How to Retire Early – The Definitive Guide

Have you dreamed of early retirement? How about the freedom it brings – financial and otherwise? It’s not just you who dreams of early retirement.

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In fact, since 1992, people have embraced the F.I.R.E. movement. It has become more popular in recent years. As an example, Natixis Investment Managers reported that Generation Y (ages 26-61) wants to retire at the age of 60 on average.

There is a slight hiccup, unfortunately. 59% of Americans don’t believe that have enough to retire, let along retire early. There are number of reasons why a majority of people feel this way. Everything from overwhelming debt, the impact of the pandemic, and inflation.

At the same time, all is not lost. As well as getting your retirement savings back on track, you might be able to still retire early. How? Well, let’s show you in the following guide.

What is Early Retirement?

Before you commit to early retirement, make sure you understand what exactly it means.

In the past, early retirement was defined as retiring before the age of 65. Technically, this is true. Nevertheless, it’s an evolving concept.

You don’t have to give up work completely by taking early retirement. Rather, your employment is purely voluntary. That means you’re free to live your life as you see fit. Why? Because you have the financial freedom to do so.

Believe it or not, people as young as 30 or 40 can take early retirement. But most of them also work in some capacity, such as with their passion projects or other endeavors.

More simply put, people who work this way do it for themselves, not because they have to.

It is important to remember that work can be fulfilling, meaningful, and purposeful. Additionally, some studies suggest that people who retire early and do not work at all may die earlier than those who remain employed.

Conversely, early retirement enables you to spend more time with your family and friends. You can also start your own company or pursue new hobbies. Or, maybe you’re burned out from the daily grind.

For many, stopping working isn’t the ultimate goal. Instead, it’s about having the freedom to do what you want.

What are the Pros and Cons of Early Retirement?

Getting to early retirement can be tough. But the rewards are typically worth all of the struggles once you reach it. Again, as soon as you retire, you are free to spend it as you choose.

Among the things you can do with all that free time are:

  • Bond with family and friends. You can visit your friends and family more often when you retire and stay for longer periods of time.
  • Take extended vacations. The question might arise, “Who on earth can spend a month in Europe or take weeklong cruises?” Now that you’re retired, the answer is obvious: You can.
  • Enjoy hobbies. Your days can be filled with the things that bring you joy once you retire, whether that is golf or reading.
  • Volunteer. There are many reasons why people do not volunteer, one of them being lack of time. Giving back to your community becomes a lot easier once you retire.

Early retirement might sound amazing, but there are a few downsides. There are even experts who claim that early retirement isn’t worth the effort. For example, 64% of Americans live paycheck to paycheck. Thus, pushing yourself to fit into an early retirement plan can be stressful and counter-productive.

Another drawback? You might get bored. In early retirement, you may wish that you were still working so you would have something to keep your mind occupied. Yes. You get to travel and engage with new hobbies. But, will this truly keep you stimulated for the next 40 or 50 years?

Overall, the financial risks of early retirement are substantial. That is, unless you have a number of sources of income or have more than enough money in the bank. If not, early retirement may completely bankrupt your dreams.

Phase 1: Pre-Retirement Planning

When you’re young, you can adopt the right mindset and financial plan to help you retire early. If that sounds daunting, here’s how you can get the ball rolling.

What does early retirement mean to you?

Retiring early doesn’t mean you have to stop working — unless that’s your endgame. Early retirement is instead a term used to describe a situation where an individual is not working to support themselves.

It simply means that you’re financially independent enough to stop working your 9-to-5 job. Nevertheless, you can still work part-time or find ways to earn a passive income. But, since you aren’t putting in 40 pus hours a week working, you can spend that time however you please.

Early retirement begins with you figuring out what it means to you. After that, you can begin to move in that direction.

The following questions may help you define your ideal early retirement:

  • Are you planning on moving or staying in the same place?
  • How will the cost of living change for you?
  • Which kind of lifestyle are you looking for? Hobbies and travel are expensive, for example. But, volunteering and spending time with your family are not.
  • Would you prefer to work part-time, full-time, or not at all?

By answering these questions accurately, you’ll be able to calculate when you’ll be able to retire.

Save money on a larger scale.

It’s crucial that you change your attitude about money if you’re committed to retiring early. The process begins with making conscious trade-offs when spending money.

Contrary to popular belief, fiscal discipline along will not solve the problem. For example, cutting back on high-cost expenditures is more sensible than giving up your daily latte. You can stick to your budget by making your coffee at home. But you won’t be able to retire early with this method.

You should, simply put, live below your means. This will allow you to save a significant portion of your earnings.

What’s the appropriate amount to save? Planners recommend saving 30% of one’s earnings over 40 years, instead of 10% to 15%.

