Friday, 15 October 2021

How to Retire Early: 6 Steps to Take

How to Retire Early: 6 Steps to Take
14 Oct

Updated on Wednesday, October 13, 2021

Many people dream of the day when they can finally sit back and relax in retirement — and a lot of people want that day to come as soon as possible. If you’d like to plan for early retirement, there are several strategies to help get you there.

You need to first determine how much money you’ll need when you retire and set a target date for retirement, then you’ll have to get to work on saving and investing your money: maxing out retirement savings accounts, living on a leaner budget, and investing your nest egg. With years of diligent saving, you can expedite your retirement and exit the workforce sooner.

1. Estimate your retirement budget

The first step toward that goal of early retirement is determining how much money you’ll need on an annual basis when you’re done working. You will still have many of the same costs as you did before retirement — including rent or mortgage payments, utilities, and transportation.

You also might incur additional costs as you get older: for example, many seniors wind up needing costly long-term care. While it’s difficult to forecast some of those expenses, you should factor in the possibility of those types of long-term costs when making your retirement budget.

Of course, social security, pension payments, and retirement savings can help seniors bear the cost of living expenses once they’re out of the workforce. If you have a good idea of how much you’ll be receiving from that type of income, you can incorporate it into your retirement budget forecast.

Planning for health insurance coverage

If you plan on retiring early, you need to consider how you’ll pay for health insurance at the beginning of your retirement. Exiting the workforce usually means losing employer-sponsored health insurance coverage, and Medicare isn’t available to those people under the age of 65.

The Affordable Care Act, popularly known as Obamacare, is an option for bridging the health insurance gap between your retirement and when you become eligible for Medicare. However, health insurance premiums and deductibles can be much higher than they were on an employer-sponsored plan.

2. Set a target savings goal

Once you have an estimate of what your annual expenses in retirement will be, you should set a goal for how much money you will need to save. There are several common ways to set a target savings goal for retirement:

  • 25x rule: A straightforward way to estimate your total retirement savings goal is to multiply your expected annual expenses by 25. That amount of money will last longer than 25 years if your nest egg earns a steady steady rate of return over the course of your retirement.
  • 4% rule: The 4% rule is an inverse of the 25x rule and is based on the idea that you should withdraw no more than 4% of your savings during the first year of retirement. In subsequent years, you should increase that amount based on the rate of inflation.
  • 80% income rule: This rule works differently and restricts the retiree to spending only 80% of their pre-retirement income (they could choose 75%, 85%, or another number too). You’ll need to multiply that annual expense estimate by however many years you expect to be retired.

Suppose you estimate that you’ll need $75,000 per year for retirement. According to the 25x rule and 4% rule, you’ll need $1.875 million in savings. It’s a rough approximation for how much money you’ll need, but it’s a way to target a specific number as you decide on your strategy for early retirement.

3. Set a target date for retirement

After coming up with a target savings goal, the next step toward early retirement is deciding when you plan to retire. Of course, that date doesn’t necessarily have to be a commitment; if you fall short of your savings goals, you may want to postpone retirement. But having a set date for when you intend to retire can help motivate you to reach those goals.

Just like your annual retirement expense estimates, you should estimate how much money you’ll be able to save for retirement per year and what kind of rate of return you expect to earn on those savings. People generally pursue aggressive savings strategies when planning for early retirement — living a leaner lifestyle before retirement can expedite that retirement date.

MagnifyMoney has a retirement calculator that can help you set your goal too. Once you’ve calculated what it will take to retire early, you’ll have to determine how you’ll save enough to do it.

4. Boost your retirement savings

A consistent savings strategy is the most important element to achieving that goal of retiring early. There are a few popular strategies when it comes to saving as pragmatically as possible with the goal of early retirement in mind.

Max out retirement account contributions

Tax-advantaged retirement accounts, like an employer-sponsored 401(k) and an Individual Retirement Account (IRA), are some of the best ways to save for retirement. With a 401(k), employers often match employee contributions and this money adds to the value of savings, even before factoring in the tax advantages.

