How to Retire Early: 9 Steps, What to Know
If you’re considering early retirement, here’s what to know to prepare your financial plan.
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For many, the idea of early retirement — leaving the workforce before age 62 and enjoying the freedom that comes with it — might seem aspirational. For others, life might have thrown a curveball that made retirement arrive sooner than expected.
Whether early retirement is a goal or an unforeseen challenge, taking steps now can help put you in the best financial position for any uncertainties down the road. Here's how you can strategically prepare your financial plan if you're curious about early retirement.
What is early retirement age?
In general, early retirement usually refers to retiring before the Social Security Administration’s full retirement age, which is the age at which one can receive full Social Security benefits. That’s age 66 or 67, depending on your birth year. People who pursue early retirement may define it differently, perhaps as retiring in their 40s, 50s or even earlier, depending on their individual goals.
» Want to know if you can retire early? Jump to our early retirement calculator to find out.
What to know about early retirement
Retiring early requires a lot of work, primarily because you need to ensure that you can self-fund your lifestyle.
The earliest that you can start receiving Social Security benefits is at age 62. However, it’s important to know that your monthly benefit will be reduced if you claim Social Security before the age of 66 or 67. Dipping in early could lead to a reduction of up to 30% in benefits, depending on how far away from the full retirement age you are.
In addition to Social Security limitations, there are also rules around when you can start taking distributions from your retirement accounts. The main rule (with a few exceptions) is that you can’t withdraw from your retirement accounts, such as a 401(k) and IRA, before age 59 ½ without potentially incurring taxes and penalties.
» What to know about traditional IRA withdrawal rules
How to retire early in 9 steps
1. Estimate how much money you’ll spend
Your current cost of living provides some foundation for estimating your retirement spending. For a rough estimate of your future living expenses, look at your current monthly spending and consider what will go down, what could go up and what might be added or eliminated altogether.
Add your final monthly expense estimates up, multiply by 12 and you’ll have a rough estimate of your annual retirement needs. If adding some cushioning is important to you, consider increasing your estimate by 10% to 20% so you have some wiggle room to splurge every once in a while or take care of surprise expenses.
2. Estimate your total savings needs
Half of retirement planning is figuring out your spending — the next is figuring out how much you need in savings. There are a few rules of thumb used by early retirees to figure out how much they might need to stash away.
Rule of 25: The first is the rule of 25, which operates on the idea that you should have 25 times your planned annual spending saved before you retire. That means if you plan to spend $30,000 during your first year in retirement, you should have $750,000 invested when you walk away from your desk. If you plan to spend $50,000, then you need at least $1,250,000.
The rule assumes that your retirement nest egg is invested so it continues to grow — after all, thanks to inflation, your spending will increase at least slightly each year, and your investments need to keep up with that.
The 4% rule: This brings us to the second rule, which indicates you can withdraw 4% of your invested savings during your first year of retirement. Each year after, you draw that amount adjusted for inflation.
The 4% rule stems from research in the 1990s that tested a variety of withdrawal strategies against historical market conditions. You may want to take a more or less conservative approach, depending on your investments, risk tolerance and how the market is performing when you retire.
But there remains this disclaimer: Neither of these rules is foolproof. You’d be hard-pressed to find a financial advisor willing to guarantee your results. But they’re generally considered reasonable strategies, or at the very least, starting points to help you think about how much you'll need to save for retirement.
» Confused about inflation? Use our inflation calculator
3. Have a plan for taxes and healthcare
Two things that are frequently overlooked during planning — both of which could put an early end to your early retirement — are taxes and health care.
Health care, in particular, is a real hitch in many plans, especially for those who get their health insurance through work. Leaving your job means leaving your policy behind. If you’re married and your partner is still working, one solution is to join their plan. Otherwise, you could research purchasing private insurance or search for a plan through Healthcare.gov.
You could also look for part-time work with health coverage — some companies extend health insurance to part-time employees — or see if you qualify for an industry association that offers group coverage. COBRA, a costly way of temporarily continuing your workplace policy by covering all the premiums yourself, is also an option.
As for taxes, the goal, as always, is to minimize them. To do that, you’ll want to strategize how and when you pull income from your investment accounts.
