5 Keys to Early Retirement
A good way to start planning for retirement is by solving a simple math equation, but trust me, it’s not that hard:
Years living on retirement income x Annual expenses – Residual income x Future value calculation = Total savings needed at retirement.
Planning for an early retirement is a lifestyle choice. Many of your life and financial choices will have to reflect your plans for you to succeed. We’ve come up with a list of the five crucial components of an early retirement plan.
Start Planning Early
Early planning is the most important part of retiring early. Without enough time to grow, your investments may not be enough to carry you through retirement. Frankly speaking, if you aren’t frugal by nature, you won’t be able to retire early without planning for it early in your career.
Knowing that you plan to retire early will also inform important life events like: purchasing a house, purchasing cars, paying for your kids’ college, and in developing a standard of living. It will be difficult to both keep up with the Joneses and retire early. Knowing that you’ll be enjoying retirement when friends, neighbors, and coworkers are bragging about new cars and expensive vacations will help keep your eye on the ball, and hopefully prevent financial missteps.
Start Saving Early
Planning an savings are two different things. Most retirees who aren’t wealthy business owners will derive the bulk of their income in retirement from investments. While some of these investments might be in non-qualified (non-retirement) accounts, the bulk will be invested through pension plans, 401(k)s, IRAs, and other qualified plans.
It is important to begin contributing the maximum possible in retirement plans each year. Depending on what kind of retirement plan your employer offers, there will be a maximum contribution you can make each year. At minimum, be certain to contribute to the employer match maximum – this is free money! The benefits of contributing to retirement plans instead of private investment accounts are as follows: deductions on taxable income; no capital gains taxes on investment growth; and tax free at either contribution or distribution.
In order to give your investments time to grow, you must begin investing early. To give a couple of illustrative examples:
$5,000 invested in 2011 (a maximum IRA contribution) will grow to $16,088.93 at 6% a year in 25 years. If you invested an additional $416 each month thereafter (to contribute the full $5000 each year), that investment would grow to $304,255 by 2036.The same $5,000 invested 10 years later in 2021, even if you still contributed $416 each month, would only grow to $131,756.02.
It can be difficult to find a $5,000 lump sum to invest each year, however, almost everyone can deduct a portion of a paycheck each month. Even if it is only $100, take it out of your paycheck before you have a chance to spend it. By investing small amounts each month, you reap the benefits of “dollar cost averaging,” which lowers the initial cost of investing.
Own Your Primary Residence
Owning your home is one of the best moves you can make towards an early retirement. Here’s why:
- You will be putting money towards an asset instead of paying rent
- You can reduce your tax burden by deducting mortgage interest
- If you pay off the mortgage before retiring (and you should), you’ll greatly reduce your annual expenses
- You will build capital and net worth, instead of throwing the money away on rent
- Property values generally rise over the long terms and can be only of your best investment options
- A mortgage is a great hedge against inflation
Consider your needs carefully, and don’t buy more house than you truly need. It is far too easy to get caught up buying too much house expecting it to appreciate. As investors learned in the mortgage meltdown, there are no guarantees that a house will appreciate. It is far better to buy a modest house on a standard mortgage than to extend yourself too far financially and lose sight of your ultimate retirement plans.
Commit to a Well-Paying Career
If retiring early is important to you, then you’ll need to commit to a well-paying career early, and start making the big bucks. Living in the United States is not cheap, and you need to start socking away money as early as possible. By having available cash early in your career, you can maximize your retirement contributions, invest early, and purchase your home.
However, if a professional career just isn’t in your future, there are other alternatives. Living within one’s means is crucial to a healthy financial future. Arranging your style of living so as to always have an excess of income is just as good as having a high-paying job. “Lifestyle creep” is an unfortunate side effect of earning more money – one’s living expenses seem to rise in proportion with every pay raise.
Living abroad can also be a way to lower post-retirement living expenses. American and European retirees have flocked to countries like Mexico, Costa Rica, Nicaragua, the Philippines, the Turks and Caicos, and elsewhere to make their retirement dollars stretch farther. Favorable real estate prices and living costs can make developing countries very attractive to retirees on limited incomes. By being willing to live in a cheaper country, you can make your early retirement plan work even without a high-paying career. However, living in developing countries is not for the faint of heart – be prepared to deal with frustrating bureaucracy, different languages, being far from family, and a very different style of living.
Develop a Source of Secondary Income
A great way to decrease the amount of money needed up front for retirement is to develop secondary or residual sources of income. Additionally, a little income each year can reduce your dependency on investments and keep you from drawing them down too much in a bad market. Although we hope never to see another financial crisis, it is very likely that you will experience a recession during your retirement. Being forced to sell investments that have lost significant value can have a tremendous impact on your overall financial picture.
For example: if you were able to save up $500,000 before retirement, those savings growing at 6% each year would only last you 15 years with monthly expenses of $4,200. However, those same savings would last into perpetuity if you were able to find an additional $2,000 a month in income since your income would exceed your expenses.
More and more retirees are choosing to have an active retirement and spend their golden years working a second career. There are many opportunities for retirees with a lifetime of experience to develop a second career. The key is to do something enjoyable and less stressful.
Another option is to invest in rental property early in your plan so that the mortgages are nearly paid off by the time you retire. This way, more of the rental income goes in your pocket, and not to the bank. However, do not underestimate the amount of work involved in running rental properties: finding tenants, maintaining each property, fixing problems, dealing with tenant hassles. Owners who want to spend their time traveling will have to hire a property manager, which will significantly cut into their profits.
Don't Put It Off, Jumpstart Your Retirement Plan Today
A comfortable retirement can only be secured with prudent planning, aggressive saving, and disciplined investing. Online research is a good start, but consider the benefits of discussing your options with a qualified financial advisor. The alternative could mean lost opportunities, higher fees, and lack of discipline. Request a free, no-obligation consultation today.Speak with an advisor over the phone about your retirement plan for FREE.