Key Takeaways
- Normal retirement age is typically 67, but a growing number of people want to retire much earlier.
- Planning for early retirement starts with clearly defining your goals and the amount of money you need to save.
- If you retire early, you’ll have fewer working years to save —and more total years in retirement— which makes investing for long-term growth even more important.
- Working with a trained expert, such as a Certified Financial Planner™ (CFP®) professional, can increase your likelihood of being able to retire early.
Is Retiring Early Realistic?
Most people think retirement is something you do in your mid-to-late 60s since that’s when the Social Security Administration says you’ll reach “full retirement age.” However, a growing number of young professionals, high earners and followers of the Financial Independence, Retire Early (FIRE) movement aim to retire in their 50s, 40s or sometimes even earlier.
Retiring early is not impossible, but you’ll need to have a strategy. Generally, the people who pull off early retirement use multiple tactics, including maintaining a lean budget, maximizing their savings, setting up passive income streams and investing for growth.
Below are six tactics and tips to help you on your journey to early retirement.
Establish Your Early Retirement Goals
Retiring early is a big goal that requires hard work and a thoughtful approach. Your first step is to clearly define your early retirement goals. You’ll need to decide when you want to retire and the lifestyle you want to have once you retire.
Theoretical Scenario
This theoretical scenario explores the financial planning of a 28-year-old who wants to retire at 48. With a life expectancy of 88, they have 20 years to build a retirement nest egg that needs to last for 40 years. By living an active and frugal lifestyle, they can use their current spending as a guide for future expenses.
Determine Your Current and Future Spend
Once you establish your early retirement goals, you’ll need to take a deep dive into your personal finances to see how much you spend on essentials. Consider if there are any major cash outlays that may pop up in the future.
If you want to retire early, frugality is critical. Since you’ll have fewer years to save up, it’s important to focus on needs rather than wants. Pinpoint the things you must spend money on to live, such as rent, utilities, groceries, transportation and insurance.
Continuing with the scenario above, let’s assume that you’re 28 years old and you currently spend about $36,000 per year. After adjusting for an annual inflation rate of 3% (the long-term historical rate), this translates to a yearly spend of about $65,000 per year by the time you retire at age 48.
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Estimate How Much Money You Need To Retire
Now that you’ve come up with an annual spend, you can estimate how much money you’ll need to save up for retirement. It’s important that your savings will last through your retirement years, regardless of market conditions from one year to the next. This minimizes your longevity risk, or the possibility of running out of money because you lived longer than expected.
Below are two methods of determining the amount of money you need to retire.
- Rule of 25: This approach specifies you should have at least 25 times your expected annual spend saved at the point of retirement. In our example scenario, you’d need to accumulate $1,625,000 to retire at age 48 ($65,000 x 25 = $1,625,000).
- 4% Rule: This approach assumes you’ll withdraw 4% of your savings during the first year of retirement. Each subsequent year, you can withdraw the computed amount adjusted for inflation. In our scenario, this means you’d need to accumulate $1,625,000 to retire at age 48 ($65,000 ÷ 0.04 = $1,625,000).
Incidentally, a more conservative approach is the “3% Rule,” which uses the same logic described above but builds in additional cushion with a more conservative inflation-adjusted return. In our scenario, applying the 3% Rule would mean you’d need to accumulate about $2,167,000 to retire early.
To gauge whether your savings target is realistic, calculate how close you are to your early retirement goal. Subtract your current savings (including any 401(k) plans, individual retirement accounts, taxable brokerage accounts, bank accounts and other sources of wealth) from your retirement savings target. For example, if you need $1,625,000 and you already have $625,000 saved, you’d need to accumulate another $1,000,000 before you can retire.
Maintain a Lean Budget and Create Additional Income Streams
Saving up enough money to retire early requires more than just a positive mindset. You’ll need to diligently maintain a lean budget and save as much money as possible. Generally, this means living a frugal lifestyle and limiting want-based spending during your working years and in retirement.
You’ll also need to do everything you possibly can to supplement your earnings. This often means launching a side hustle. Perhaps you could leverage your professional experience by establishing a consulting business or joining the gig economy to bring in some extra money on nights and weekends. Maybe you could even monetize a hobby.