Keep in mind that many tax-advantaged retirement accounts, such as 401(k)s and IRAs, have rules for when you can take qualified distributions. In most cases, withdrawing requires a minimum age of 59 ½ to avoid taxes and penalties. (The exception: Roth IRAs, which allow you to distribute contributions — but not earnings — at any time.)
There are a few exceptions to the early distribution rules. One popular strategy among early retirees is to start a series of substantially equal periodic distributions, which are allowed by the IRS, provided you follow specific protocol. You might consider working with a financial pro to develop a strategy for tapping your investments while avoiding taxes and penalties where possible.
» Compare our picks for the best financial advisors
4. Make a plan to eliminate or reduce debt
Without a steady paycheck, regular mortgage or car loan payments can become a financial liability. As part of your financial preparation, assess all outstanding debts, including mortgages, credit cards and other loans, along with which ones have the highest interest rates for priority repayment. You can also take into account which debts can be refinanced or consolidated to streamline payments or receive a lower interest rate to help you square away as much as possible before retirement.
5. Make adjustments to your current budget
No matter how you want to slice it, retiring early means making some changes to how you currently earn and spend money so that you can afford more financial flexibility in the future. For many people, that means cutting their budgets to the bare minimum. Many people with early retirement ambitions aim to live on 50% of their income (or less). The rest gets funneled into savings.
Those who follow the FIRE (“financial independence, retire early”) movement adhere to certain principles to help them achieve early retirement. The strictest followers save up to 50% to 70% (or more) of their take-home pay, cutting out large and small expenses to make it happen. There are also different types of FIRE, which could help spark inspiration for how to save money on transportation, utilities, food and housing costs.
6. Make use of tax-advantaged accounts
Maximizing tax-advantaged accounts can help you ensure you spend the most of your money on your expenses instead of taxes. Contributing as much as you can toward retirement accounts, such as a 401(k) and an IRA, as well as a health savings account, can help those investment gains compound over time. If you’re 50 or older, consider making the full catch-up contribution to help grow your nest egg faster.
For high earners, your contributions to a Roth IRA might be limited or reduced based on your annual income. If that’s the case, a backdoor Roth IRA conversion could help you transfer funds from your traditional IRA to a Roth IRA.
» What else to know: How to set up a backdoor Roth IRA
7. Invest for growth
When it comes to investments, retiring early means two things: (1) you have a shorter period during which you can save, and (2) you have a longer period during which the money you’ve saved needs to support your spending.
Both of those mean investment returns are going to be your best friend. To achieve the best returns, you need to invest in a balanced portfolio geared toward long-term growth. One option could be low-cost index funds with an allocation that is tilted toward stocks for as long as you can stomach it.
You may think the opposite is true: Because you have a shorter time horizon before retirement, you might want to take on less risk. But it’s important to remember that the time you spend in retirement should be included in that horizon — you might be retired for 50 or 60 years; you need your money to continue to grow during that time.
As you approach your planned retirement date, you might want to shift a small amount of your savings into safer, more liquid accounts so you can tap it without worrying about selling investments at a loss. Perhaps you do that with a year or two’s worth of expenses. But consider leaving the rest invested, slowly shifting to cash as you need it, so your money grows and supports that 4% distribution rate discussed earlier.
» Need guidance? Learn more about how to invest in stocks
8. Consider other sources of income
It's also wise to find ways to bring in some extra income that can go directly into your early retirement coffers. For some, planning an early retirement means saving enough to retire and working only when they want to or when the circumstances are convenient for them.
If you haven’t started taking Social Security, a side hustle or part-time job won’t affect your benefits. (But be aware that if you’re under the full retirement age and already collecting, your benefits could be reduced.)
» MORE: Explore new ways to make money
9. Keep your expenses in check during retirement
You’ve done a fair amount of work estimating how much you’ll spend in retirement. The harder job will be actually sticking to that estimate.
After entering retirement, you might find yourself with some extra time on your hands. New pastimes such as vacations, shopping, hobbies or even adopting a new pet could increase your rate of spending beyond the recommended 4% rule (or any rule that you set for yourself).
While occasional splurges are expected, making it a regular occurrence could put a strain on your finances. The 4% rule is designed to keep pace with inflation but not to withstand large spending increases beyond that.
Each spending increase — particularly recurring expenses, like a new debt payment — increases your likelihood of running out of money and going back to work.
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