How To Retire 15 Years Early
Early retirement is a common daydream for many, offering financial and personal freedom before age 65. Whether it's a planned choice or forced upon, there are several things to consider when preparing for it. For those who pursue early retirement, it usually means retiring in their 40s, 50s,or even earlier, with the aim of having financial independence and more control over their work life. The FIRE movement, which stands for financial independence, retire early, has redefined the concept of early retirement ,emphasizing financial independence rather than simply leaving work. However, early retirement requires a lot of work to self-fund retirement, as Social Security benefits do not kick in until age 62. Taking Social Security benefits before the full retirement age of 66 or 67, depending on birth year, can result in a reduction of up to 30% of monthly benefits.
1. Make Some Adjustments To Your Current Budget
Retiring early is adream for many, but it requires some adjustments to your budget and lifestyle. The first step is to make changes to your spending habits to save more money for your retirement. Early retirees typically aim to live on 50% or less of their income and funnel the rest into savings. This requires getting creative with how you save money on transportation, utilities, food, and housing costs. You may need to consider cutting large and small expenses, including debt like mortgage loans.
To supplement your savings, it's also wise to find ways to bring in extra income. There are different groups of FIRE devotees, including lean FIRE, fat FIRE, and barista FIRE. The lean FIRE group focuses on living as frugally as possible, while the fat FIRE group prioritizes increasing earnings through investments or side hustles for a comfortable lifestyle. The barista FIRE group saves enough to retire early and work only when convenient for them. If you fall into this group, you may not need to get rid of your car just yet. Consider driving for Lyft to supplement your income.
2. Determine Your Annual Retirement Expenses
Congratulations on completing Step 1! By now, you should be accustomed to living on a smaller portion of your income, which bodes well for your retirement savings. The next step is to estimate your retirement expenses, factoring in what may increase or decrease from your current monthly spending.
Once you've tallied up your monthly expenses, multiply that number by 12 to determine your annual retirement needs. It's wise to add an additional 10% to 20% to this amount to account for unexpected expenses that may arise.
It's important not to overlook potential costs like taxes and healthcare. Health insurance, in particular, can be costly and problematic for those who rely on employer-provided coverage. Consider other options like purchasing private insurance, searching for a plan through Healthcare.gov, or finding part-time work that offers health benefits.
Taxes can also be a significant factor in retirement planning. To minimize taxes, develop a strategy for withdrawing income from your investment accounts, keeping in mind the rules for qualified distributions from tax-advantaged retirement accounts like 401(k)sand IRAs. Typically, you must reach a minimum age of 59½ to avoid taxes and penalties, with the exception of Roth IRAs, which allow for tax-free distribution of contributions at any time.
3. Calculate Your Total Savings Requirements
With your estimated retirement spending in hand, you're already halfway there, thanks to a couple of widely-used rules of thumb among early retirees.
First is the "rule of 25": You should have 25 times your planned annual spending saved before you retire. For instance, if you plan to spend $30,000 during your first year of retirement, you should have $750,000 invested before you quit your job. If your first-year spending is $50,000, you need $1,250,000 in savings. This is a great incentive to keep your spending under control.
This rule assumes that your retirement savings will continue to grow, because your spending will increase with inflation each year. This brings us to the second rule: the "4% rule," which suggests that you can withdraw 4% of your invested savings in the first year of your retirement. In the subsequent years, you can draw that same amount, adjusted for inflation.
In the 1990s,research was conducted to test various withdrawal strategies against historical market conditions, which led to the development of the 4% rule. However, depending on your investments, risk tolerance, and the performance of the market when you retire, you may want to take a more or less conservative approach.
It's important to note that these rules are not foolproof, and no financial advisor can guarantee your results. However, they are generally considered to be reasonable strategies.
If you plan to rely on savings from your tax-deferred retirement accounts, it's essential to remember that withdrawing funds before age 59½could be considered early retirement, and you may incur income taxes and penalties. On the other hand, you can withdraw money from a brokerage account without paying penalties at any time.
4. Invest In Growth
To state the obvious, early retirement means you have a shorter window for saving and a longer time frame for using those savings to support your lifestyle. This makes investment returns critical to your success. To achieve the highest returns, it's important to invest in a well-balanced portfolio that focuses on long-term growth. Low-cost index funds can be a great option, with an allocation that leans toward stocks for as long as you can tolerate the risk.
It may seem counterintuitive, but taking on more risk with your investments can actually be a good idea if you're planning for early retirement. Although you have a shorter time frame to save, you also have a longer time frame in which your savings will need to support you. This means that investment returns will be crucial, and you should consider a balanced portfolio that prioritizes long-term growth with low-cost index funds and a stock-heavy allocation.
It's important to keep in mind that your retirement could last several decades, so you need to account for that in your investment horizon. As you near your planned retirement date, you may want to move a small portion of your savings into more secure and liquid assets, such as cash, to cover immediate expenses without risking investment losses. However, the majority of your savings should remain invested in a way that allows it to grow and support the 4% distribution rate mentioned earlier, with a gradual shift towards cash as you require it.
5. Keep Your Expenses In Check
After estimating your retirement expenses, the real challenge is actually sticking to that budget. Small expenses can quickly add up, especially if you find yourself with newfound free time in retirement. Perhaps you indulge in a vacation, take up anew hobby, or adopt a pet, causing your spending to exceed the 4% rule.
It's important to avoid this scenario because the 4% rule is designed to account for inflation, not unexpected expenses. Any increase in spending, particularly recurring expenses like a new debt payment, increases the risk of running out of money. And as you probably know, running out of money in retirement could mean having to return to work.
Therefore, it's crucial to adhere to your budget and avoid over spending to ensure your retirement savings can support your expenses throughout your golden years.