How to Prepare for Early Retirement

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If you’ve started saving for your future, then you’ve probably thought about retirement. When planning for retirement, it’s common to want to retire early. Early retirement allows you the time to do things you weren’t able to do while working, such as traveling and exploring passions. Here we go over the basics of early retirement and all of the important things you should keep in mind.

What Is Early Retirement?

Retiring early means that you’re prepared with enough money to comfortably live the rest of your life off of savings. An early retirement doesn’t mean you can’t work anymore, it just implies that you’re no longer relying on your income to live.

The normal retirement age varies based on the year you were born, but is typically between 65 and 67. This is often called the full retirement age because it’s when you’re eligible for full Social Security benefits. Many people choose to wait until this age range so they can receive full benefits. If you retire early, you should be able to support yourself without Social Security benefits for a period of time until you collect benefits, or take reduced benefits.

The Pros and Cons of Early Retirement

Retiring early isn’t for everyone, even if they have the means to do so. There are a few factors that contribute to this decision.

Pros:

  • Time to explore new career or hobbies
  • Freedom to travel
  • Focus on health

Cons:

  • Hard transition that impacts mental health
  • Have to make savings last longer
  • Don’t receive full Social Security benefits

Why Do People Want to Retire Early?

There are plenty of enticing reasons to retire early. Retiring early can give you the opportunity to try new things and travel to places that you never had the time or money to visit when you were younger. It could also be beneficial for your health, giving you ample time to sleep, cook healthy meals, and spend time with loved ones.

You can also start a new career path you’ve always wanted to try. After working for so many years, you have a lot of valuable information and experience that can be transferred to a new industry. Others choose to dive into personal hobbies. Regardless of what path you choose, it’s easy to stay busy after retiring early.

What Are the Fears of Early Retirement?

While some are excited by the idea of so much free time, others fear it. They may have a hard time transitioning to an unscheduled day after working for so long. This lack of structure can leave people feeling lost and can take a toll on their mental health. For example, some people have a hard time drawing from their savings after decades of only putting money into it.

Another fear of retiring early is not having enough savings. Without a permanent job, there will be additional costs such as health care that need to be paid for. An unexpected cost could put a dent in your retirement savings, requiring you to have to go back to work. Unfortunately, a large number of individuals retire early because they get laid off or can no longer work due to health issues, making going back to work impossible for many retirees. For some people this means adjusting the way they have spent and saved money their whole lives.

Last but not least, you could get less Social Security benefits if you retire early. This means you’ll need savings to support yourself without additional government aid. Many decide that it’s worth waiting until they can receive full benefits to retire if they can not afford their needs without the Social Security Income. However, if you retire early and have the max of 30 wage income credits, your social security is not reduced.

How to Achieve Early Retirement

If you think early retirement is for you, there are steps you can take to ensure you’re financially stable. Read on to prepare yourself for an early retirement.

Step 1: Calculate Your Expenses

The first step in your early retirement journey is to calculate what you currently spend every month on necessities like rent, groceries, and car payments, plus other nonessentials like movie tickets and dog toys. It’s crucial that you calculate your expenses so that you understand how you can budget your income and plan your savings based on your spending habits.

Many individuals who are looking to retire especially early save money by living on 50 percent or less of their income. This is a good place to start when planning for retirement because you know that you can always budget to save at least half of what you make. However, this is more of a plan for those who want to retire around the age of 45.

You should recognize that your budget and expenses will be different depending on your age and career progression. With age and experience, you may find that you have more money to work with. However, you’ll also be presented with opportunities such as purchasing a home or a new car. With that said, it’s a good idea to restructure your spendings and savings every time your income changes. If you still have debt to pay when you retire, you will run the risk of using up your savings and needing to go back to work.

Step 2: Figure Out How Much You Need to Retire

Once you calculate your monthly expenses, the next step is to calculate your annual retirement spending. This is the amount of money you expect to spend every year during retirement. To calculate this, you should include every expense you have. This number will consist of all current expenses, plus your debts, taxes, and insurance (think home, auto, medical, etc.). Once you’ve determined that number, multiply it by 12 to yield your annual retirement spending.

Multiply by 25 Rule

One popular strategy that people use to reach their early retirement goals is the rule of 25. This simply means that before retiring, you should have 25 times your annual expenses in investments and one year of expenses saved before retiring. For instance, let’s say that you’ve determined your yearly expenses to be $55,000 every year of retirement. In this case, based on the rule of 25, you should have $1,375,000 invested by the time you retire.

Plan for The 4 Percent Rule

Once you’ve planned your savings based on the rule of 25, you’ll need to be aware of the 4 percent rule. This rule primarily focuses on your rate of return during retirement. Taking this into consideration, the first year of retirement you should withdraw 4 percent of your retirement savings. After the first year, you can continue to draw 4 percent or take less if you don’t need it and use the excess to build a cash reserve.

Step 3: Refine Your Budget

Now that you have the concrete number you need before retirement, you’ll need to cut expenses to make up the difference. It’s essential to your early retirement that you learn how to manage your spending so that you don’t go over that 4 percent. After years of your hard-earned money being tucked away, it can be difficult to control once you finally have access to it.

Hence, the rule of 4 percent only works if you stay disciplined and avoid overdrawing from your retirement accounts. If you choose to take more than the calculated amount, then you might jeopardize your retirement plan.

It can also help to have a second income to arrange extra savings while you’re planning for retirement. There are plenty of people who have retired and gone on to continue working for their personal enjoyment or for extra cash.

Step 4: Grow Your Money 

One of the best strategies that you can use to retire early is to invest for long-term growth. As long as you keep your money invested, it can continue to grow. When done correctly, investments can yield returns that can be a second form of income. It’s important that you also continue investing during retirement. This will help you further grow your money to keep up with spending and inflation.

Most retirement accounts put limits on how much you can contribute in a given year. If you can afford to, you should add to your retirement accounts every year. Currently, you can invest $6,000 per year into a traditional or Roth IRA, and if you are over 50 years old you can add an additional $1,000 in catch-up contributions (a total of $7,000). If you invest into a 401k, then you can put up to $19,500 and if you are over 50 you have a catch up limit of an additional $6,500 (a total of $26,000). It’s important to put in as much as you can early so that your money has the most potential to grow and compound over time.

Whether you’re confident in your own saving and investing ability or not, you should still consider working with a financial advisor. This is someone who can help you manage your various retirement and savings accounts. They can also help you create a retirement plan and keep you accountable. Once you retire, your financial advisor can help ensure that you have a safe withdrawal strategy to maintain a comfortable lifestyle.

Considerations

Now that you know what it takes to prepare for an early retirement, you can start the journey. Remember to determine what you can live without, and refrain from withdrawing early from your retirement accounts to avoid penalties. If you decide to stick to these guidelines and stay disciplined, then early retirement can be possible.

Sources: IRS | Fidelity | thebalance I Investopedia

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