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5 steps to retiring early

Early retirement is becoming an increasingly popular financial goal for many Americans. The FIRE movement — Financial Independence, Retire Early — has gained traction in recent years, and more people find themselves aggressively saving with the hopes of leaving the workforce in their 40s or 50s rather than their 60s or 70s.

But how does one actually retire early? While the movement may be popular, actually retiring early, and in a comfortable financial position is far from simple. Let’s break down five steps to help you retire early.

1. Assess Your Current Situation

As with any journey, you must determine where you’re starting before you can figure out how to arrive at your final destination. And early retirement is no different.

In order to retire early, it’s important to take inventory of your current financial situation, including:

  • Outstanding debt
  • Total savings
  • Current retirement savings
  • Annual income
  • Annual spending

“I find that so many people just don’t even really know,” said Dr. Lakisha L. Simmons, a professor and single mother who amassed a net worth of more than $750,000 in just four years. “I’ve had women tell me, ‘I’m afraid to see how much debt I really have’ or ‘I’m afraid to know what my picture really looks like.’ It is scary. I was afraid, too. But ... all you have to do is take one step forward.”

One of the most important steps is to determine how much you currently have saved for retirement. Data from Personal Capital shows that the average millennial has a retirement savings of about $169,239, while the average Gen X individual has $576,782.

Once you know how much you have saved, you’ll have an easier time setting specific savings goals.

2. Decide How Much You’ll Need to Retire

One of the most challenging parts of planning for early retirement is determining just how much you’ll need to save. To do so, you’ll have to consider a variety of factors, including your estimated spending during retirement, the age at which you plan to retire, income expectations in retirement and the anticipated growth rate of your investments.

First, take a look at your budget and consider how much you expect to spend each year during retirement. Will you spend more or less than you do today? Certain expenses may be lower — you’ll no longer be commuting daily, grabbing lunch with coworkers, or building a business wardrobe. On the other hand, you’ll have to pay for healthcare out of pocket. Additionally, many people retire early so they can travel, which is a considerable added expense.

Once you have an estimate of your annual retirement spending, it’s easier to figure out how much to save. A general rule of thumb is that you should have 25 times your annual spending saved in order to retire. This rule stems from the calculation that says you can withdraw roughly 4% of your invested savings each year without running out of money.

The final aspect to consider is how much you must actually save each month to retire at your planned time. To know this, you’ll have to estimate income that may offset your spending in retirement, and the expected growth rate of your investments. Historically, the stock market has seen an average annual return of about 10%. The growth you see may be less, depending on how much of your portfolio you have in stocks versus lower-risk investments.

3. Reduce Your Living Expenses

Studies consistently show that the majority of Americans are living paycheck to paycheck. In other words, while they might be making ends meet, there isn’t much left at the end of the month. Unfortunately, that isn’t enough to achieve early retirement.

In order to reach early retirement, most people save a significant portion of their monthly income. In fact, many aspiring early retirees live on 50% or less of their income.

“You really need to be close with that budget — to know everything that’s going out at any given time,” Simmons said. “For me, I do live on way less money than I make, and that’s what’s enabled me to invest so much of my money. But I am truly enjoying my life.”

To reduce your living expenses, look at each part of your budget. The obvious places to cut are often discretionary expenses like travel and eating out. But reducing your biggest expenses can make the most significant difference. Can you refinance your current mortgage at a better rate? Or find a smaller home with a lower monthly payment? Can your household live with one car or without a car so that you’re reducing car payments and costs related to insurance, gas, and maintenance?

As Simmons shared, you can still enjoy your life while living on a budget. Reducing your expenses doesn’t have to mean depriving yourself — it simply means prioritizing your money.

4. Invest to Build Wealth

For most people, saving alone isn’t enough to reach their retirement goals. This is especially true for those seeking early retirement who need their money to grow even more quickly. Instead, it’s critical that you put your money to work for you by investing.

Many early retirees use a combination of tax-advantaged retirement accounts and taxable brokerage accounts, investing in low-fee index funds. Investing in both taxable and tax-advantaged accounts ensures you’ll have enough money set aside for your later retirement years, while still having funds available to retire before the normal age.

While it might seem like only large contributions to your investment accounts can really make a difference, small deposits made regularly can go just as far.

“Any time I get any little extra money, I invest it,” Simmons said. “And that is how I was able to reach financial independence so quickly — because I was focused on becoming financially independent.”

5. Plan Ahead

Thorough planning is one of the most critical steps to early retirement. Not only is there a significant amount of planning required to identify and reach your target savings goal, but there’s also planning required for your post-retirement life.

Planning for future income

Reaching your net worth goal is one thing, but it’s an entirely different thing to determine how you’ll turn those savings into regular income. Many people can generally expect some income from Social Security, but most will need to supplement from savings. Generally, there’s three buckets to consider when supplementing your income in retirement - taxable investments, tax-deferred investments and tax-free investments. 

For those who plan to retire early, taxable investments are critical as individuals must pay an additional 10% early withdrawal tax on tax-advantaged investments unless an exception applies. In a taxable account, there are normally two ways you can earn an income: capital gains and yield.

Many early retirees also continue to work in some capacity. For them, retiring early simply means leaving their 9-5 jobs, leaving time to focus on personal projects or jobs they’re passionate about that perhaps don’t pay as well.

Planning for health care

A significant number of workers in the United States receive health insurance from their employers. And once you leave the workforce, health insurance may be more difficult (and more expensive) to secure. Because early retirees aren’t yet eligible for Medicare, there are a few alternatives they can consider:

  • Health insurance through the Affordable Care Act
  • COBRA coverage
  • Private health insurance plans

Planning for an economic downturn

Retiring early comes with its fair share of risks. First, when you set your savings goal, you’re making an assumption about your expenses during retirement. You’re also often relying on the performance of your investments to support you.

If you find yourself in a situation where your expenses drastically increase, or your investments lose a large portion of their value overnight, you’ll need a backup plan.

Some early retirees keep several years of living expenses in a savings account, so when the market is down, they can avoid having to sell investments at a loss. You may also consider whether you’d be willing to return to the workforce in some capacity if the situation warranted it.

As with many big financial decisions, there are no guarantees when it comes to early retirement. But proper planning can help to create the peace of mind you need to give you the financial flexibility you desire in retirement.

Ready to accelerate your retirement plans? Please visit FirstMidwest.com/Wealth today.  

This article was written by Shannon Lynch from Benzinga and was legally licensed through the Industry Dive publisher network. Please direct all licensing questions to legal@industrydive.com.

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