You may be sitting at your job one day and suddenly have that light bulb moment that leads you to the question, “what if I don’t have to do this forever,” or “when is there an end to the rat race and get control of my own destiny and when can golf on a Wednesday at noon whenever I feel like it?”
If you have ever had any of these types of thoughts, you very well may be interested in retiring early. This seems like a daunting thought at first, but when you walk through the hypothetical path that you would need to take, early retirement very is attainable.
Valid concerns over having enough money to cover bills, potentially out-living your money, or simply just enjoying your golden years comfortably need to be considered. There are certain steps that can be taken to make sure that this can be achieved and to reduce your anxiety.
How Much Do I Need To Retire Early?
Coming up with a retirement age can vary by what your goals are, where you are with your life, or what your habits will be like after you leave the work scene for good. Your end goal number can vary based on several factors, you should ask yourself:
- Will you be able to qualify for social security?
- Will you keep a portion of your money in an interest-earning account?
- Are you taking into account inflation?
- Are you preparing for emergencies?
These are just a few of the big items to consider in your journey towards early retirement. Mostly there are small behavioral changes that you can make to guide you to the path of financial freedom. Each individual choice you make should have the big picture in mind, and that is, how do I live my life every day so that I may retire early?
10 Steps To Retire Early
Retirement can mean many things to different people. Some people have lavish dreams of post-work bliss, while others intend to live a very modest life. No matter what your goal is, these are the steps that should be considered and taken in order to achieve it.
Step 1 – Define What Early Retirement Means
What does your world look like after you leave your job or career? Is there an empty void waiting to be filled, or are there already journeys and occupations waiting on the other side? You need to identify what you would like to do and start building a plan for it.
Do you want to:
- Work part-time?
- Travel around the country (or the world)?
- Study or learn something new?
- Create your own business?
- Explore your hobbies?
If you stop working early, you may find yourself with an abundance of excess time. It is important to know what you want to pursue after you decide to retire, and that you’ll have enough saved in order to do these things. You may be unprepared if you are planning on traveling in retirement but did not appropriately budget for this for example.
Step 2 – Assess Your Current Assets and Liabilities
In order to be able to get to where you want financially, you need to know where you are currently at. You need to have a firm grasp on what your financial picture looks like today so that you can see what the path is to achieve your goal.
Calculate your net worth, first and foremost. To do so, you need to identify and compare all assets against liabilities. Ideally you would like to retire debt free. Debt can include, but it’s not limited to the following:
- Credit card debt
- Mortgage payment
- Student loans
- Unpaid medical bills
Having little to no debt is critical if you want to retire early. If you do carry debt into retirement, however, you must make sure that you’re able to cover these costs with the money you’ve allocated. For example, if you still have student loan debt upon early retirement, you just need to make sure this was factored into the budget as well.
Step 3 – Estimate How Much You Will Spend In Retirement
An easy way of determining how much you will need in retirement is to look at your current monthly expenses and predict if there can be anything that you can get rid of, or if there are any possible additions as you age. This will give you a good baseline to work off of when predicting future expenses.
If you review your monthly expenses and multiplied by 12, this would equal your annual (or yearly) expected expenses. From here, you can try to determine what your ideal retirement number would be. One caveat to this is trying to factor in costs you may not be accounted for, such as taxes or health care. These should be added to the equation when figuring out what your spending habits should be.
Step 4 – Determine Your Target Retirement Number
There are a couple of ways of looking at this. You can use the 4% rule, otherwise known as the “safe withdrawal rate.” This can be used as a multiplier of your annual salary to predict how much you will need. This number is typically 25 times your annual salary.
For example, if your expenses are $50,000 per year. you would multiply $50,000 x 25 to get $1,250,000, or how much you would need.
In short, the 4% rule is when you add up all of your investments and withdraw 4% of that amount in retirement. Studies have shown that your retirement should last 25 to 30 years, however, this is not a 100% certainty due to possible recessions, emergency withdrawals, and other random.
Thoughts behind 4% Rule:
- Over the past 100 years or so, the average return on investments in the stock market is 7%
- Over that same period of time, the average inflation rate is 3%
- Using 7% return minus the 3% inflation = 4% (expected increase of your net worth each year)
Major considerations:
- Life expectancy: This should play a major role in determining what your retirement number should be if you are relatively young, plan on supplemental income, or withdrawing less.
- Account for inflation: Inflation grows over time, so be sure to include it when determining any withdrawal amounts.
- Stick to your plan: Overspending in one year can reduce the principal which limits possible withdrawal power.
Since the 4% rule is not a 100% certainty, if possible, you should supplement your nest egg with an additional income source. If you really want to be conservative, use a 3% rule as a safeguard.
Now that you understand what your net worth is, and what you should be shooting for. Below are some ideas on how to hit your ideal retirement number.
Step 5 – Live Below Your Means
If you have any real intention of retiring early, you must learn to live well below your means. Essentially, what this means is that you want to try to spend as little as possible while saving as much as you can. The earlier you start, the better.
