. Some are blindingly obvious, others are sneaky perks and reminders.
— More freedom in your life sooner. Less savings/investments needed, meaning a shorter stint to FI (even if it’s only half-FI!). In many cases, it will shave off between 5 and 10 years!
— Most people are highly likely to work part-time and earn money after retiring early anyway. This may be hard to envision right now, but it’s almost certain to be true.
— You’ll have more days off than you work. Even if you work 2 days per week, you get a 5-day weekend every single time!
— Due to the ingrained saving and investing habit, you’re likely to manage your finances so that you maintain a surplus and add to your portfolio over time.
— You get the confidence, mindset and lifestyle benefits of someone who is fully retired, yet you only have to do a small amount of work to keep everything humming along.
— Superannuation can be accessed later on, further reducing the need to earn income and/or strengthening your financial cushion.
— It’s less of a shock to your system than going from 100% work to 0%. Semi-retirement can act as your stepping stone.
— You get to spend your time doing things that mean more to you than work. Your health, your family, your hobbies etc. As a result, your life will be happier and less stressful, even as you continue partly-working and building wealth.
— The government pension will be available if you somehow manage to earn zero money ever again, while simultaneously spending down your portfolio and find yourself needing income later in life. And by the way, for homeowners, the pension is more than enough to live a good life.
— You’ll likely still become 100% FI over time, as your portfolio grows faster than inflation, and more-so if you can add small amounts to it periodically.
— Some folks don’t want to stop working entirely. Maybe you love your job and would simply be happy to work less and have more free time for other things. Semi-FI is perfect for that.
— Due to earning less, you’ll be on a much lower tax rate than before. Each hour of work will earn you more after-tax than before. This uses your time more efficiently and gives you an effective pay-rise for working less. Not bad huh!?
In my view, a great starting point to consider semi-retirement is when you have half your expenses covered by investments. Either that, or having your home paid-off, because for most people, a mortgage tends to be around half of their yearly spending.
To me, this level of financial strength gives a good foundation to break away from the full-time rat race and transition into a cushy-yet-still-productive lifestyle.
Also, knowing in your mind that half your expenses are covered by investments, or that your mortgage-free, is a meaningful achievement, psychologically and financially. Being a third or quarter of the way to FI just doesn’t come close to having the same power.
Getting to the half-way point might seem arbitrary to some. But I feel it offers a genuine mental, lifestyle and happiness boost! We’ll call this: “the 50% rule.”
Let’s take a scenario where a household has annual spending of $50k. Half of this is regular spending, and the other half is their mortgage or rent.
At this rate, they’ll need roughly $1.25m to be financially independent forever, assuming their investments provide a sustainable 4% per year. But what if they follow the 50% rule?
Well, rather than needing 25 times their annual spending to retire, they only need 12.5 times. So, all that’s required in this case, is $625k of investments.
Either that, or to pay off their home in full. Either option will mean half of their expenses are covered, and they have enough financial strength to semi-retire.
How much time will this shave off their working careers? Well, in this simple scenario, a 16-17 year FI journey is cut down to just 10 years (this is when their savings exceed $625k).
They can now turn the dial more towards ‘life’ and activities of their choosing, and away from ‘mandatory work’. For now, they still have a $25k per year spending gap to cover. What about that?
So, our semi-retirees need to find $25k per year from somewhere. Or, ideally, a little more than that so they can increase their investments, further strengthening their financial position over time. This is where part-time work comes in.
Between a couple, $25k per year should be easy enough to earn. Even on minimum wage, this equates to roughly 3 days per week. Spread across two people, that’s just 1.5 days of work each, per week.
And at the median Aussie wage, this equates to less than 2 days of work per week. Or, roughly 1 day each. (income figures are from this recent post using ABS data).
Of course, as is often the case with most things regarding early retirement, lower spenders have a built-in advantage. Why? Because it’s much easier to plug a spending gap of $25k than $50k.
So the part-time work chosen doesn’t need to be lucrative or high-paying. This means the more frugal early retirees have a wider range of options. Also, they can choose work based more on what they think they’ll enjoy, rather than needing a certain amount per-hour, for example.
Another option is to scale down work steadily as your investments and passive income grow. This won’t be suitable for everyone due to workplace requirements, but it’s worth keeping in mind.
This also slows down your progress to 100% FI. But on the plus-side, you get more freedom sooner and some of the benefits listed earlier.
Imagine you build investments of $300k, giving you a passive income of $12k per year. At this point, you could probably afford to drop one day per week of work. As long as you maintain a surplus to add to your investments, you’ll soon be able to afford two days off. Then three, and so on… until eventually you’re 100% FI.
This would suit people who are generally happy with their careers, okay with slower progress and just looking for some extra free time each week while still growing their investments.
Another savvy method is Flamingo FI. This is where you build some savings, then switch to part-time work a.k.a. cruise mode. You make sure this part-time income is enough to live off, while your investments compound in the background, eventually taking you to 100% FI.
This wouldn’t be a Strong Money post without me riffing on the virtues of frugality, at least a little 😉
As you remember, the 50% rule says that the ideal time to declare semi-retirement (if that’s your plan), is when you’ve got enough investments to cover half your spending.
Under this rule, a household who spends $50k per year needs $1.25m to fully retire, and $625k to semi-retire.
Now, let’s say they’d been saving and investing for a while and had built up $500k. This is 40% of their total FI target, and 80% of the way to semi-FI.
But maybe they decide to re-examine their lifestyle desires and further optimise a few things. After this, they conclude that $40k per year would likely be enough for a happy and healthy retirement. This cuts the amount they need to retire.
Now their total FI number is $1m. And their semi-retirement number is $500k. That means their progress jumps! Now they’re 50% of the way towards total-FI and can semi-retire straight away!
Constantly re-visiting and questioning our wants and needs is honestly one of the best things we can do. Once we start turning away from standard consumer culture, and see how destructive and ultimately unsatisfying it is, we often find our desires melt away over time.
I think there’s another really useful way to approach this for some people. And it’s this…
Retire on the basics, and use part-time work to pay for the luxuries.
I’d encourage this approach for a few reasons, especially those who are planning a higher-spending retirement.
Firstly, this gives our brains the correct message about our spending. That these luxuries require extra time and energy from our lives to attain. So, by separating your basics and luxuries, this becomes a constant and unavoidable reminder of the trade-off, in the healthiest way.
Okay, what’s my overall verdict on semi-retirement? I think it’s a fantastic idea! And I’d strongly consider it if we had to start from scratch today.
So, for those that are keen, follow the 50% rule or any other flavour of semi-retirement you like. Also, it’s a good idea to retire with around 6 months spending in cash.
This gives you time to unwind, settle into your newfound freedom, as well as find the right part-time work without rushing. Remember, you’ve got investments behind you, so there’s little need to stress.
So, that’s the ultimate solution for the folks who aren’t wedded to the all-or-nothing approach to Financial Independence. And for those who were planning to work part-time anyway, shooting for semi-retirement is a fine way to go.
And remember, if you structure your finances right and maintain a small savings rate, your wealth will continue to grow over time, leading to complete Financial Independence as an added bonus.
There’s no shortage of reasons to consider semi-FI. It can give us the time and freedom we desire, allowing us to focus a bit less on work, and more on the other valuable parts of our life.
We get to live a great lifestyle, stay engaged and productive, all with a respectable pot of savings looking after us in the background.
So if you’re looking for a killer shortcut to freedom, maybe semi-retirement is for you!
What are your thoughts on semi-retirement? Let me know in the comments…