Contributing Writer at Tally
February 6, 2020
Does doing what you want each day — without a boss breathing down your neck — sound like the life for you? You don’t have to wait for your golden years. You can make it happen sooner by following the path toward early retirement.
As quality of life continues to become a driving force in the careers of younger generations, especially millennials, early retirement is becoming a popular trend. 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 share seven tips to get you on the path toward early retirement. First, let’s talk about what early retirement really means.
Early retirement is not like traditional retirement where you drop your full-time job and kick back on the beach. You can if you’d like, but it’s more about doing what you want instead of what your employer and financial situation dictate.
Maybe you spend eight hours a day right now at your job. Sure, you may make a decent income, but stress, an unrelenting boss or missing precious time with your family might make you resent clocking in every day. For you, early retirement may mean leaving that high-stress, low-reward job behind and taking on activities that make you happy.
These activities can be starting a blog, launching your own business, taking a low-stress part-time job in a field you’ve always wanted to explore, freelance work or volunteering. The key to being financially independent is that you no longer have the financial obligation to work. You work when you want to and relax when you don’t.
Here’s a step-by-step process to start working toward early retirement.
The first step to financial independence for early retirement is taking a good look at your financial situation. You’ve got to see where your money is, where it’s going and how you’ll need it in the future.
Look at 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 want to look into how much you spend per month on:
Household costs (including rent or mortgage)
Health insurance premiums
Other health care costs
Personal care (such as haircuts or manicures)
Credit card payments and other debts
With these yearly numbers in hand, check out the Bureau of Labor Statistics’ Consumer Expenditures report and compare your annual expenses to the average American family. Pay attention to categories where you may be overspending and have room to cut.
A key to reaching your goal of early retirement is saving cash today, and this 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.
For example, 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. This can save you extra cash each month that you can funnel toward your early-retirement dreams.
Another way to cut expenses is by looking into your transportation budget. If you’re spending $400 per month on a car loan and still have a few years of payments left, you’re leaving money on the table. Offload that car and pick up a reliable used model for cash. Roll that $400 per month you’re now saving toward your retirement.
If you live in a city where it’s practical, public transportation may be an even better transportation solution. That $100 monthly bus or subway pass not only cuts out the need for a car payment, but it also eliminates fuel and maintenance costs.
While you may be excited to head toward early retirement, keep in mind you still have a life to live today. Make sure you leave enough available cash to enjoy how you’re living now.
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 per year, you would need to save at least a $1.25-million nest egg.
Not included in the $1.25 million above is your Social Security income. Because it has a murky future, you want to remain conservative when considering it and not rely on it too much in retirement. It should be supplemental income only.
You can get a rough estimate of your potential Social Security retirement benefits online. This number can sometimes be hard to hone in on, so you may want to speak with a financial advisor to make sure you’re prepared for all scenarios.
When looking at your potential Social Security income, keep two things in mind. First, you can’t collect it until you reach at least 62 years old. Second, by the time you retire, the benefit could be smaller due to cuts by the government.
In many cases, cutting your annual expenses helps, but there is still not enough leftover cash to make the sizable dent you need to 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 (task completion, ride-sharing, grocery shopping, etc.)
Real estate investing
Freelancing (writing, photography, web design, etc.)
With these types of 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.
Before you can start funneling cash into your retirement accounts, you must eliminate your high-interest credit card debt.
Why can’t you just keep making your minimum payments and roll your leftover cash into your retirement accounts? It’s all about interest rates.
While the interest your 401(k) gains can vary significantly based on market conditions, financial experts consider 5-8% to be the average annual return. Now, compare that to the average credit card interest rate of 19.02% for new accounts and 15.10% for existing credit card accounts, and you can see how paying off this debt is vital in skyrocketing your net worth and building your retirement savings.
For example, if you put $200 in a savings account that yields 1.5% interest but leave $200 on a credit card at 19% annual percentage rate (APR), you’re earning just 25 cents per month on your savings while paying $3.17 per month in credit card interest. That’s a net loss of $2.92 per month.
There are a few ways to pay off this high-interest debt, including the debt avalanche and debt snowball methods.
In the debt avalanche method, you pay off your debt with the highest interest and balance first, then work your way down. In the debt snowball process, you pay off your lowest balances first and work upward from there.
When looking to retire early, you want to maximize your earned interest, so cutting high-interest debts as quickly as possible gives you a big advantage. If you’re looking to be part of the FIRE movement, the debt avalanche method is the better choice.
Hitting the numbers you need to retire in a short time frame requires significant contributions to your various retirement accounts. With all your debts out of the way and side gigs in place, you’ll want to roll all your extra cash into retirement savings vehicles.
There are many retirement accounts you can opt into, and each one has its benefits and caveats. Most workers are familiar with employer-sponsored 401(k) accounts. These accounts not only have the benefit of 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.
Another option is an individual retirement account. IRAs also offer tax benefits, and you can sign up for one of these without an employer, making them great for self-employed folks. 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 2020, the IRS lets you contribute up to $19,500 to your 401(k) and $6,000 to your IRA. If you’re over 50 years old, your catch-up contribution limit is $6,500 for your 401(k) and $1,000 for your IRA. You’ll want to hit these IRS maximums to reach the retirement savings you need as quickly as possible.
The only problem with maxing out these accounts, is there are 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 retiring at 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, including the stock market or index funds. These more accessible accounts can give you the retirement income you need to get through those first few decades of retirement.
By far, the largest expense in most American’s lives is a mortgage payment. Eliminating this expense by paying off your mortgage can help stretch your retirement savings.
Yes, choosing to accelerate your mortgage payoff will likely slow your retirement contributions. On the flip-side, paying off your mortgage will put a huge dent in your annual expenses once you hit retirement age, meaning you need to save less to retire early.
For example, if you pay off your $1,000 monthly mortgage before retiring, your necessary retirement savings fall by $12,000 per year, assuming you live in the house you’ve paid off.
Financial experts have mixed feelings about this option. Some say heading into retirement without this huge monthly burden can be liberating. Others say with today’s mortgage interest rates hovering well under 4%, the return on investing more cash far outweighs the money lost in paying interest on a mortgage.
Deciding which path is better for you requires a deep dive into returns on investments and your risk tolerance. If you can tolerate the volatility of the stock market, the potential returns are likely worth the risk. If you are later in your career and can’t risk losing much, you have a guaranteed net gain by paying off your mortgage early.
If you can’t quite decide which is best for you, speak with a financial advisor for more insight.
With a firm plan now in place, it’s time for execution. 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 not sure if this is the path for you, your first stop may be to a financial advisor to see what your options are.
Either way, there’s no time like the present to start saving toward retirement.