You might think that’s an impossible goal. But it’s possible if you automate your savings. The reason being is that you’ll stash this money away before you can spend it. You should also contribute to your savings whenever you receive a windfall of cash, such as a bonus or tax refund.

Keep your lifestyle in check.

It’s okay to reward yourself when you get a generous raise or promotion. However, with greater earnings comes a natural tendency to spend more money. Financial advisors refer to this as “lifestyle creep.”

How can you keep your lifestyle in check? You can save half of those additional dollars by setting up automatic deductions from your paycheck or making a bank transfer.

But you should also refrain from feeling restricted when using your dollars. If you find ways to cut costs or search for the best deals, you can still travel. Perhaps you could stay with a friend or family member rather than book a hotel.

This can’t be stressed enough. Retiring doesn’t mean that you stop working. Taking a part-time job or starting a side business are possibilities. Because you’re still generating an income, you can still enjoy a comfortable lifestyle.

Become more aware of your financial decisions.

Regardless of your retirement plan, the only way to achieve your retirement goals is to make wise financial decisions. You can secure your financial success in the future if you make smart decisions today.

What’s the best way to get started? Get the basics down first, like;

  • Spending only what you can afford. Create a budget to keep you from overspending. If necessary, try creating a mock retirement budget with your monthly expenses for retirement as well. To calculate how much maintaining that lifestyle would cost, you can work backwards.
  • Paying off high-interest debts, such as credit cards.
  • Creating a fund for emergencies so that you won’t be forced to tap into savings.
  • Putting your tax returns and bonuses to good use, as well as your savings from unnecessary purchases. The obvious examples are paying off debt or contributing to a retirement or emergency fund.

But, let’s also address the elephant in the room. Housing.

Your house is probably your biggest expenditure, and therefore your biggest opportunity for savings. According to the Bureau of Labor Statistics, Americans spend a third of their income on housing. In order to figure out what you can realistically afford, check out calculators provided by Bankrate, NerdWallet, or Mortgage Loan. If you can’t downsize and buy a home that you can actually pay off your mortgage in a shorter time-frame.

More likely than not, you’ve heard this advice before. There’s a good reason for this. By following these steps, you can put money aside, plan for the future, and manage the unpredictable.

Maximize your tax savings.

Do you really want to retire early? As much money as possible should be deposited in tax-favored accounts if that’s the case.

Maximizing your 401(k) would be the logical starting point). As of 2022, employees can contribute up to $20,500 to their 401(k). The catch-up contribution for individuals over 50 years old in 2022 will be $6,000 more.

You can also choose a Roth IRA.

A Roth IRA contribution is after-tax. However, you must meet certain income requirements to contribute to a Roth IRA. To qualify, your Modified Adjusted Gross Income (MAGI) must be under $144,000 in 2022 if you’re filing as a single person. To contribute to a Roth IRA for tax year 2022, your MAGI must be less than 214,000 if you’re married and file jointly.

Combined, you can contribute these amounts to all your IRAs;

  • $6,000 for those under 50
  • $7,000 if you’re 50 years old or older

Additionally, you can contribute a portion of the income from your side job as well as your regular job to a SEP-IRA.

You may also want to consider putting as much into a health savings account as possible if you have a high-deductible health plan. HSAs can sometimes be a better investment than 401(k)s when certain factors apply. HSA earnings are not taxed if they are used to pay for qualified medical expenses today or in the future, and taxable withdrawals are also not allowed. For a self-only plan, you can contribute $3,650, and for a family plan, $7,300 as of 2022

Phase 2: Getting Ready to Dive Into Early Retirement

Nearing your early retirement? Make sure these key elements of your plan are in place.

Make an estimation of your retirement savings.

In order to plan a successful early retirement lifestyle, you must estimate your expenses and income. You can estimate your retirement income by combining your Social Security, pension, and any side jobs you have.

Most retirees depend on Social Security and, less frequently, pensions for income. With a pension, the payments are often available as early as age 55, and with Social Security at age 62. If you take early benefits, however, your monthly benefits will be smaller. In the long run, your retirement plan will be affected by Social Security, even if it is only the cream on top.

You will be able to see the projected benefits on the Social Security website if you file early. If you’re part of a couple who earns two incomes, it’s best to discuss your options with a Social Security offiicial or a financial professional.

Suppose you die with a higher monthly benefit than your spouse. The earlier you claim your benefits, the less you will receive, and the less your spouse will receive in the event you pass away.

Ask your employer’s pension administrator how much your pension payment will be at different ages. With this info, you’ll have a better idea of how much income you’ll get.

You may have difficulty calculating your expenses, however.

Establish a retirement budget.

