Many of us dream of retiring early, which may mean different things to different people. If you get an early start, you’ll have a better chance of achieving that goal.
For example, someone who begins working right out of college at the age of 22 and retires at the age of 65 has 43 years to save for retirement. According to the Social Security Administration, a male’s life expectancy is just over 84 years on average, while woman can expect to live until almost 87. That means a retirement of 20 years or longer from a normal retirement age is possible.
However, if you’re in your 30s or 40s and just starting to save for retirement — or if you’re just behind in general — it will take some extra planning and additional risks to get there.
What does retirement mean?
In our parents’ and grandparents’ generations, retirement typically meant they worked until retirement age (generally 65). When they retired, they stopped working and lived off their savings, employer pensions and Social Security.
However, retirement has evolved, and pensions are rare today. Many people are working two or three jobs to make ends meet and are pinched for spare money to build a nest egg for retirement.
So, where do you start if you’re in your mid-30s with an early retirement date? First, you should get a financial checkup.
Crunching the numbers
You’ll need to crunch the numbers to determine when you can comfortably retire. Set a retirement budget based on your desired lifestyle.
You also will need to take into account all your retirement savings and potential financial resources. That goes beyond savings and retirement accounts and encompasses any other assets that could be converted into retirement income. Also consider other sources of income you might receive, ranging from a pension to Social Security, including any of the below investments:
- Workplace retirement accounts such as 401(k)s, 403(b)s, governmental 457(b)s, pensions, SIMPLE IRAs, etc.
- Roth and traditional IRAs
- Self-employed retirement accounts like SEP IRAs and solo 401(k)s
- Taxable investment and brokerage accounts
- Cash, savings accounts, CDs and similar vehicles
Social Security and pensions
Although Social Security might not seem relevant to people who are retiring early, it can be a good source of income that kicks in during retirement and could help extend other retirement assets at a key time in your life. While Social Security is an income stream you may want to include in your retirement financial forecast, it also makes sense not to heavily rely on it as a large contributor.
Pensions are becoming increasingly rare, especially in the private sector, but they are more prevalent in the governmental and nonprofit sectors. With most pensions, if you work a certain number of years, you become vested in a benefit, but it might not be available until you hit a certain age. Even if you retire early, you may be entitled to a pension benefit, so you should be sure to understand the details.
Once you have taken stock of your financial resources, you will need to figure out how much retirement income those resources translate to. This can be a complicated task, as you will need to make some assumptions about how your investments will be allocated, the long-term returns from your investments and a withdrawal strategy. Evaluating and rebalancing your portfolio should be an annual occurrence.
There are a number of retirement calculators that can help, or you can work with a fee-only financial advisor to help with your retirement plans. You may want to consider Vanguard, Schwab and Financial Mentor, among others. If you come up with a gap between your desired cost of living and your projected income, you will need to make some changes in your savings strategies.
How to retire early by saving
To start, you should take full advantage of employer matching if it’s available. This is free money given to you just for saving for your future. A good strategy is to defer enough each pay period to earn the full amount of the match. For example, if your employer matches 3% of your salary on the first 6% contributed, that is approximately a 50% return on your money.
You should strive to max out your retirement plans by contributing the maximum allowed to your 401(k) and IRA. Contribution maximums vary by plan; for example, a 401(k) has an employee contribution limit of $19,000 for 2019. IRAs have varying contribution limits as well, such as $13,000 for a SIMPLE IRA and $6,000 for traditional and Roth IRAs.
If you’re in your 50s, you have additional options for retiring a few years early. Catch-up contributions are available to those age 50 and older. For IRA accounts, an additional $1,000 can be contributed each year over the $6,000 cap for 2019. For 401(k)s, 403(b)s and some other employer-sponsored retirement plans, an extra $6,000 can be contributed on top of the $19,000 cap for 2019. SIMPLE IRA plans allow an extra $3,000 in catch-up contributions.
Retire early by being frugal
Another way you can rev up your savings strategy is by cutting back on things that burn a hole in your wallet. Cut back on current living expenses to carve out more of your income to devote to retirement savings.
People who are behind on their retirement savings should “increase their savings rate by reducing the Big Three of housing, transportation and food,” said money coach Steven Donovan of Even Steven Money. “Assuming your income stays the same, reducing your major expenses will create the largest gap and fastest way to ramp up your retirement savings.”
Donavan learned by personal experience.
“My personal example of housing is purchasing a multi-unit building in the city of Chicago. We lived on the top floor while renting out the other units in the building for income,” he said. “This eliminated most of our housing costs and allowed us to have a higher savings rate because of it. The money was then added to our investment of choice: paying down real estate or investing in taxable and nontaxable investments.”
Another way to increase the gap between your income and expenses is to start a side hustle or get a second job. Side hustles can serve a dual purpose; as they grow, they might be a vehicle for income when you do retire early that allows you to generate income while working on your own terms in retirement.
Risks of early retirement
Although early retirement sounds glamorous (because who wants to work forever?), there are some trade-offs you should consider. For example, paying for health care that previously was covered by your employer can be a huge expense.
“The biggest factors that make early retirement different from ‘normal retirement’ are health care and where your income or withdrawals will come from,” said Katie Brewer, certified financial planner, virtual financial planner and owner of Your Richest Life. “Medicare doesn’t kick in until age 65, so someone retiring in their 40s or 50s will need to cover their health insurance until age 65 through an individual policy, a spouse’s policy or a health sharing plan.”
There are a number of fees and rules that apply to early withdrawals as well.
“As far as income goes, regular retirement plans have stipulations on when you can take the money out. There is usually a 10% IRS penalty when taking money out of retirement plans before age 59 and a half,” said Brewer. “Someone wanting to retire early will want to save into a nonretirement account, such as a regular brokerage account, to give flexibility on when to take money out without penalty.”
For 401(k) and public sector plans, there are exceptions if you leave your company at age 55 or later. In other cases, you can take advantage of the 72(t) rule. This rule allows penalty-free withdrawals from IRAs, 401(k)s and 403(b) accounts and requires the account owner to take equal withdrawals for at least five years or until they reach the age of 59 and a half, whichever is longer.
The bottom line
Retirement is tough at any age. Early retirees face the challenges of funding a longer retirement period and saving over a shorter period of time. Even if you get a late start, early retirement is achievable, but it will take some serious planning and discipline.