How to retire early in Germany

Last summer, I got a letter from German Pension Insurance about my pension. It had lots of details about what me and my employer paid in, how much pension I could expect, and when I could retire earliest. They even gave some guesses about my future pension based on different inflation rates. It was surprising to see that I could retire in 2061 when I’m 67.

I do like my job, but I also like the thought of having the freedom to choose how I spend my time. If you weren’t born rich, you either wait till 67 to retire or make a plan to retire early.

FIRE Movement

The FIRE (Financial Independence, Retire Early) movement aims for financial independence and early retirement. You save money each month and invest it in low-cost, low-risk ETFs until you reach your goal. Then, you can retire early and live off your investments. It’s a straightforward idea.

This movement isn’t about being cheap or not enjoying life until retirement. It’s about being smart with your spending, making a solid financial plan so you can retire early and do what you want. You don’t need to make a lot of money; it’s about how much you save and when and how you want to retire, as there are different ways to retire early in the FIRE movement.

Steps to retire early

Steps to retire early in the FIRE movement are quite straightforward. You aim to have 25 times your yearly expenses saved up. Once you reach this amount in your investment account, you can withdraw 4% annually to cover your living expenses without having to work. So, the first step is to know your yearly spending.

1. Calculate your expenses

You can use budgeting apps or simply create a spreadsheet like the one below:

Each weekend, add your transactions to the sheet. At the end of the month, create a table showing the sum of each category:

Repeat this for 12 months, then create a final page for an overview:

Lastly, create a table showing total and average spending for each category:

This simple sheet gives a clear picture of your monthly spending. With this overview, you can identify areas to cut back and save. For instance, a friend realized he was spending too much on food delivery and limited themselves to 100€ per month. You can do the same.

2. Create your emergency fund

Setting up your emergency fund is crucial in the FIRE movement’s long-term planning. While early retirement might not happen overnight, with a good saving rate, you can definitely retire before hitting 67. Since we’re in it for the long haul, we don’t want to dip into our investments for sudden expenses. That’s why an emergency fund is essential.

Typically, the rule of thumb for this fund is around 3 to 6 times your monthly expenses. So, if you spend around 1.500€ monthly, having 9.000€ stashed away is a wise move. In Germany, there’s a bit more safety net compared to other places like the US, thanks to unemployment insurance. If you unexpectedly lose your job, you can rely on unemployment benefits for a year. But if that’s not enough to cover your expenses, you might dip into your emergency fund.

When I first set up my emergency fund, I saved up 6 times my monthly expenses. Later on, I upped it to 12 times just for extra security.

Once you’ve decided on the amount for your emergency fund, it’s smart to choose a savings account with a high-interest rate, so your fund doesn’t lose value against inflation. I personally recommend Trade Republic for this, as they offer 4% interest on savings. That’s where I keep my emergency fund. You can check it out here.

3. Calculate how much you need to retire early

Calculating how much you need to retire early is pretty straightforward. Once you know your yearly expenses, you just multiply that by 25. That gives you your FIRE goal. Once you hit that number, you’re ready to retire. After retiring, you withdraw 4% of your portfolio yearly to maintain your lifestyle without reducing your standard of living.

Let’s say your monthly expenses are 1.500€, which means your yearly expenses (1.500€ x 12) are 18.000€. Multiply that by 25, and your FIRE goal would be 450.000€.

The number might seem daunting, but by saving monthly and investing in your portfolio, you leverage compound interest. For instance, if you’re earning 40.000€ annually as a recent graduate at 24, your monthly take-home pay might be 2.200€ after taxes. If you save 700€ per month and invest it in a common ETF like the S&P 500, which yields 10% annually, by the time you’re 44, you’d have 481.000€ in your investment account. That means you could retire 23 years earlier than the pension system allows.

As you progress in your career, you’ll likely earn more, allowing you to invest more and possibly retire even before turning 40. However, life circumstances can change. Maybe you move to a city with higher living costs, or you start a family, altering your expenses. In such cases, you might need to recalculate. But understanding the main idea—managing spending, saving wisely, and maintaining your lifestyle—can help you retire much earlier than relying solely on the pension system.

The key is to start early. That’s why I mentioned a 24-year-old example. Some parents even set up investment accounts for their newborns, depositing 100€ monthly. By the time the child turns 18, there could be 55.000€ in the account, thanks to compound interest. This money could fund education, buy a car, or even travel the world before university. It may sound unbelievable, but it underscores the power of compound interest. (Here’s a compound interest calculator if you want to try a similar calculation.)

4. Decide your portfolio

Most folks I know who are into the FIRE Movement prefer investing in ETFs. An ETF is like a basket of stocks from various companies and sometimes countries. Common ETFs include All-World ETFs, Emerging Markets ETFs, and the S&P 500 ETF. These ETFs hold stocks from all over, including emerging markets like China, India, Taiwan, Brazil, or from the S&P 500 index in the US. Warren Buffet often suggests investing in the S&P 500, but many of my friends opt for a mix, like 70% All-World and 30% Emerging Markets, to diversify beyond just the US market. ETFs are generally less risky than crypto or individual stocks since they spread your investment across hundreds or thousands of stocks. However, if you choose more diversified ETFs, your returns may be lower.

