Many people dream of retiring early. Perhaps you want to travel, learn a new skill, or spend more quality time with your family and loved ones. Whatever your reasons, if early retirement is your goal, you’ll want to plan ahead and make sure you’re set up for a comfortable and fulfilled life post retirement.
Retiring early is all about deciding what you want your retirement to look like and developing a comprehensive strategy to put yourself in a financial position to make that vision a reality.
Decide How Much You Need in Savings
Retirement looks different for everyone, so it’s important to start thinking about your specific goals and how much money you’ll realistically need to achieve them. The earlier you retire, the bigger your nest egg needs to be.
Do you plan to travel extensively? How often do you dine out? Be honest with yourself about your expectations and lifestyle and plan accordingly.
Take Inventory of All Your Finances
One of the first things you need to do is take inventory of all your finances to get a broad snapshot of your current financial situation. This involves calculating your net worth and annual expenses. This will help you determine where you need to make changes in order to plan for the future.
Your net worth can be calculated relatively easily by subtracting your total liabilities (debts) from your total assets. You can get a general idea of your annual spending by looking at your credit-card and bank statements, but it’s a good idea to track your expenses more closely, either with a self-made spreadsheet or with an online tool or smartphone app.
Minimize Your Expenses
Building wealth and retiring early is almost impossible if you spend more than you earn. Living below your means and developing frugal spending habits as early as possible puts you in a position to aggressively invest and save.
First, focus on reducing your biggest and most necessary expenses, which may include the following:
- Mortgage or rent
- Child care
Then also aim to reduce your discretionary spending, which includes things like groceries, entertainment, travel, and gifts. Keep in mind that limiting your spending is a lifestyle choice and a long-term goal, and small incremental changes over time can make a big difference to your overall financial wellbeing.
Maximize Your Income
Keeping your spending in check is only half the picture. In order to strategically save for early retirement, you’ll also need to increase your positive cash flow over time. Maximizing your employment income (wages and salaries) before retirement through career development and advancement is always a good idea. However, diversifying your income strategy protects you against risk and provides long-term sources of income.
Take advantage of passive and portfolio sources of income while you’re still working and during retirement. These sources may include dividends, interest, royalties, capital gains, and real-estate/property income.
Max Out Your Retirement Accounts Every Year
One of the most intelligent financial decisions you can make is to optimize your savings through retirement accounts. Employer-sponsored retirement accounts and IRAs offer substantial tax advantages and investment growth potential. Just keep in mind that there can be restrictions and penalties associated with withdrawing money from your 401k. A Roth IRA, however, allows you to withdraw contributions tax-free, since the money has already been taxed.
Pay Off Your Mortgage and Any Debts
Become liability-free by eliminating any consumer debt and paying off your mortgage. While getting rid of any debt with high interest rates should be your first priority, paying off your mortgage as well means you can retire completely and totally debt-free. It also allows you to use the money that would have gone toward your mortgage payments for other purposes.
Make Strategic Investments
If you’re already contributing the maximum amount to your retirement accounts and working toward paying off any debts you may have, the next step is to open a brokerage account. This allows you to invest directly in the stock market.
Your optimal strategy will depend on a variety of factors, including your net worth, your age, and your specific financial goals. Your investment portfolio should be tailored to your exact needs and risk tolerance and actively managed to accommodate changes in market conditions and in your life.
Develop a Realistic Post-Retirement Budget
Once you’ve made the decision to retire early and put yourself in a position to do so, it’s important to develop a budget detailing your retirement income and all your expenses. Do this well in advance of actually quitting your job.
Your expenses will fall into three general categories: essential (monthly bills, living expenses, etc.), discretionary (entertainment, charitable donations, etc.), and one-time expenses. It’s important not to overlook one-time expenses, as they can be costly and add up over time. Common one-time expenses include:
- An emergency (home repair following an earthquake or hurricane, hospitalization following a car accident, etc.)
- A new vehicle
- A child’s wedding
- Home improvement
Consider Your Health Insurance Options
One of the most important things to think about when contemplating early retirement is how you’ll access health insurance. Many people get their healthcare coverage through an employer-sponsored plan; if you decide to retire early, that option will likely go away. One of the reasons many people wait until they’re 65 to retire is because that’s when Medicare coverage kicks in. If you choose to retire before then, you’ll need to figure out how you’re going to pay for healthcare until you qualify for benefits.
Early retirees have a few different options. While rare, some employers offer retiree health insurance, which extends coverage for a fixed period of time or until the former employee qualifies for Medicare. These programs are becoming less and less common, but it’s worth checking with your company’s human resources department. You may also be able to join your spouse’s insurance, if they’re still working.
If neither of these solutions are available to you, your options are generally limited to COBRA (which allows you to continue getting insurance through your former employer for up to 18 months, but you’re responsible for paying the entire premium) or the Health Insurance Marketplace (where you may qualify for a subsidy depending on your income level).
Is early retirement right for me?
Retiring early is a big decision. It takes discipline, hard work, and dedication. But with enough planning and a comprehensive retirement strategy, it's definitely doable. Chatterton & Associates offers comprehensive wealth, tax, and estate planning. Our approach helps streamline your financial strategy to help you create and preserve your wealth to ensure you and your loved ones live comfortably in retirement and for generations to come.
The Team at Chatterton & Associates
Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Federal tax laws are complex and subject to change. This information is not intended to be a substitute for specific individualized tax or legal advice. Neither Royal Alliance Associates, Inc., nor its registered representatives, offer tax or legal advice. As with all matters of a tax or legal nature, you should consult with your tax or legal counsel for advice.