Do you dream of the day when you can finally call it quits and spend your days exactly how you want? Traditionally, “retirement” meant working for decades then living out our golden years traveling, spending more time with loved ones and pursuing our hobbies.
But imagine if you could push up that timeline five, 10, or even 20 years. That’s what early retirement is all about. Retirement is centered around the concept that you can achieve enough financial independence through passive, unearned income each year to cover all of your living expenses until you die. And doing so early enough while you have lots more time to enjoy your freedom? That sounds even better.
Saving for retirement is always a great idea, regardless of when you plan on retiring. But is early retirement the right fit for you? It all depends on your personal preferences, values, and lifestyle. How aggressive are you willing to be in reaching your financial goals? What risks or sacrifices are you willing to make?
What Is the Early Retirement Movement?
Also referred to as the FIRE movement (financial independence, retire early), the early retirement movement is based on the idea that it’s possible to quit working while younger (i.e., not have to wait until you reach traditional retirement age such as 65 or 66) if you have certain savings and passive income measures in place. Some participants in the FIRE movement continue working part-time, while others retire completely.
For current generations, the concept of early retirement is particularly appealing. The job landscape has changed over the past few decades — young people are no longer working for just one or two employers their whole life, and they can’t necessarily rely on a pension and guaranteed Social Security to cover most of their income in old age.
Instead, many people are bouncing from job to job, deciding to be self-employed, or participating in the gig economy, all of which make saving for retirement a different, more individualized endeavor. Early retirement allows people to take the retirement planning process into their own hands and push up the timeline if they want.
Although many FIRE devotees strive to retire as early as 30 or 40, early retirement can also mean retiring at 50 or 55. Early retirement boils down to understanding the various factors that contribute to financial independence and figuring out how quickly or slowly you’d like to achieve them.
Retirement Calculations Made Simple
There are three primary factors that need to be taken into consideration if you’re considering early retirement:
- Your ongoing income from investments and retirement accounts (as well as businesses and real estate).
- Your lifestyle expenses.
- The number of years you anticipate having in retirement following your desired retirement age.
(Your annual rate of return is also important, but not as important as these three components.)
Have you ever tried to lose weight? If so, you’re likely familiar with the simple math it entails: Your calories consumed need to be less than your calories burned. To achieve a balanced weight, you monitor these numbers, making sure you burn about as many calories as you eat.
The math for retirement can be thought of in a similar way. The amount of money you have coming in should be more than the amount of money you have going out — for the rest of your life.
Here are the primary factors to consider when making calculations for early retirement:
Money Coming In
By definition, retirement means you’re no longer working. This means the money you have in retirement comes from passive, unearned sources, such as:
Portfolio income. Your savings and investments are throwing off interest and dividends, and perhaps you are also selling off your investments a bit at a time.
Rental/business income. Also referred to as “net cash flow,” one source of passive income is money made through a rental property or business. Perhaps you invested in real estate and your assets are earning you income after expenses. Or, maybe you have a business that runs profitably and smoothly without too much of a time commitment from you. These are both examples of passive income in retirement.
Guaranteed income. This includes things like pensions, insurance products (like annuities), fixed-income investments, Social Security, and other retirement savings. (Just keep in mind that you cannot draw Social Security until your 60s.)
Money Going Out
When calculating the money you’ll have going out in retirement, you’ll want to take the following into consideration:
Lifestyle expenses. This includes cost-of-living expenses like housing and its associated maintenance, utilities, food and dining, transportation, etc. You can also add in the “nice-to-have” category here, such as travel, clothing, entertainment, gym and personal care, shopping, housekeeping, home electronics, etc.
Taxes. This will primarily include income taxes and property taxes, as well as state and local taxes, if applicable.
Health care. Take into consideration what your health care needs will be, and if you’ll need to cover any children or other dependents on your policy.
Caring for others. Think charity contributions, gifts, education savings for your children, expenses for elderly parents and children, etc.
So, Can I Retire Early?
Early retirement all boils down to your personal habits and earnings. Decide which of the above areas you’re willing to work hardest on. Perhaps you’re committed to saving more aggressively. Or, maybe you’re willing to cut your spending drastically. Maybe you’re committed to doing both. Regardless of the specific strategy you choose, planning for early retirement will likely entail fairly drastic changes to your personal finance habits.
Here’s how to meet your early retirement goal, depending on where you decide to focus your energy.
Money Coming In
If you’re looking to focus more on the “money coming in” category, you’ll have to be dedicated and aggressive in your savings strategy. Below are best practices for focusing on money coming in.
Investing Best Practices
- Maximize your retirement plan accounts by learning to save money aggressively. This is referred to by some as extreme retirement savings.
