Dreaming of early retirement is a common theme among Americans. Who wouldn’t want to stop working at a relatively young age? Some people think there’s no way for that dream to come to fruition … but there is.
A new movement called Financially Independent, Retire Early, otherwise known as “FIRE,” has made it possible for people to retire much earlier than anticipated. With this, some individuals have the finances to stop working in their 40s and 50s. Without needing to work, they can do whatever they want, whether work on projects, travel, or kick back and relax.
FIRE has redefined early retirement. It’s more about gaining financial independence when you’re ready to retire than it is about leaving your job at a younger age than most.
Achieving Early Retirement
It takes significant work to retire early. That’s why it’s common to see people working well into their 60s because they don’t have much of a nest egg for their “Golden Years.” However, with determination and some innovative strategies, there’s no reason you have to end up in this same situation.
The following five steps will help you attain your goal.
1. Adjust Your Budget
You need to start by adjusting your current budget, including both earnings and spending. Usually, people try to reduce the amount of money they live on by 50 percent. Everything else goes into a retirement savings account.
With FIRE, you can use different strategies to lower your spending. The goal is to pay off all debt, including car and mortgage loans. Simply put, focus on both small and big expenses. This might require some creativity on your part, but it’s doable.
Also, look for additional revenue streams. There are two FIRE groups. First, the lean group focuses on living as lean as possible. Second, the fat group isn’t quite as frugal, and they turn most of their attention to making extra money. That could entail working a part-time job or making good investments.
2. Determine Your Yearly Retirement Spending
The second thing you need to do is determine how much you’ll spend each year as a retiree. If you adjusted your budget, you’re already accustomed to living on less income. So, you can see it’s possible to live comfortably on less money. However, you’ll still need to estimate your retirement spending.
Look at your current monthly spending. Then consider specific things that could go up or down in price, as well as expenses you can eliminate. After coming up with an estimate of your monthly expenses, multiply that by 12. That number is what you’ll need for retirement spending. As a safeguard, increase the spending amount by 10 or 20 percent.
Most importantly, don’t overlook the cost of healthcare and early retirement taxes. If you have healthcare through your employer, you’ll have to pay for insurance yourself after retiring. If your significant other still works, you can go on their healthcare plan, at least until they too retire. If not, check out plans through the Affordable Care Act marketplace or review what private insurance companies offer.
Another possibility is to get a job with a company that offers part-time employees healthcare insurance. Two of the best that FIRE devotees like are Costco and Starbucks. You might even find a policy through an industry association. As a last resort, you could go with COBRA, which unfortunately has high premiums and short-term coverage.
Now, on to taxes, which you want to minimize. To do so requires some strategy. You need to know when and how to withdraw income from your retirement accounts. Many tax-advantaged retirement accounts, including IRAs and 401(k)s, have strict rules. For these, you can avoid penalties and taxes but must wait until you’re 59.5 years of age to make a withdrawal.
To bypass early distribution rules, you might start a series of substantially-equal and periodic distributions. The IRS allows this as long as you follow certain protocols. Since this is somewhat tricky, consider speaking with a financial advisor.
3. Estimate Your Overall Savings Needs
Next, you need to estimate your total savings needs. One option is to save 25 times your planned annual spending before you decide to retire. So, if you’ve estimated spending $30,000 during your first retirement year, using this strategy, you should have invested $750,000 when you retire. Due to inflation, you can anticipate your spending to go up slightly every year, which means you need to keep up with the change.
There’s also the 4 percent rule. With this, you can withdraw that percentage of your invested savings during your first year as a retiree. From there, you’ll need to make adjustments based on the current inflation rate. While neither strategy is perfect, they’re both beneficial in some way.
The best way to estimate how much you need to save is to create a retirement plan. Many FIRE advocates are do-it-yourself types and they want to feel empowered. For them, WealthTrace is a great option to plan for retirement. It allows them to create their own retirement plan and figure out just how much they need to save. It also allows people to save a lot of money vs. hiring a financial planner.
4. Invest to Achieve Growth
When retiring early, focus on investment returns. You’ll need to invest in a balanced portfolio that’ll work toward long-term growth. Probably your best option is low-cost index funds with allocation more toward stocks.
Regardless of when you retire, you want your money to keep growing until you step away from your job. As you get closer to that time, you can move your savings into a safer type of investment. Preferably, do that with one to two year’s worth of expenses, keeping the rest invested.
5. Control Your Expenses
Although you’ve done a lot of hard work to this point, now, you need to keep your estimate in check. If not, you could end up in a bad financial situation. If you want the 4 percent rule to work, you have to stick with it. Remember, it’s not meant to handle large spending increases but rather allow your spending to increase in line with inflation.