When you are within five years of your desired early retirement, think about the lifestyle you want and what it might cost you. Determining where and what activities you will engage in will assist you with this. It’s an incorrect belief that a person’s expenses will decrease after they stop working. Actually, retired people spend about 20% more during retirement than during their working years.

Even though you’ll have more time to spend on hobbies and trips, this obviously costs more. Moreover, if you leave the workforce young, you can enjoy an active and most likely costly retirement if you are healthy and energetic.

Budget items may rise faster than inflation overall, so you must keep this in mind. For example, health care costs could rise as much as 7% or 10% annually.

In some cases, a retirement income calculator such as T. Rowe Price’s Retirement Income Calculator will let you know whether your retirement portfolio will allow you to retire early. Your retirement will be delayed if you reduce your lifestyle expectations, boost your savings, or delay your retirement.

Just add up your pension, Social Security, and savings. After this, calculate how much you would have to spend every month (including income taxes) if you were to retire five years early and become eligible for Social Security and pension benefits earlier. It should give you an idea of how much you will need in retirement.

But, to give you a ballpark figure, the Bureau of Labor Statistics’ Consumer Expenditure Survey found that the average household earns $84,352 a year. In addition, the average household spends $72,258 each year. The data also shows that roughly $5,854 is spent monthly on bills and other expenses.

Make sure your health insurance is in place.

Nobody wants to blow through retirement savings by paying for unanticipated medical expenses in the years between early retirement and Medicare eligibility. Until you are eligible for Medicare, you will still need private health insurance.

COBRA allows you to keep your employer-sponsored health insurance. But, you can also join the plan of your spouse or enroll in a health insurance plan through AARP and other organizations may offer discounts on coverage as well.

You might also want to think about long-term care insurance. It’s not just the long-term care costs that can be expensive, it’s medical insurance too. In order to save money, you might like to research it while you’re still young.

Even if you have some sort of health insurance, taking care of yourself is a surefire way to keep healthcare costs at bay. The most obvious places to start is eating a nutritious and balanced diet and engaging in physical activity.

Don’t take any risks with your portfolio.

Suppose you’re planning to retire at 50. You should be more conservative with your portfolio in your late 40s than your peers who plan to keep working until 65. The objective is to avoid what’s called “sequence of return risk.” This is the risk of having a series of bad markets occur at a time when your finances are particularly fragile.

In fact, according to Dr. Wade Pfau, professor of retirement income at the American College of Financial Services, this is what makes the first couple of years in retirement so dangerous.

“I’ve estimated that if somebody is planning for a 30-year retirement, the market returns they experience in the first 10 years can explain 80% of the retirement outcome,” he told Barron’s. “If you get a market downturn early on, and markets recover later on, that doesn’t help all that much when you’re spending from that portfolio because you have less remaining to benefit from the subsequent market recovery.”

The solution?

“There are four ways to manage the sequence-of-return risk,” Dr. Pfau adds. “One, spend conservatively. Two, spend flexibly.” You can manage sequence-of-return risk if you can reduce your spending after a market downturn by not selling as many shares to meet spending needs.

“A third option is to be strategic about volatility in your portfolio, even using the idea of a rising equity glide path,” he states. “The fourth option is using buffer assets like cash, a reverse mortgage or whole life policy with cash value.”

Create a 10-year financial buffer.

“At least five years before their early retirement date, investors should set aside the amount of money required to provide income for their first five years of retirement,” says Phil Lubinski, CFP, co-founder of IncomeConductor. “This will effectively put a 10-year buffer between the money they need for early income and any market volatility that could take place during their five-year countdown to retirement.”

By setting aside this money from their main retirement savings, investors are able to protect the wealth they’ve accumulated. The recommended five years of income can be rolled into a new IRA. These funds can then be invested in a portfolio designed for capital preservation, such as one using cash-based investments such as Treasury Bills or bonds, suggest E. Napoletano and Benjamin Curry in Forbes.

With a separate account for the money you’ll need for retirement, you give yourself a cushion in case the market experiences volatility. You’ll have years to bounce back from any losses experienced in your remaining investments under this model.

Phase 3: Maintaining and Sustaining Your Finances

So, you were able to retire early. Congratulations! However, while you’re in the initial stage of retirement, keep an eye on your compass and be prepared to correct course.

Keep your retirement funds secure.

“One of the biggest misconceptions many people have is that retirement simply means living off of their pension, Social Security, or retirement savings,” notes Pierre Raymond, cofounder of Global Equity Analytics & Research Services LLC (GEARS). “While this may be the case for a minority of people, the latter reveals that some Americans have still not placed any stress on their financial future when they reach the age of retirement.”

A retiree’s expenses can become more manageable by investing in various stocks and portfolios, or perhaps taking out an annuity. An annuity offers a guaranteed lifetime income. Because of this, it’s an ideal supplement to other income sources.