- A recommended retirement savings rate is 10-20%, but if you’re looking to retire early, you’ll need to save more than that. Can you push yourself if this goal really means that much to you? Can you increase your savings rate to 50%?
- Consider investing in low-cost investment funds with a diversified portfolio of stocks and bonds. While diversifying might result in less of an upside than investing in a winning stock, like buying Apple in 2005, you also spread the market and financial risks across many different companies and investments since not every stock is an Apple. You may not want to risk losing all of your money by investing in one “hot” stock.
- Look into working for a company with a promising future value in terms of stock, stock options, and stock purchase plans.
Rental/Business Income Best Practices
- Learn from experienced investors you trust (not just those hawking books and seminars), proceed with caution, and monitor your investments closely. Investing for rental or business income could quickly become a second job, so it’s important to ensure you’re ready for the commitment.
- For those interested in real estate: Dedicate your spare time to learning about owning and investing in properties. Getting to the point where properties are earning income after expenses (i.e. mortgage, maintenance, vacancies, etc.) requires both capital, time, and even “sweat equity.”
- If you started a business, think of how the business can one day operate without you while still being profitable. Getting to this point has two benefits: 1. You can rely on the cash flow in retirement, and 2. The business will become more attractive to buyers, so you can always cash out that way.
Money Going Out
To retire early, you have to make decisions regarding the degree of security, comfort, and luxury you wish to have in retirement. Here are some best practices to keep in mind if you want to focus your financial efforts on cutting back your expenses.
Where You Live
- Is the house or condo you own high- or low-maintenance? Keep in mind that an expensive neighborhood will mean significant property taxes and upkeep over the years.
- If you’re a renter, is your rent predictable? Or is there a chance that costs will escalate?
- How expensive or affordable is your hometown? Many FIRE converts end up relocating to less expensive towns, sometimes even overseas, to meet their early retirement goals. Since housing is one of the household largest expenses, it’s easy to understand why.
- What are the state and local income taxes in your city? Depending on where you live, these can be a large expense. Is it worth moving to a state that doesn’t have state income taxes, such as Texas or Florida?
How You Live
- What is your current lifestyle like? How do you expect it to change in retirement? Will you pare things down and live a simpler life, or are you more interested in luxurious living?
- Get a hold of your actual spending and figure out which expenses are non-negotiable for you. Then, figure out what you are willing to let go of to meet your early retirement goals.
- Once you’re retired, what sacrifices are you willing to make in order to reduce your spending if you had to?
- Keep in mind that without employer coverage, self-funding your health care can be quite costly when it comes to premiums, deductibles, and out-of-pocket costs.
- Health care costs are increasing each year. Optimal retirement planning should include realistic assumptions regarding health insurance and the various costs related to health care, such as doctor’s visits, insurance co-pays, prescriptions, etc.
Caring for Others
- Ask yourself where you might stand, financially, if something happens and you need to help a relative in need. Could you do it?
- Would you be willing to work a little longer to help save for your child’s education or to pay for your parents’ in-home nursing or assisted living?
Once you’ve taken into consideration your money coming in and going out, there’s a third factor you need to consider: How many years you’ll have in retirement.
Remember: Early Retirement Could Be a Long Time
Before taking the leap and deciding you’d like to join the ranks of other early retirees, it’s important to know what this entails. At the end of the day, early retirement shortens the time you have to acquire passive retirement income, and it gives you more years of spending, or money going out.
You also need to give considerable thought to the implications of early retirement. If you retire at 45, that could mean 35 years (or more!) without work. If you retire later on, say at 55, you could still have 25 or 30 years ahead of you without work.
It’s important to take a close look at your timeline, because retirement is a big step that affects the rest of your life. Sure, you can always get another full-time job if you choose to, but being out of the workplace for a while could affect the feasibility of this. One way to counter this would be by keeping yourself marketable with part-time work.
If you’re primarily concerned about growing stagnant in retirement, you can always consider volunteering or taking classes. After all, there are myriad benefits to staying engaged and active in the community, connecting with a network of colleagues and friends, and using your talents.
Ready to dive deeper into your numbers? Learn about how much you’ll need to save to meet your goals by trying out a few retirement calculators mentioned in this blog post on retirement planning.
Know the Early Retirement Rules and Know Yourself
The average American spends 20 years in retirement, and for some, that’s just not enough time to enjoy freedom from work. Early retirement can be a wonderful thing — so long as you know what you’re getting yourself into.
Saving aggressively to reach early retirement can be achievable for the motivated many, and saving steadily for retirement at a later date is admirable, too. It all depends on your personality, personal finance habits, and future goals.
Figure out how you can achieve your specific financial goals while also looking at what personal values matter to you most. This way, you’ll be on track toward a retirement on your own terms.