Contributions to 401(k) accounts are often made pretax through payroll deductions, grow tax-free, and are taxed upon withdrawal. IRAs work similarly, though they’re contributions that are made independently from an employer. Investors can choose a Roth structure for their 401(k) or IRA, in which contributions are taxed and withdrawals are tax-free instead. There are contribution limits on all of these types of accounts, but because of those tax advantages, experts recommend making the maximum contributions if you can.

If you retire early, though, beware that you cannot withdraw funds from your 401(k) or IRA without penalty before the age of 59½ — meaning that you’ll need to use your other savings earlier in retirement.

5. Live on leaner budgets

Of course, in order to contribute a significant portion of your income toward saving for retirement, you might need to cut back on your expenses in the short term — or develop some alternative income streams.

There are plenty of ways to cut costs so you can contribute more money to retirement: living with roommates, using public transit, avoiding large purchases, and so on. Unless you earn a lot of money, you might need to make some sacrifices in your budget in order to contribute enough to reach that target date for early retirement.

Financial Independence, Retire Early: FIRE

An online movement led by younger investors focuses on tactics for early retirement; it’s called FIRE, which stands for Financial Independence, Retire Early. The idea is to take the strategies for retiring early to their logical extremes: investors are encouraged to spend as little as they possibly can while increasing their income, all with an eye toward exiting the workforce as soon as possible.

While most people might not want to live the lifestyle of the most fervent FIRE adherents — like having an austere, bare-bones budget while working two or three jobs definitely doesn’t appeal to everyone — this mindset could apply to anyone looking to retire early. For example, paying off debt as quickly as you can is considered a best practice for retiring early.

Each dollar saved is a dollar toward retirement. Everyone wants financial independence, and the FIRE movement gets people there faster.

6. Investment strategies for early retirement

Chances are you’ll have additional money to save once you’ve maxed out your retirement savings accounts, especially if you’re dedicating much of your income toward your eventual retirement.

There are a lot of strategies for investing — and the one you choose will depend on your risk tolerance and the target date for retirement. Here are some common investment methods:

  • Stocks — Investing in the stock market is a common way to grow your net worth, and your retirement savings accounts may be tied into the stock market. Experts tend to recommend index funds that track the broader stock market and an asset allocation strategy including bonds as a hedge against a potential market downturn.
  • Bonds — The bond market works much like the stock market, though instead of shares of a publicly traded company, bonds are assets with a guaranteed return at their maturity date, backed by private companies or the federal treasury. Bonds are a comparatively stable investment relative to stocks.
  • Real estate — If you can afford it, real estate has two benefits: it holds value as a speculative asset for when you’re ready to sell it, and you can collect rents on commercial or residential properties. There are some maintenance costs and taxes, and real estate investments don’t always appreciate in value (though they usually do).
  • Deposit accounts — Investors targeting an early retirement generally don’t keep much of their money in deposit accounts like savings accounts or certificates of deposit (CD) because the return is lower, but it is the safest strategy and could be a good option as you near that target date.

Investors tend to pursue more aggressive tactics when saving for early retirement, but it’s important to consider the potential downsides of putting your nest egg into volatile investments. Targeting a high rate of return is an important part of investing with an eye toward retiring early, but avoiding unnecessary risk is just as important.

Staying on track to reach retirement

Once you’ve set your retirement goals, it’s important to regularly check-in to see whether you’re hitting your target savings amount each month, assessing whether you have any unexpected changes that cause you to change your goals and revising your target retirement date accordingly. You may not have to check in on the big picture every month, but you should take stock of where you stand at least once per year.

Of course, a financial advisor could help you navigate those dynamics and provide those updates for you — though they do come with a cost for their services. Even if you’re working alone, it’s critical to have a good idea of where you stand when it comes to your goal of retiring early.

The “Find a Financial Advisor” links contained in this article will direct you to web pages devoted to MagnifyMoney Advisor (“MMA”). After completing a brief questionnaire, you will be matched with certain financial advisers who participate in MMA’s referral program, which may or may not include the investment advisers discussed.


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