Retirement – it’s the ultimate goal of most hard-working Americans. Early retirement means fast-tracking to achieve that new lifestyle within a shorter timeframe. Believe it or not, being able to retire early can be done – with some careful planning and staying committed to your goals.
If retiring early is one of your goals, it’s important to gain a comprehensive understanding of what the journey entails. To help you get started, we’ve created a straightforward guide that details 5 ways to retire early. By following the steps that we’ve outlined, you can develop a customized plan to accelerating the path to your golden years.
What is Early Retirement?
To some people, early retirement means they’ll stop working at age 55 or 60; to others, it can mean as early as 35 or 40. Basically, early retirement means retiring before you turn 65, which is the usual statutory retirement age for workers in the U.S.
Retiring in your 30s or 40s may sound impossible to some people. After all, Social Security doesn’t kick in until at least age 62. And, most people’s retirement savings are locked up in retirement plans that don’t allow for penalty-free withdrawals until age 59½.
However, increasingly more people are modifying their life plans so they can retire anytime they want. The popularization of the Financial Independence/Retire Early (FIRE) movement has helped large numbers of people—namely millennials and Gen Z-ers—make strides toward retiring early.
All this to say—retiring early is possible. To learn what it would take for you to achieve this dream, keep reading to discover 5 ways to retire early.
Learn to Retire Early the Right Way
Unfortunately, most people form their early retirement plans using faulty logic without even realizing it. They begin their planning with a number in mind: “If I can save up $1 million,” they think, “I’ll be able to retire early.”
However, this type of goal setting isn’t very effective, if you want to achieve an early retirement that you’ll comfortably enjoy. This is because saving up $1 million (or any arbitrary retirement savings number) without proper future forecasting doesn’t give an indication of the lifestyle you’ll be able to live. Consider the following scenarios.
For example, imagine you live in a nice, 3,000-square-foot home in the Washington D.C. Metro area. You’re within walking distance of your favorite local hangout spots. You drive a nice car and can take a luxury beach vacation every summer. A $1 million nest egg, while seemingly a cushy savings balance, may not be enough for you to continue enjoying the lifestyle you’re accustomed to.
If, on the other hand, you live in a small townhome in Springfield, Missouri, a $1 million nest egg might be plenty to live on. Your townhome is located just a half mile from your workplace, so you can bike or walk to work most of the time. And you’re more of a homebody anyways, so you don’t like traveling to exotic locations when you’re off work. You’d rather spend time at your local golf course with your friends.
As you can see, retirement plans can differ drastically from one person to another. Each person’s financial roadmap includes different levels of income, sacrifice, and strategies to get there. To truly learn how to retire early, you have to plan for what your early retirement looks like—and then create a financial plan to get there.
How to Save Money for Early Retirement
When you’re just starting to learn how to retire early, saving enough money for early retirement can feel overwhelming. But with a few lifestyle modifications and commitment to your goals, saving money for early retirement can be within your reach.
Of course, saving money for early retirement will likely require some sacrifices. Most people working toward early retirement increase their income, reduce their expenses, or both.
Fortunately, there are many ways to save money for early retirement. As you learn more about how to retire early, you can choose to save money in ways that best align with your lifestyle.
For example, some people find that focusing on cutting their expenses and paying off debt frees up a huge amount of money in their budget. Eating out less, curbing unnecessary shopping sprees, and taking fewer extravagant vacations are cost-cutting examples that can make a big difference in your finances. Others opt to downsize their homes or sell their car, opting for less expensive modes of travel like walking or biking to work.
If cutting expenses feels impossible—perhaps you already live frugally—increasing your income is another way to boost your savings for early retirement. To find out ways to increase your income, consider seeking out new employment, side hustles and/or methods to earn passive income. Learning what others have done that may align with your personal goals.
