How To Retire Early
Imagine that you could quit the workforce for good before age 65.
Believe it or not, a fair amount of people do just that.
By adhering to proven strategies and exercising some discipline, you too can join this group of dedicated savers.
But retiring early isn’t as simple as saving more money.
There are a few questions you need to ask yourself before you can work toward an early retirement.
Not to mention, there’s a whole lot of planning to be done if you want to pull off a smooth early retirement.
The Why: Why Do You Want To Retire Early?
Alright, let’s be honest here.
A massive majority of the workforce would retire right now if they were able to.
But believe it or not, a lot of early AND on-time retirees find themselves bored early into their retirement.
Sure, they’re out of their “boring” day job, but they cannot seem to fill the rest of their time with anything meaningful.
In addition, they might become restless; they’ll be overwhelmed with all the new freedom and choice and begin to crave the structure that their career provided them.
Some even pick up part time jobs at their old company so they can feel as if they’re contributing to society and not just wasting time.
So while wanting the freedom early retirement bestows upon you is a good starting point, it’s not specific enough.
You need to have a clear reason why you want to retire early.
3 Reasons to Retire Early
Here are few reasons people choose early retirement over working.
Travel
Do you want to travel extensively and before you get too old?
This is one of the most common reasons why people want to retire.
The world is full of beautiful places and interesting cultures just waiting for you to explore them.
Family Time
If you value family over most other things, than early retirement will be a huge boon for you.
Retiring early allows you to spend so much more time with your family.
One big motivator in the family department is children.
Many people want to see their children grow up and be there for all their significant milestones, but spending 40, 50, or even more hours in an office can make that impossible.
Health
Not everyone has 100% control over when they should retire.
Some people might unfortunately experience declining health long before their time.
Retiring for health reasons raises the stakes; you’re no longer retiring out of pure desire.
Despite the sad circumstances, there’s one upside:
Sink or swim.
When your back is against the wall, you’re more willing to do whatever you need to succeed.
But enough with the deep stuff; let’s get to the “what”.
The What: What Lifestyle Do You Want in Retirement?
So you know why you want to retire so early?
Good, but what lifestyle do you desire in early retirement?
Again, this is important question because the lifestyle you want will be provided by the savings your accumulate while you’re still working.
For example, if you wanted to buy fancy cars and participate in expensive activities, you’ll need a hefty amount of savings to fund all that.
But if you’re just looking to reduce your stress levels and not live so large, your monetary needs won’t be as great.
Make sure you define the lifestyle you want so you know what kind of financial numbers you’re looking at hitting.
Speaking of financial numbers…
The How: Figuring The Numbers
Reason for early retirement?
✔ Check.
Desired lifestyle?
✔ Check.
Now, about getting there.
Planning for retirement is a lot of work, but planning for early retirement can be even more stressful.
Your retirement years will be much longer than your typical retiree.
Therefore, you’ll need a lot more assets AND probably more sources of income since you won’t be able to claim Social Security for a long time.
But before we go into all the ways to invest for an early retirement, let’s talk budgeting.
Budgeting For An Early Retirement
Now that you know your desired retirement lifestyle, you need to put some numbers to your dreams.
Coming up with a sufficient mock retirement budget is important because it won’t be the same as your current budget or tracked expenses.
Think about it: once you’re out of the workforce, your income will change.
In addition, you won’t be spending money on the same things.
Now, there are plenty of free retirement calculators online that let you plug in your desired retirement information.
These calculators will then spit out data on how much you need to be saving in order to reach your goal.
Of course, you should bank a little bit more than what the calculator says (if you can afford it) since priorities change.
It never hurts to have extra money!
Alright, on to investing for retirement.
Investing For Retirement
In order to retire early, you’ll have to dedicate a lot of money towards investing.
Why?
Two reasons:
- Your money will be “locked away”, making you less tempted to spend it
- Your money will work for you; you’ll earn money on the money you invest, which will only further pad your retirement savings.
No dollar should be wasted; if you don’t need to spend it, invest it.
There are a ton of ways to invest your money for maximum return so you can successfully attain your early retirement goals.
401(k)/403(b)
It’s time to turn up the 401(k) contributions.
If your employer matches your 401(k) contributions and you aren’t contributing up to the full amount to which they’ll match, you’re missing out on tons of free money.
Also, when you put your money into a 401(k), you won’t be tempted to spend it as you can be penalized for early withdrawals.
401(k) contributions are pretax, so Uncle Sam won’t get a cut right away; 100% of your contributions will go into your 401(k).
You’re only taxed on your 401(k) money once you begin to withdraw it.
By then, your money will have grown as well since it’s being invested.
But wait, what about 403(b) plans?
Unfortunately, employers that offer 403(b) plans don’t typically offer a dollar-for-dollar match on your contributions.