Raymond also suggests that you have an investment portfolio and minimize withdrawals from retirement funds. And, as mentioned several times already, think about how you can introduce new income streams. Some suggestions would be:

  • Starting a blog or online course.
  • Renting out a spare bedroom.
  • Providing baby-or-petsitting services.
  • House-sit internationally.
  • Being a freelancer or local business consultant.
  • Tutoring.
  • Selling handmade goods online.

Take a strategic approach to Social Security.

Did you know you can manage the size of your Social Security check? Yes, you can – to an extent. The key is when you start getting benefits.

“About 1 out of 3 Social Security recipients apply for benefits at the earliest age, which is 62,” writes author and certified financial planner Liz Weston. “It’s often a mistake.”

“Benefits grow by a guaranteed 5% to 8% each year that the applicant delays,” she adds. “Starting early also can stunt the survivor benefit that one spouse will have to live on when the other dies.”

Don’t rush it. Wait until the right time comes. This will increase your Social Security benefits.

Seek the advice of a financial advisor.

In order to retire early there are two major challenges to consider:

  • It takes less time to save for retirement.
  • After retirement, you’ll have more free time.

You should work with a financial advisor regularly — unless you’re a financial expert yourself. An advisor can help you to develop an investment strategy so that you can meet your retirement goals. In addition, a financial planner can show you how much you have to invest per month to hit your goals over time.

Even after retirement, it’s possible for you to work with your advisor to ensure that your retirement funds last. Income streams include dividend income, required minimum distributions, Social Security, defined-benefit plans, and rental income from real estate.

Trust is imperative since you’ll probably work together for a long time. Likewise, an advisor’s fee shouldn’t just be based on their time, but also their expertise. In the end, hiring an advisor with the right expertise is more than worth it.

Follow your plan, but enjoy life as well.

Discipline and time are both essential for executing and maintaining your plan. Save and invest while you can, but don’t forget to take advantage of your youth. If you dream of touring Patagonia, you should do it when you’re younger and in good health.

In the words of early retiree Steven Adcock, “Sacrifice is necessary to retire early, but it’s not all we do, either. It is important to treat and reward ourselves along the way by celebrating those smaller achievements.”

Frequently Asked Retirement Questions

1. When can I retire?

There is no set age to retire. As long as you are able to retire, you can leave the workforce whenever you wish.

There are some factors, however, that may limit when you can retire. Pensions are usually available to employees after 20 to 30 years of service. Aside from that, Social Security benefits aren’t available until the age of 62. And Medicare won’t kick in until 65. So, people covered by their employer’s health insurance may not be able to retire until 65.

2. How much money do I need for retirement?

An individual’s retirement income depends on a variety of factors. The factors considered include Social Security benefits, monthly expenses, retirement age, and life expectancy. It’s helpful to have a financial advisor help you figure out how much you’ll need for a comfortable retirement.

3. How will early retirement affect my Social Security benefits?

In general, you can receive Social Security retirement benefits as early as age 62. Benefits may, however, be reduced by up to 30%.

“Workers planning for their retirement should be aware that retirement benefits depend on age at retirement,” notes the Social Security Administration. “If a worker begins receiving benefits before his/her normal (or full) retirement age, the worker will receive a reduced benefit. A worker can choose to retire as early as age 62, but doing so may result in a reduction of as much as 30 percent.”

“Starting to receive benefits after normal retirement age may result in larger benefits,” adds the SSA. “With delayed retirement credits, a person can receive his or her largest benefit by retiring at age 70.”

For each month before normal retirement age, you lose 5/9 of one percent of your benefits. When the number of months over 36 is exceeded, the benefit is reduced by 5/12 of one percent per month.

“For example, if the number of reduction months is 60 (the maximum number for retirement at 62 when normal retirement age is 67), then the benefit is reduced by 30 percent,” the SSA states. “This maximum reduction is calculated as 36 months times 5/9 of 1 percent plus 24 months times 5/12 of 1 percent.”

4. Should I pay off my mortgage before retiring?

At the end of the day, it’s a personal choice. People who itemize deductions can reduce their taxes by paying mortgage interest. In addition, if the interest rate is low enough, it might make more sense financially to invest money rather than pay off the debt.

If you plan on retiring comfortably, it’s important to think about how paying off your mortgage will impact your ability to do so. Though a debt-free retirement is ideal, don’t use too much money from a retirement account to pay off a house.

5. What does a good monthly retirement income look like?

An individual’s definition of an adequate monthly retirement income may differ from another’s. Various factors will determine how much retirement income is adequate. This includes your retirement lifestyle, any dependents you have (kids, grandkids, debts, etc.) and your health.

A good retirement income is usually between 70% and 80% of an individual’s last income before retirement.

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