A recent trend is the “FIRE” movement, which stands for “Financial Independence Retire Early.” This is more of a drastic step that can be taken if someone is deadly serious about early retirement. With this tactic, you would save anywhere from 50% to 70% of your income.
While this movement may not be for you in totality, here are some reachable steps or suggestions that you can take to try to save as much as possible:
- Keep monthly expenses to a minimum: Try to reduce the expenses you do have through smart shopping (e.g. cell phone, cable, groceries, etc.).
- Get rid of unnecessary subscriptions: Take a look into reoccurring expenses you may not be using (e.g. Hulu, Netflix, Amazon Prime, Spotify, gym, and countless other services).
- Don’t overspend on a house: If you are a single person, don’t buy a 6 bedroom/4 bathroom house.
- Don’t overspend on a car: Don’t buy a high-end vehicle with an exorbitant payment when you are trying to save every possible penny for early retirement.
- Be mindful of miscellaneous spending: Such as entertainment, shopping, eating at restaurants, or going to bars. These can kill your budget.
Remember that every dollar spent on frivolous items isn’t worth it in the long run, keep eyes on the prize. If you really want to retire early, you need to be smart about everything that you spend money on. What areas can you reduce? What areas can you completely get rid of? These are the questions that you need to address in order to achieve your goal.
Step 6 – Max Out Retirement Accounts
If you are at an employer that offers a 401(k) plan, you must absolutely take advantage of the company matching percentage, if not much more. Ideally, you should max out the contribution limit, which for 2020 that would be $19,500.
401(k) plans often have limited offerings for bonds, mutual funds, and stocks that you can pick from — Depending on the company. If you wish to retire early, you should try to have the most aggressive strategy within your 401(k) choices in order to have the most potential growth.
Another route is to opt into your company’s IRA plan after maxing out your 401(k). A Roth IRA or traditional IRAs are both great options to keep investing after you meet your maximum contribution limit on your 401(k). An IRA, however, has a much lower contribution limit, which is $6,000 for 2020.
Step 7 – Invest Into Brokerage Accounts
Your first priority is to invest in tax-advantaged retirement accounts, either from your employer or through a brokerage. The next step is to invest “after-tax” money into your personal brokerage accounts. Any money that you can contribute helps steer towards early retirement, so a hefty and consistent, diversified investment strategy across the wide range of stocks, ETFs, mutual funds, or bonds available is best.
How to invest and retire early with your brokerage account is simple in theory. The more you contribute, the quicker you can take advantage of compounded interest ultimately growing your nest egg. A good strategy for your brokerage account is to invest in several low-cost index funds or ETFs. Investing in your brokerage account may be extremely important, as your other retirement accounts may have an age restriction on withdrawals, 59.5 for IRAs, and 55 for 401(k) plans. Your intended retirement age may influence how much is needed in these types of accounts.
Step 8 – Explore Getting Secondary Income
You may evaluate your retirement goal and see that you cannot achieve it solely with your day job. Turning your hobbies into income would be an excellent way to earn extra money. This may not be possible, but there are still many side hustles that you can get into in order to supplement your income that you may enjoy as well.
Some side gigs that you can explore are:
- Lyft, Uber, GrubHub driver
- Babysitter, or caregiver
- Dog walker
- Freelancer on UpWork
Some professional athletes use only their endorsement income to cover their bills, and do not touch a cent of their income from their contract period or earnings. While the majority of people will never earn what a professional athlete does, the general principle is the same. If you devote your day job income to main bills and lean heavily into your investing strategies, then your side gig money can hopefully cover as much of your other expenses as possible.
Step 9 – Weigh Your Health Care Options
When you are younger and considering retirement costs, health care may not even enter your mind. You are young and healthy, what could possibly happen to you right? This type of thinking could lead to disaster if you are not sufficiently covered, however.
Some options you have for health care coverage are:
- If you leave a job: Cobra can cover you for up to 18 months through your employer’s plan, this is quite costly though.
- Explore options: Look into private health insurance plans or a plan through the affordable care act marketplace.
- Part-time employment: Some part-time jobs offer health care, and may which may be a smart route to take for both income and benefits.
- Shared plans: Hop on to your partner’s health care plan if you are married.
Important Note: Medicare doesn’t kick in until 65 so you may need to bridge the gap with one of the options listed above. Health care is a critical aspect to consider as you age and is often overlooked. So keep this in mind as you plan out retirement.
Step 10 – Work With A Financial Advisor
This step may be the most important of all, especially if you do not have a clear direction. Not everyone knows how to handle money successfully. Luckily there are professionals that can guide you on your journey to financial freedom. Work with a financial advisor near you for expert advice and counseling on how to achieve your early retirement goals.
Should I Even Consider Early Retirement?
If you shoot for early retirement by 45 for example and don’t meet that exact age, it is ok. If you get to retire by 50 instead, this still should be seen as a success.
Even if you don’t retire by the age you hoped for, you will be in a much better financial standing than you would have been otherwise. Using the best financial practices outlined above will ensure a path for comfortable living post-work. For this reason, you should definitely shoot for early retirement because you will be in a much better financial position regardless.