They might offer something less, like 50 cents on the dollar.
Still, it’s a good idea to contribute the maximum amount that your employer will match up to.
Free money is free money, and you need every last dollar you can get your hands on if you want this thing to work.
IRA
IRA stands for Individual Retirement Account.
There are two types of IRAs:
- Traditional IRAs – Contributions are tax-free when you make them, but you’re taxed on withdrawals in retirement.
- Roth IRAs – You’re taxed on Roth IRA contributions when you make them, but you enjoy tax-free withdrawals in retirement.
Both types of IRAs have a much larger investment selection than 401(k) and 403(b) plans, but the annual contribution limit is much lower.
Many people use IRAs as a way to supplement their 401(k) or 403(b) after they’ve reached the maximum company match percentage, but that’s ultimately up to you to decide.
Unfortunately, you can’t make penalty-free withdrawals from either type of IRA until you turn 59.5 years old. If you plan on retiring long before then, you won’t have access to your money for a while.
Picking the right IRA for you requires a lot of planning and some financial knowledge; time value of money must be considered, and tax rates can change in the future.
I’d recommend talking with a financial planner if you’re thinking about an IRA.
Annuities
“Annuity” is financial jargon for “contract with regular payments”.
You can buy annuities from insurance companies.
But how do they work?
Well, you first buy the annuity from an insurance company.
The company invests the money.
The insurance company then guarantees either a fixed or variable return on your investment that is paid to you regularly over the amount of time defined in the annuity contract.
Life insurance is a common example of an annuity.
Funds and Securities
Securities and investment funds provide great housing for your money while you’re saving for retirement.
You have plenty of options when it comes to securities:
- Stocks – Individual stocks are always an option. Some of them also pay dividends, which could provide you another income source in retirement.
- Bonds – Bonds are loans you make to either corporations or the government. You receive fixed interest payments on a (typically) semi-annual basis until the borrower pays you back in full.
- Mutual Funds – These are professionally managed funds. Mutual funds are created with specific fund objectives in mind (such as growth or income).
- ETFs – ETFs are share some similarities with mutual funds. ETFs track a stock or bond index, such as the S&P 500. Check out this post for a full primer on ETFs.
Investing in these assets and funds will potentially do 2 things:
- Grow your money and outpace inflation because of appreciation
- Pay you dividends and interest as another income stream
Ultimately, you want to invest in many different assets/funds for diversification.
It’s never a good idea to put all your eggs in one basket, so having multiple income sources in retirement will protect you against losing your money.
Drastically Reduce Your Current Expenses
Remember how I said you need to invest any extra dollars you make?
Well, if you want to retire early, you’ll have to make sacrifices in some areas now in order to live the early retirement lifestyle you want.
Here’re a few areas you need to deprioritize in favor of investments.
Vacation
You can still take vacations, but they can’t be lavish in any fashion.
Ruthlessly slash your vacation budget for the time being. Redirect all savings into your investments.
There will be plenty of time for vacation after you punch the time clock for the last time.
Subscription Services
We tend to hammer on subscription services a lot.
While they can be very convenient, many of them ultimately waste valuable dollars that could be invested.
All the interest/dividends/gains on your savings can be used to get those subscriptions back in a couple years when you’re enjoying the retirement lifestyle.
Dining Out
Most meals you have while dining out can be had for a fraction of the price if you stay in.
And those savings will add up.
Many people don’t realize how much money they spend at restaurants ever year; it can add up to thousands of dollars!
Romantic dinner dates with your spouse can wait until you no longer have to work.
The 4 Percent Rule
Over the course of your shortened stint in the workforce, you’ve been disciplined with your money.
- You could’ve gone on a bunch of shopping sprees, but you diligently paid down all your debts instead
- Instead of eating out 3 times a week, you maxed out your 401(k).
- Rather than buying a fancy new car, you invested as much of your paycheck as you could afford into appreciable assets (and some of those assets pay nice dividends)
And now that you’ve finally made it to your early retirement, you have tons of capital amassed in various financial vehicles so you can live the lifestyle you want.
But how much money should you withdraw from your retirement savings every year?
That’s where the 4% rule comes in.
This rule says that 4% is a safe rate at which to withdraw your retirement savings.
Most of each withdrawal will be interest and dividends you’ve earned on your savings, but some will be principal.
Here’s how to use this rule to calculate how much you need to save.
If you estimate your early retirement will last X number of years, then you need to save enough to take out 4% of that every year.
For example, let’s you want to live on a modest $50,000/year in retirement.
According to the 4% rule, you’d need about $1,250,000 to survive.
That’s a good chunk of change!
Caveats To The 4% Rule
Now, the 4% rule might not be suited for everybody.
