How to retire early

Many workers yearn for the freedom that comes with early retirement. When you retire early, you free up a lot of time to travel the world, start a business, pursue a passion project, or just stop working. However, taking an early retirement means you need to build a sufficient nest egg to maintain your lifestyle in retirement.

If you want to retire early, start by determining how much income you will need in retirement by adding up your key expenses like housing, food, healthcare, etc., and discretionary expenses. Next, evaluate the amount you will need to save to meet your monthly spending. You should then adjust your budget to trim your expenses, and use the surplus cash to max out your retirement accounts or invest in stocks, bonds, real estate, etc. You should create a savings plan and investment plan, and keep your expenses in check.

What is the FIRE movement?

Financial Independent, Retire Early (FIRE) is a financial program where people adopt extreme savings techniques so that they can retire earlier than traditional retirement plans would allow. This concept borrows ideas from the 1992 book “Your Money or Your Life” by Vicki Robin and Joe Dominguez.

The FIRE movement appeals to people who want to gain financial independence, quit work, or are dissatisfied with consumerism. Proponents of this movement aim to save up to 70% of their annual income so that they can retire early and live off small periodic withdrawals from their savings. Typically, FIRE followers aim to withdraw 3% to 4% of their savings annually to meet their living expenses in retirement.

What is considered an early retirement age?

Early retirement age is any age before the full retirement age, which is determined by the federal government. If you were born between 1943 and 1954, your full retirement age is 66, and it rises gradually until 1960. If you were born in 1960 or later, your full retirement age is 67.  

The full retirement age is the age when workers become eligible for federal benefit programs like Social Security. If you retire earlier than the full retirement age, you may be able to access reduced benefits or no benefits. For Social Security, the earliest age you can access Social Security benefits is age 62.

Steps to retire early

If you plan to retire early, here are steps you can follow to prepare for early retirement:

Determine how much income you need in retirement

If you want to retire early, you should start by estimating how much money you will spend when you retire. Add up key expenses that you cannot avoid such as housing, food, healthcare, insurance, and utilities.

Next, add up any discretionary expenses such as entertainment and travel costs. The sum of these expenses will help you know how much money you will need to maintain your lifestyle in retirement.

Your retirement lifestyle will determine whether you will need a bigger or smaller budget. If you want to travel, you will need a big budget to finance your air tickets, hotels, meals, insurance, etc. However, if you want to do volunteer work, your estimated budget may be lower.

Estimate your retirement expenses

Once you have estimated how much income you will need, you should figure out the amount you will need to save. There are several rules you can use to estimate your savings needs i.e. rule of 25 and the 4% rule.

The first rule of thumb is the rule of 25. This rule provides that you should have 25 times your expected annual expenses before you retire. For example, if you plan to spend $50,000 per year, you will need to have saved $1,250,000 to retire.

The second rule of thumb is the 4% rule, which provides that you can withdraw 4% of your accumulated funds during your first year of retirement. This rule shows you how big your nest egg should be. For example, if you plan to spend $60,000 per year, you will need $1,500,000 ($60,000/0.04).

You can evaluate how much more you need to save by subtracting your current savings from the target savings. For example, if you need $1,500,000, and you have saved $700,000, it means you need to save $800,000 more to reach your savings goal.

Adjust current budget

Once you figure out how much more you need to save to reach your goal, you need to free up cash from your budget. Start by identifying your top expenses, and see what expenses you can cut. For example, you can review your spending on food, housing, and transport, and use the savings to pay down debt and increase your savings.

Create a savings and investment plan

Retiring early means that you will have a shorter period during which you need to ramp up your savings. If you have a 401(k), 403(b), IRA, or other retirement plans, you should max out these retirement plans, and collect an employer match where possible. For example, if you have a 401(k) with your employer, you can contribute up to $22,500 in 2023, and an additional $7,500 if you are above 50; your employer can also match your contributions either partially or dollar-for-dollar.

If you have surplus earnings after maxing out your retirement accounts, you can invest in a retirement annuity, stocks, bonds, real estate, and other investments that align with your investment strategy. If you are not sure what investments to allocate your money to, you can consult a financial advisor to help you figure out how much you should save and where to invest depending on your risk tolerance and age.

Keep expenses in check

You should track your spending habits on a continuous basis, and make adjustments where necessary. If your expenses increase due to new debt or increased spending, you risk running out of money in retirement. You should be consistent in your spending habits and recurring expenses to achieve your target savings goal.

The rule of 25 and the 4% rule allow the annual budget to increase with inflation, but it does not accommodate large increases in spending beyond the amount allowed. If the spending increases year after year, it means the target savings won’t be enough to last through your retirement years.

Stick to the plan

If you want to retire early, you should develop a plan and stick to it. One way to maintain consistency is to automate your savings goals by using investment apps that automatically transfer funds to your preferred investments. However, you should allow room for flexibility, since you may need to adjust your savings when your income grows or declines.