Your portfolio depends on your preferences. You can explore the “booglehead” approach, considering your age and risk tolerance to decide on your portfolio. Currently, my portfolio looks like this:

• 60% Vanguard S&P 500 ETF
• 20% Vanguard All-World ETF
• 20% Apple stock

My portfolio might seem a bit risky because both the S&P 500 and All-World ETFs include Apple. If something happens to Apple, my portfolio value could drop significantly. As I get older, I might sell my Apple stocks and invest more in All-World and Emerging Markets to balance my risk. Some folks find ETFs risky and prefer investing in bonds.

The S&P 500 holds the largest portion of my portfolio because historically, it has returned around 10.5% annually. With data spanning a century, I feel secure in this investment, considering it has weathered wars and financial crises. That’s why I don’t advocate day-trading; instead, invest for at least 10-15 years and withdraw only a small percentage.

Simplicity is key in portfolio design. If I were starting now, I might go for a combination of All-World ETFs and Emerging Markets. You can learn more about this topic on boogleheads.org.

5. Create an investment plan

Once you’ve decided what to invest in, it’s time to create your investment plan. When I moved to Germany, there weren’t many neo-brokers with English support that offered affordable investing options. So, I opted for DEGIRO. Initially, investing in their core selection ETFs was free, but now it’s 1€ per transaction. The only drawback is you have to handle taxes yourself, but I’ve outlined the process in a blog post. It’s as simple as entering your capital gains into one field on your tax form, but calculating taxes for ETFs that accumulate dividends can be a bit complex.

If I were starting now, I’d likely choose Trade Republic because they handle taxes for you and provide an annual tax report for easy filing.

Once you’ve chosen your broker, decide how you want to invest. For me, when my salary lands in my N26 account, I keep what I need for the month and send the rest to my broker to buy S&P 500 ETFs. It’s that straightforward.

This monthly investing method also employs dollar-cost averaging, removing the need to time the market. Some friends invest quarterly or annually, but I recommend monthly investing to avoid extra money sitting in your bank account, tempting you to spend unnecessarily.

What about taxes?

Taxes in Germany can be hefty, with income tax reaching up to 42%. However, capital gains tax is comparatively lower, at 25% plus a 5.5% solidarity surcharge, resulting in an effective tax rate of 26.375%. If your ETFs include at least 50% stocks, like All-World or S&P500, then 30% of your capital gains are exempt from taxes (known as “Teilfreistellung”), bringing down your effective tax rate to 18.46%. Considering this, investing becomes more attractive for those living in Germany.

Additionally, you don’t pay taxes on your first 1.000€ of capital gains each year. So, if your regular dividends total less than 1.000€, you won’t owe any capital income taxes for that year.

Since tax calculations can be complex, I highly recommend using Trade Republic as they handle all tax matters for you.

Which FIRE type fits me

In this blog post, I’ve described the leanFIRE approach, where you continue working and investing until you reach a sum that covers your expenses. However, there are other types of FIRE that might suit your circumstances better.

fatFIRE: Instead of aiming for just enough to cover expenses, you target higher amounts, ensuring a luxurious lifestyle where money worries are a thing of the past. This usually falls in the range of 3-5 million €, making it quite challenging to achieve.

baristaFIRE: When you hit your financial goal, rather than retiring completely, you take up a job (like being a part-time barista) that covers your expenses and health insurance, allowing you to use your savings for personal pursuits.

avocadoFIRE: If you have specific lifestyle desires, like indulging in avocado toast daily, this type of FIRE is for you. It’s akin to fatFIRE, but with a lower financial goal.

For me, baristaFIRE seems ideal, especially initially. Working around 20 hours per week allows for social interaction, a sense of routine, and covers health insurance costs. I might opt for a role like a bike shop mechanic. Later on, if I feel the need for more freedom, I could transition to leanFIRE.

The choice is personal. Some friends are aiming for fatFIRE to completely eliminate money concerns. Other options may leave you with lingering financial anxieties, despite having enough to cover expenses. With fatFIRE, you’re prepared for any unforeseen changes or challenges that life may throw your way.

What’s next?

I hope this blog post has provided you with a basic understanding of the FIRE movement and how to get started. My aim isn’t to offer financial advice, especially regarding taxes, but rather to offer a path that could lead to early retirement.

In the US, you can invest your pension savings into the ETFs mentioned in this post, potentially growing your retirement funds substantially. Christian Lindner, Germany’s Finance Minister, recently discussed introducing a similar system in Germany called Generationenkapital to shore up the struggling pension system. I’m hopeful that the government will manage to pass the necessary laws to implement this system, easing financial worries for retirees at 67.

One final note, if you want to calculate your leanFIRE goal on your iPhone, I’ve developed a free app called FIREcalc. It allows you to easily determine when you can retire based on your savings. Alternatively, you can use this website for web-based calculations.

Please note that some of the links I’ve shared here are affiliated. If you choose to use any of the services mentioned, I may earn a commission.