How to Save Money for Early Retirement
The key to retiring early is to devise a simple plan and follow it—it doesn’t have to be more complicated than that. So, if you want to really learn how to quit your job sooner rather than later, these 5 ways to retire early can help you create an effective plan to get there:
- Set specific goals
- Evaluate your income and expenses
- Create an early retirement budget sheet
- Research 401(k) plans, IRAs, and investment options
- Start an early retirement savings account
1. Set Specific Goals
Early retirement may be your overall goal, but if you truly want to learn how to retire early, your goals have to be defined and actionable. Don’t be afraid to dream big. Even if your goals seem ambitious, put them in writing. You may find that figuring out the nuts and bolts of your early retirement plan shows you just how attainable those goals actually are.
To determine specific goals for early retirement, consider the questions below. I recommend using a journal to answer these questions—research shows that writing your goals down increases the likelihood that you’ll achieve them. And as you embark on your journey, you can return to your writing to reflect on your progress, adjust your goals, and celebrate your achievements.
- How do you picture your early retirement in a broad sense? Will you travel? Start a business? Spend more time with loved ones?
- What are you excited to accomplish in early retirement? What activities, adventures, or challenges will you pursue to create a sense of purpose in your life?
- What will your day-to-day life in early retirement look like? How will you spend ordinary days? How will you fill your time?
- Who else will be a part of your early retirement journey? Who will you need or want to provide for? (This may include a spouse, children, grandchildren, pets, and even charitable giving goals.)
- What are your health and lifestyle goals for early retirement?
Answering these questions will help you set more specific intentions for your early retirement dreams. Once you have more tangible goals, you can better identify the numbers you need to make your early retirement dreams a reality.
2. Create an Early Retirement Budget Sheet
Identifying specific goals helps you more accurately estimate your expenses in early retirement. For instance, if you want to travel the world, your monthly budget will need to be fairly large. On the other hand, your budget may be more flexible if your vision involves starting a business.
Either way, your specific goals should give an indication of the lifestyle you’d like to enjoy so you can plan for the associated costs.
List anticipated expenses
Begin by listing your expected expenses for the early retirement lifestyle you’ve envisioned. Some common expenses may include:
- Mortgage/rent (unless you’ll have your mortgage paid off)
- UtilitiesGroceries and household supplies
- Transportation costs
- Insurance premiums
- Medical/dental expenses
- Home and auto maintenance
- Dining out
- Emergency savings
You may have expenses in addition to the ones included above. Make sure to add those to your list as you think of them. Once you have a complete list—with numbers included—add the expenses together to determine how much income you’ll need on a monthly basis.
Estimate your early retirement savings number
Multiply your expected monthly expenses by 12 to figure out how much annual income you’ll need. To estimate how much you’ll need to save, we’ll use two popular rules of thumb that can help you figure out a ballpark number for your early retirement savings goal.
The first rule of thumb to follow is the rule of 25. The rule of 25 states that you should save about 25 times the amount of your planned annual spending. So if you plan to spend about $75,000 in your first year of early retirement, you’ll need a savings of about $1,875,000 to make that happen. The rule of 25 assumes that your savings are invested for growth. Due to inflation, your spending needs will likely increase each year, so your investments need to keep pace.
The second rule of thumb is the 4% rule. The 4% rule, based on 50 years of market data (from 1926 to 1976), states that a retired person can withdraw 4% from their invested retirement account each year (adjusted for inflation). The retirement account could reasonably be expected to last for 30 to 50 years following this withdrawal rate. Using the example above, 4% of $1,875,000 is $75,000.
It’s important to remember that both these rules of thumb are just that—rules of thumb. They can be used to determine a general estimate of your retirement savings number, but they should not be considered guarantees of your actual needs. You may need to also seek the advice of a financial professional to gain a more solid understanding of what you figures need to be.
3. Evaluate Your Income and Expenses
Now it’s time to really scrutinize your current financial situation. Assessing your current income and expenses will help you in two ways. You’ll discover how much you’re able to save each month, and you’ll be able to identify what changes you can make to help you save more.
Begin by listing all of your current income sources. Include wages from a job, supplemental income from a side hustle, dividends from investments you hold, and anything else that adds money to your bank account.
