The decision to retire early is a very complex one. One the one hand, you will have more time to pursue your passions, travel, and achieve other personal goals, but on the other, you will have less time to earn money and pay off debt while potentially facing Social Security ramifications. Not to mention, some people simply get bored with so much free time on their hands.
However, with proper planning, early retirement can be very fulfilling. Though you may not think it’s feasible, you can retire early if you start working toward the goal early enough and follow some key tips.
1. Live below your means
One of the keys to retiring early is living below your means. In your younger years, it is best to forego some things you wish to do or want to have so that you can prioritize saving.
While total deprivation is unwise, living just beneath your means will allow you to funnel a significant portion of your earnings into investments. To achieve this goal, create and frequently update a budget that accounts for all monthly expenses to figure out how much excess money is left after bills are paid. This discretionary money can be increased by making certain sacrifices, such a finding a cheaper gym or eating at home more often. This extra money should be put into any retirement accounts.
2. Minimize your debt
People who want to retire are often delayed by their debt. While retiring with high-interest debt can put you at risk of bankruptcy, having debt earlier in life can prevent you from saving as much as you need to retire early. In general, you should pay down your high-interest debt as quickly as possible and work to avoid taking on similar debt in the future. After all, interest paid toward these bills would be much better applied to retirement savings accounts.
People with a large amount of high-interest debt may end up paying more in interest than they can save for retirement in a given period. You should always know your current debts and the interest rates on them so that you can prioritize paying off the ones with the highest rates. Then, you can focus on creating emergency funds to avoid the need to take on debt in the future.
3. Invest in your retirement
To retire early, you will need to prioritize contributions to your retirement accounts each year. Ideally, you will max out on your contributions.
In 2020 people can contribute up to $19,500 to a 401(k) and $6,000 to an individual retirement account (IRA). These maximums increase once individuals turn 50. Maxing out retirement accounts annually is one of the most important moves for achieving early retirement, especially given compounding interest in these accounts. If you can, prioritize your 401(k) if your contributions are matched by your employer and then turn to an IRA.
You should also think about opening a taxable brokerage account. While these accounts do not have the tax advantages mentioned above, they provide much more control over how your money is invested so you can achieve more growth. Plus, you can withdraw from these accounts whenever you wish, so it is easy to move money from them into a tax-advantaged option. With a brokerage account, it is important to balance risk with potential return and become more conservative over time to avoid the potential of losing big just before retirement.
4. Address your health care
A challenge that people who retire early face is getting healthcare coverage. While Medicare provides coverage for people who have reached retirement age, early retirees will need some sort of insurance to fill the gap, especially since they will not have options from an employer.
Additionally, the ability to extend an employer-sponsored plan lasts for only a short period of time once you leave your job, so you will need to figure out a different plan. Plus, COBRA is a very expensive option.
Some people may be able to get coverage through a spouse’s employer, but what about when both individuals wish to retire before they reach retirement age? Purchasing private insurance for the gap may be more expensive than you think, so it is important to do some research and make sure that that cost is built into your overall healthcare budget. Do not consider going without insurance, as a medical emergency could put you in serious debt, even bankruptcy.
5. Personalize your retirement plan
Perhaps the most important step in retiring early is being confident that you have enough money to do so. You need to make sure that your savings will last for the rest of your life (which can be many decades for individuals who retire before 65).
First, you will need to figure out your expected annual expenses in retirement, which depends on lifestyle, housing, debt, and many other factors. Then, this number should be multiplied by total life expectancy and increased by about 3 percent each year to keep up with inflation.
If this math sounds complicated, there are several online tools to help. These calculators will also estimate annual returns on retirement account investments. Currently, a conservative yet realistic estimate is about 5 percent or 6 percent, although your money may grow more than this. You can also factor in your Social Security benefits that you will eventually get. Doing this math gives you a savings goal that you can use to determine if early retirement is feasible.