6 Must-Follow Tips to Reach Early Retirement
Because life is too short to spend it sitting in a cubicle.
July 25, 2022
This article is provided for informational purposes only and should not be construed as legal or investment advice. Always consult with a professional financial or investment advisor before making investment decisions.
Early retirement is becoming a popular trend among younger generations, especially millennials who want to do more with their lives than just work. The financial independence, retire early (FIRE) movement has spread rapidly, and now young people are finding ways to retire in their 30s and 40s, no lottery ticket required.
Members of the FIRE community use smart personal finance skills and dedication to build the retirement savings they need to walk away from their day jobs for good.
How do they do it? Below, we’ll explain what early retirement is and share six tips to get you on the path toward becoming an early retiree.
What is early retirement?
Early retirement is when a person retires before the normal retirement age of 65.
But early retirement may not be like the traditional idea of retirement, where you drop your full-time job and kick back on the beach.
With early retirement, some may choose to take on a part-time job, launch a business or explore new interests. The key to being financially independent and retiring early is that you no longer have the financial obligation to work. You work when you want to and relax when you don’t.
What is the earliest someone can retire?
The earliest you can retire and take Social Security is age 62. But the Social Security Administration considers the age of 70 the “full retirement age,” so you will likely receive reduced benefits at age 62. However, you’re free to retire as early as possible, provided you have enough savings to support yourself.
Is it worth retiring early?
Early retirement can be beneficial for your health because it eliminates the stress of mandatory work. It also gives you time to travel, focus on hobbies and spend time with family.
How do I become an early retiree?
You can retire early by:
Exploring your finances
Trimming expenses where possible
Calculating how much retirement savings you need
Eliminating high-interest debt
Finding more income streams
Rolling extra cash into retirement accounts
Let’s dive into this step-by-step process to start working toward early retirement.
1. Explore your finances
The first step to financial independence is looking at your financial situation and budget.
Figure out the total of all your fixed monthly bills to see if you’re barely scraping by or earning enough to make early retirement a reality. To do this, you’ll need to calculate how much you spend per month on:
Household costs (including rent or mortgage)
Health insurance premiums
Overall health care costs
Credit card payments and other debts
Once you add up your monthly expenses, multiply them by 12 to see what they cost you annually.
With the total cost of your annual expenses in hand, check out the Bureau of Labor Statistics’ Consumer Expenditures report to compare your annual expenses to the average American family.
2. Trim expenses where possible
A key to reaching your goal of early retirement is saving cash today, which means living well below your means. Do your living expenses take up nearly all your take-home income? If so, see where you can trim expenses to increase your retirement savings rate.
Consider trimming expenses like:
Cable: If you’re paying $150 per month for a cable, phone and internet package but don’t even own a home phone like most U.S. households, you may be a candidate to switch to a low-cost internet-only package and subscribe to a streaming cable service.
Transportation: If you’re spending $400 per month on a car loan and still have a few years of payments left, you might consider selling that car and paying cash for a reliable used model. If you live in a city where it’s practical, public transportation may be an even better solution for you. Whatever you save per month on transportation, you can roll that extra money into your retirement or savings accounts.
Mortgage: Paying off your mortgage can help stretch your retirement savings. For example, if you pay off your $1,000 monthly mortgage before retiring, your expenses in retirement fall by $12,000 per year, assuming you live in the house you’ve paid off. Also, if you pay off your mortgage pre-retirement, you can start adding that $1,000 a month to your retirement savings account.
While you may be excited to head toward early retirement, remember that you still have a life to live today. Make sure you leave enough available cash to enjoy how you’re living now.
3. Calculate how much retirement savings you need
Since the average life expectancy is about 79 years old, you’ll need enough income in your retirement accounts to keep you afloat. Heading into retirement, many financial experts recommend having enough money to cover at least 25 times your annual expenses in retirement savings. Using the trimmed annual expenses you calculated above, multiply that by 25 to get an idea of where you need to be.