And it might not be suited for you unless you can save a lot.
That’s because again, you’re going to be retired a lot longer than your typical retiree.
If you want to live on 4% every year, you’ll need a lot more money saved to sustain your desired lifestyle.
In addition, this rule completely breaks down if you start to splurge in your retirement.
But why?
You have a ton of cash saved, so why not enjoy some of it?
Well, large purchases will reduce the principal amount in your investments, which of course greatly diminishes the amount of compounded interest you’ll earn.
The 4% rule requires discipline.
Backup Plans
You can do everything right:
- Define why you want to retire early
- Decide on your retirement lifestyle
- Nail all the numbers down
However, even the most flawless-looking plans sometimes fail.
Not to mention that circumstances change and priorities shift as time goes on.
And so, you need a back up plan in case something goes awry.
One of the best ways to stay prepared in case your early retirement falls by the wayside is to maintain some level of job skill.
No need to go back to college, but think about taking classes while you’re working to learn new skills and keep existing ones sharp.
These skills could come in handy if you ever need to reapply at your old employer or freelance to temporarily make ends meet.
Also, network heavily as your days in the workforce draw to a close.
Networking is important for advancing your career, but it also helps you build connections in case you need to jump back into the workforce.
Of course, no one wants to rely on a backup plan.
But as they say: hope for the best, but prepare for the worst.
Meet With A Financial Advisor
Early retirement is a massive undertaking.
It’s possible to track everything alone, but your journey will be very stressful.
I highly recommend speaking to a financial advisor about early retirement.
Most of their job is helping clients achieve lofty financial goals, so they know what they’re doing.
When you meet with a financial advisor, you can lay everything out and work with an expert to identify ways to make your early retirement more viable.
In addition, they can answer any questions you have about complicated financial matters related to your early retirement.
Financial advisors come especially in handy when navigating the seemingly endless investment options you have.
They’ll help you pick the ones that work best for you based on your individual situation and your retirement goals.
But don’t just meet with a financial advisor once.
You’ll want to meet with them regularly so you can both evaluate your progress towards early retirement and make any necessary adjustments.
Beware This “Creeping” Threat To Your Retirement
So the plan’s all in place.
But there exists something that could destroy your dreams of departing the workforce for good.
It looms in the shadows, threatening to ruin your retirement plans as soon as you let your guard down.
But what is this ominous threat to your early retirement?
Lifestyle creep.
Ever heard of “keeping up with the Joneses”?
Well, lifestyle creep is a similar concept.
As your income rises, you gain access to more luxuries.
At first, these luxuries DO seem like luxuries.
But over time, your thoughts and behaviors change ever so slowly.
What used to be luxuries begin to turn into necessities.
You can no longer imagine flying in those cramped, uncomfortable coach seats; you demand first class.
Or how about that shiny new Mercedes you saw down at the dealerships? Time to ditch the old Toyota (that easily has 80,000 more miles in it, mind you) and get something fast and fun.
It’s easy for both new entrants to the workforce (like college grads) and those nearing normal retirement age alike to suffer from lifestyle creep.
Young people get their first salary; they feel like they’re making the big bucks, so frugality falls by the wayside.
Likewise, retirees might fall victim to lifestyle creep because they feel as if they deserve to reward themselves for a lifetime of hard work.
Now as a disciplined saver, you might think you’re invulnerable to lifestyle creep.
Stop right there.
Remember, lifestyle creep isn’t about hard numbers; it’s about your thinking.
And everyone knows that the human mind will take the path of least resistance when possible.
You need to fight hard to maintain a saving mindset.
If you get a raise or a bonus at work, consider pouring that extra money into investments.
Remember, every extra dollar matters.
But it will be difficult.
Temptations will be everywhere both before and during retirement:
- New houses
- New cars
- Fancy dinners
- Entertainment
Don’t fall for them.
It’s a slipper slope to running out of retirement funds.
You need to stick to your financial guns if you want to have a successful early retirement.
It’s Not Easy, But It’s Worth It
Early retirement is a path not tread by many, and it’s a path fraught with difficulty.
There’s a ton to figure out:
Why do you want to retire early?
What kind of lifestyle do you want to have in retirement?
What kind of numbers do you need to hit in order to retire successfully?
Where should you invest your retirement money to maximize your returns and most efficiently reach your early retirement goals?
Not to mention, you have to avoid lifestyle creep.
You can’t slip up and start justifying useless purchases if you want to be able to afford your retirement.
Ultimately, you have to save a lot more money in a lot less time than the average retiree that waits until their mid-60’s.
Relentlessly stick to your plan, meet regularly with your financial advisor, and remember why you wanted to do this in the first place.
I promise that it will all be worth it when you’re living the retired life well before most others are even thinking about it.