Next, create a budget for your monthly expenses. Track how much you spend each month and where that money goes. This information will help you identify categories where you can cut back your spending so that you can save more for early retirement.
If you find there’s a gap in the amount of money you’re able to save and the date you want to retire, you have two options: You can either cut your expenses or you can increase your income.
While cutting your expenses is certainly a worthwhile endeavor, there may be only so much you can cut. Many people who plan to retire early also find ways to increase their income so they can reach their early retirement goals faster.
4. Research your Investment Options
No matter how much you cut your expenses or increase your income, you usually can’t rely on simple savings to gain early retirement. Typically, you have to invest your savings for growth. Your asset allocations may need to lean more heavily toward growth assets so you can make up for the fewer amount of years you have to save and benefit from compound interest.
To invest your savings and allow your savings to continue to grow even after you’ve retired, you’ll want to research your investment options, including the types of accounts you’ll keep your investments in as well as the actual investments you’ll make.
Employer-sponsored retirement accounts
First, research your company’s retirement benefits options if you have access to a 401(k) plan or similar employer-sponsored account. If your employer offers a matching contribution, you should plan to contribute at least the minimum amount to receive the maximum match from your employer. You don’t want to leave any “free” money on the table.
Individual retirement accounts (IRAs)
In addition to an employer-sponsored retirement account, many people choose to open an Individual Retirement Account (IRA). An IRA may provide you with more investment options than the ones available through your company plan. An IRA also allows you to contribute more to your retirement savings if you’ve met the annual contribution limit for your employer-sponsored plan.
When researching IRAs, consider whether it’s in your best interest to open a traditional or a Roth IRA—or both! A traditional IRA allows you to contribute money pre-tax, meaning you can deduct your contributions in the year you make them. You’ll pay taxes on your withdrawals once you retire. In the meantime, these larger contributions have a longer amount of time to grow.
A Roth IRA allows you to pay taxes on your contributions now—you won’t have to pay taxes down the road when you withdraw the money from your account. And because you’ve paid taxes early, your investments can benefit from tax-free growth.
At Lafayette Federal, you can open a traditional IRA, a Roth IRA, and/or put money into IRA certificates (fixed and variable options available). Our options allow you to spread your retirement savings over different types of IRAs for both tax diversification and asset allocations.
Most people who plan to retire early also contribute to a brokerage account. Retiring early means you’ll most likely need to access your retirement savings before age 59½, but the IRS imposes steep penalties if you withdraw the funds from the account before then. While investments in a brokerage account don’t benefit from tax advantages, they allow early retirees to make penalty-free withdrawals before they turn 59 ½.
When researching brokerages, you should consider a variety of factors, including the account minimum requirements and fees, as well as the brokerage’s online features, ease of use, educational resources, and customer service. To begin researching brokerages, consider this list of the best online brokers for beginners from Bankrate.
In addition to researching which retirement and brokerage accounts are best for you, you’ll also need to research the best investment options for your goals. Keep in mind that employer-sponsored retirement plans (although not all) may limit your investment options. Check with your specific plan documents to find out what your investment options are.
IRAs and brokerage accounts typically allow investors to choose from the full range of available stocks, bonds, mutual funds, exchange-traded funds (ETFs), and other assets. When it comes to retiring early, cost-effective investment options like ETFs and index funds can sometimes be your best choice.
5. Start Your Retirement Savings Account
Once you know how much you need to save to reach your early retirement goal, don’t wait to get started. Investments do best when they have time to grow from the power of compound interest. Early retirement means you’re already working against the clock.
If you follow our recommendations, you’re on the right path to developing a plan for your early retirement. The retirement accounts at Lafayette Federal Credit Union were created to help you reach your retirement goals with confidence. In addition to traditional and Roth IRAs, we also offer fixed and variable IRA certificates that you can use to earn dividends up to 3.55% APY without risking your savings.
To learn more about the IRA options at Lafayette Federal, give us a call at 301-929-7990 or (toll-free at +1 800-888-6560) or send us an email at [email protected]. A Member Service Representative will get back to you within 24 to 48 business hours.