For some people, working more may not sound appealing. Fortunately, this is not the only way to supplement your earnings. Generating passive income streams is another practical option. This may require some upfront work, but the effort can yield consistent, hands-off returns for years to come. Examples of ways to generate passive income include establishing an affiliate marketing program, selling educational content online, selling stock photography and investing in financial securities and real estate.
Invest for Growth
As we’ve already covered, retiring early means you’ll have more years to spend in retirement and fewer years to save up. This will require you to save as much as possible and invest your money to capitalize on the power of compound interest.
Generally, the most effective investment approach for someone who wants to retire early is to invest in growth-oriented assets, such as stocks and real estate. Debt investments, including certificates of deposit, bonds and bank loans, also make sense in some situations, but you’ll want to make sure those investments are tilted heavily toward growth.
With any investment strategy, it’s important to be aware of potential risks and embrace diversification whenever possible. A low-cost way to do this is to invest in index funds, exchange-traded funds (ETFs) and real estate investment trusts (REITs) rather than individual securities and real estate properties.
Another way to manage risk is to maintain a dynamic asset allocation strategy as you get closer to retirement. As you approach your planned retirement date, consider gradually tempering your growth-oriented tilt and increasing your allocation to stable-value debt instruments. Alternatively, you could opt to maintain a large liquidity reserve (with enough to cover 12 to 24 months of living expenses) and invest the rest in growth-oriented assets.
To retire early, you’ll need to invest as early as possible and for as long as possible. However, do not forgo establishing and maintaining an emergency liquidity reserve that amounts to at least six to 12 months of living expenses. Park your reserve in a high-yield savings account or money market mutual fund. Right now, the most competitive instruments yield over 5%.
Retirement Accounts vs. Taxable Brokerage Accounts
Retirement accounts, such as 401(k) plans, individual retirement accounts (IRAs) and Roth IRAs, provide powerful tax advantages. For most retirees, maximizing contributions to these tax-efficient retirement savings vehicles makes a lot of sense. However, for early retirees, putting too much money into these types of accounts can actually be detrimental.
This is because the money you put into retirement accounts typically can’t be accessed before age 59½ — unless you pay a 10% penalty. Roth-style investment accounts offer some flexibility with withdrawals (for contributions, not earnings), but the amount of money you’re allowed to put into these accounts is limited to $7,000 annually (or $8,000 annually if you’re 50 or older).
As a result, if you’re planning to retire early, you’ll want to ensure a sizeable portion of your nest egg is fully accessible. Generally, this means diverting anywhere from 25% to 50% of your savings to a taxable brokerage account. You can still own a 401(k) and IRA in early retirement, but you shouldn’t put all of your savings into these types of accounts.
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Partnering With a Financial Advisor
Theoretically, anyone can devise a plan to reach early retirement. However, few people have the knowledge and skillset to implement the plan, and even fewer can objectively maintain it, given the financial and behavioral challenges that are bound to pop up over time.
A smarter approach is to work with someone reputable, such as a Certified Financial Planner™ (CFP®) professional, to help formulate a sensible, risk-conscious plan and establish early retirement investment strategies. Working with a professional will improve the quality of your plan and ensure you have the right tools and controls in place to evaluate your investments through economic ups and downs. Ultimately, a financial professional can help increase the probability that you’ll be able to retire early.
Editor Norah Layne contributed to this article.
Frequently Asked Questions About Retiring Early
A good retirement income varies from one person to the next and will depend on your where you live, your lifestyle preferences, family size, debt level and health. Generally, a good retirement income amounts to around 70% of your pre-retirement annual income.
If you were born in 1960 or later, the Social Security Administration defines “full retirement age” as 67. This is the age at which you can claim full retirement benefits from the government. If you claim Social Security before full retirement age, your benefits could be reduced by up to 30%. The earliest you can start receiving Social Security benefits is age 62.
There are three common strategies of the Financial Independence, Retire Early (FIRE) movement. The “lean” FIRE strategy involves living on as little money as possible to accumulate an adequate and sustainable amount of retirement savings. The “fat” FIRE strategy focuses less on frugality and more on generating the most earnings possible — through high-income jobs, entrepreneurial pursuits, investments or side hustles. The “barista” FIRE strategy is a hybrid approach that involves saving enough money to quit your primary career but still work on a part-time basis — when and how you want.
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