For example, if your expenses show you spend $50,000 annually, you would need to save at least a $1.25 million nest egg.
Not included in the $1.25 million are your Social Security benefits. You can get a rough estimate of your eligibility and potential Social Security retirement benefits online or by speaking with a financial advisor. Because of the United States’ retirement system and its rules, you can’t collect benefits until you’re at least age 62.
However, by the time you retire, there’s a chance the monthly benefits and survivor benefits will be reduced (or nonexistent). Because SSA distributions have a murky future, you should consider Social Security as supplemental income only.
4. Find more income streams
In many cases, cutting your annual expenses helps, but there may not be enough leftover cash to make the sizable dent you need in your retirement accounts. This is when finding additional income streams can help bolster your retirement planning.
Today’s economy is vastly different from that of previous generations. If your parents or grandparents wanted to earn extra income, more often than not, they would have to get a second job with a fixed schedule to manage. In today’s gig economy, there are plenty of side hustles that offer extra income streams on your schedule, including:
App-based gigs (i.e., task completion, ride-sharing, grocery shopping, etc.)
Real estate investing
Freelancing (i.e., writing, photography, web design, etc.)
With these on-demand side gigs, you can control how much you work and earn instead of adhering to a rigid schedule. You not only get a much-needed income boost, but you also control your work-life balance so you can enjoy life while saving toward retirement.
5. Eliminate high-interest debt
Before you can start funneling cash into your retirement accounts, you must eliminate your high-interest credit card debt.
Why can’t you keep making minimum payments and roll your leftover cash into your retirement accounts? It’s all about interest rates.
While the interest earned by your 401(k) can vary based on market conditions, financial experts consider 5% to 8% to be the average annual return.
Now, compare that to the average credit card interest rate of 16.17% (as of Q1 2022), and you can see how paying off this debt is vital to increasing your retirement savings.
There are two popular ways to pay off high-interest debt:
Debt snowball: With the debt snowball method, you pay off your lowest balances first and work upward from there. This can lead to early wins, but it often results in paying more in interest over time.
Debt avalanche: With the debt avalanche method, you pay off your debt with the highest interest and balance first, then work your way down. It may take longer to get your first debt paid off, but you will save in interest in the long run.
6. Roll extra cash into retirement accounts
Hitting the numbers, you need to retire in a short time frame requires significant contributions to your various retirement accounts. With your debts out of the way, you’ll want to roll your extra cash into retirement savings vehicles.
There are many retirement accounts you can opt into, but 401(k)s and IRAs are two popular options:
401(k): Most workers are familiar with employer-sponsored 401(k) accounts. These accounts not only benefit from being funded with pretax dollars, but many employers also provide contribution matches that are basically free money. This “free money“ can lead to big jumps in your 401(k) balance.
Individual retirement account (IRA): IRAs also offer tax benefits, and you can sign up for one without an employer, making them great for self-employed people. In a traditional IRA, your contributions are tax-deductible, and withdrawals are taxed. In a Roth IRA, your contributions are post-tax, but the withdrawals are generally tax-free.
In 2022, the IRS will let you contribute up to $20,500 to your 401(k) and $6,000 to your IRA. You’ll want to try to hit these IRS maximums to reach the retirement savings you need as quickly as possible.
Keep in mind that these accounts have strict withdrawal rules. If you take a withdrawal from a 401(k) or IRA before you’re 59 1/2 years old, you’re subject to a 10% penalty. So if you plan on a retirement date at age 40, you will have 19 1/2 years before you can start making unpenalized withdrawals.
With nearly two decades where you can’t touch your 401(k) or IRA without being penalized, you may want to consider rolling any additional free cash into more accessible investment accounts, such as the stock market or index funds. These more accessible accounts may give you the retirement income you need to get through those first few decades.
Execute your early retirement plan
With a firm plan now in place, it’s time to execute. Depending on your comfort level with finances, you may be ready to dive right into the first step toward early retirement. If you’re still unsure if this is your path, your first stop may be to a financial planner to see your options.
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