Clearly, the idea of early retirement is having a moment. But whether early retirement means a headlong dash to the beach in your 30s, or simply leaving the workforce on your milestone 50th birthday, the basic problem is the same: How do you fund your lifestyle during the years after you have given up paid employment, but before your retirement savings and Social Security are available to you?
The first gap is the length of time between when you leave your job and when you are 59 ½ years old. That is the first age at which you can usually access your retirement account savings penalty-free. With that said, it may be possible to use the “Rule of 55” to withdraw penalty-free from the workplace retirement plan of your last employer at the age of 55. The second gap is the period between when you are able to access your retirement savings, and the age at which you are able to collect a Social Security benefit. (The issue of when it is “best” to take Social Security is an entirely different discussion.)
The first planning question to conquer is entirely straightforward: “How many years of expenses will I need to fund between my 59 ½ birthday and my goal retirement date?” But the next question is going to involve more thought: “How much do I expect to spend each year?”
Start by looking at your expenses today and listing which ones you expect to still be with you on your target retirement date. For example, if you have children, expenses related to child-rearing and education may be over. You may intend to pay off your mortgage before your early retirement date. On the other hand, your expenses for health insurance will likely jump considerably.
How will you spend your time? Fishing in a nearby stream, or circumnavigating the globe? This step — figuring out what early retirement will look like — is easily the hardest part of the planning exercise. Don’t expect that you will have all of the answers at the start. Keep asking the question, and as your vision becomes clearer, adjust your projections accordingly.
Whatever you decide your total is today, now you will need to increase this amount to account for inflation between now and your projected retirement date. (Here is a simple calculator that you can use for this purpose.) Do not forget this important step!
Alright, you know how many years the first gap will be and you know the inflation-adjusted dollar amount you will need for that first year. If you simply multiply one by the other you have a very rough starting point. It’s still rough because, for example, you have not included the inflation that will occur during those gap years. Still, you have a decent starting point and if this dream is years away, that is probably good enough for today. At another time, you can refine this calculation…
…Because now you are anxious to get on to the fun stuff! How much do you need to save each year to reach the goal that you just roughly calculated? Where and how should you save it? You can use this simple Savings Goal calculator to answer the first question. But to make that calculation, you will need to take a guess at what your savings will earn. And that leads us to the second question: How do you invest for early retirement?
As a general concept, your timeline will determine the answer. If this dream of early retirement is many years away, you will likely want to invest more aggressively (think more stocks and less bonds). On the other hand, if the target date is nearby (let us say 10 years or less), then you will likely prefer a less risky investment choice; if the value of your investment falls, you do not have very much time to recover. And here’s the other thing: As the years pass and your retirement goal date draws nearer, how you invest will need to change as well. Your timeframe for investing draws shorter with each passing year. You could reasonably start with 8% as an estimated return (the historical average return for a balanced portfolio of stocks and bonds), and adjust up or down from there based on your own viewpoint and timeline.
The “where” part of the question follows from the “how” above. Likely you are angling for some mix of stocks and bonds. That means opening up a regular, taxable brokerage account. “Taxable” because, unlike your IRA or workplace retirement account, you will pay tax annually on anything that you earn within this account from dividends, and if you buy and sell during the year, capital gains. Working with a professional who is licensed to give specific investment advice (which could be a robo-advisor, by the way), you can easily create a portfolio that matches your risk preferences and timeline for early retirement.
I have gotten you to your 59 ½ year birthday. From here, the exercise is conceptually the same. If you assume the same expenses (inflation adjusted), how much of this can be covered by your retirement savings, or pension if you have one? (Don’t forget that you likely turned off your retirement account contributions early.) While the well-known “4% rule” is certainly not a precise recipe for how much you should withdraw each year from your retirement savings, it can give you a general, back-of-the-envelope sense of whether your retirement account nest egg is likely to be sufficient for your purposes. Estimate the income stream from your future retirement nest egg here, and compare that to your projected expenses. Do you need to save more in your retirement accounts to fund this second gap?
This has been a lightning fast review of what will ultimately be a more complex series of decisions. But if early retirement is on your radar, don’t hesitate to start playing around with the numbers today. The everyday decisions that you will make over many years will be influenced by this goal. Even a ballpark plan, just to put a bit of definition to your dream, is good enough for right now if early retirement is still more than a decade away. And we are here to help you make that plan!
While we don’t give investing advice, Hey Money is there to help you understand all the steps you need to take to have the retirement you hope to have. To start your relationship with a Hey Money expert, go here!