Hit the lottery!
That’s the answer you’ll most commonly get when you ask just about anyone how to retire early. Sure, it’s one of many ways to make a million dollars and get it done, but winning the jackpot is not a realistic plan.
Get a second job!
Alright, you could do that. And truthfully, your personal savings might add up fast enough for you to take somewhat of an early retirement or even semi-retire, but don’t expect any sort of work-life balance while working those extra hours.
Here’s the plain truth, if you’re serious about retiring early you need to do more than just get a second job to increase your income. Really, reaching your goal of retiring early almost always boils down to careful personal financial planning. While it’s not hard in theory, it does take an incredible amount of discipline and commitment.
If you’re ready for that, then here are the steps you should be taking to retire early:
Step 1: Define what early retirement means to you
To understand how to retire early, you’ll first need to define what exactly that means to you. Everyone has their own definition and terms for early retirement, so it’s important that you determine this before any of the following steps.
For example, early retirement might be retiring work-free by the age of 50. For others, retiring might simply be a matter of not working in your current profession by the age of 60. If that’s the case, is consulting and/or freelancing part of your plan from 60 to 70? Will you continue working, but only on a part-time basis?
Or is retirement a completely work-free lifestyle where you are now able to travel to exotic beaches and take on hobbies that you never found the time for before?
Take a moment and write down what retirement looks like to you. The more specific you can get with what retirement looks like to you and the lifestyle you want to live, the better your efforts will be in preparing for just that.
It’s important to keep in mind that proper retirement planning deals a lot with evaluating your cash flow and the future money requirements you’ll need. By understanding your retirement in detail, you’ll be able to determine exactly how much money you will need to live the lifestyle you want throughout your retirement years.
Remember, you don’t need to have this part completely figured out. In fact, chances are it will change throughout the years. But as long as you have a general idea of the type of lifestyle you want to live, you’ll be able to give yourself more purpose and direction with your money.
You can get started right away by using Savology’s free retirement calculator and by building a free financial plan in just five minutes.
Step 2: Examine your current situation and budget
Next, you’ll want to take an assessment of your current financial standing. At least when it comes to your current spending habits and your budget.
The reason for this is simple: it’s almost impossible to know where you’re going if you don’t understand where you are right now. The relationship between your current financial situation and your future one is key to understanding how to get there.
This requires you to assess your current budget and spending habits. You can do this by analyzing your total income from all sources and your total expenses.
By doing this, you’ll be able to assess where you might be spending too much. Your budget can also help you identify how you can better put your money to work for you in order to reach your retirement goals.
If you want to take this to the next level, do this. As you’re going through your budget, take note of what types of income you will still be bringing in, and what types of expenses you might still have during your retirement years. Understanding these future implications will help you paint a better picture of your retirement lifestyle costs. Keep in mind interest and inflation while you’re doing this.
Step 3: Cutting expenses is like giving yourself a raise
As you go through assessing your current spending and saving situation, you’ll start to get a very good understanding of your monthly inflow and outflow.
Right away, you’ll likely be able to determine areas where you are spending too much that you can reduce, or even eliminate entirely.
Generally speaking, we can break our expenses out into two main categories: fixed costs and variable costs. Alternatively, some people prefer to break it down by needs and wants.
Fixed costs are expenses that are always there no matter what. Rent or mortgage payments, utility bills, phone bills, car loan payments and even your student loan payments.
Variable costs, however, are expenses that often change on a monthly basis. These usually include things such as eating out, clothing, travel, and entertainment costs.
Variable costs often come with the lowest friction when it comes to reducing them or eliminating them altogether. That’s why it’s often easy to start with analyzing your current spending on variable costs and nix anything you can.
However, there may also be some fixed costs that can be relatively easy to shave spending on. For example, cable and internet service are two areas where you can either negotiate rates, change packages with service providers, or even replace them with streaming services. Take the same approach with your phone and cell provider – evaluate your current plan and switch to something more cost-effective.
Another example if you have children would be looking for ways to cut down on the amount you’re spending on activities and instead find cheap indoor activities for your kids. As someone who’s a new parent, I know all too well how the cost of toys and activities compounds and can become quite expensive. You’d be surprised by the hundreds, even thousands, of dollars you’ll be saving yourself.
By understanding where you reduce your spending, you’ll be able to then identify how you can better put your money to work for you in order to reach your retirement goals.
Step 4: Eliminate debt and interest payments
Unfortunately, debt has become somewhat of a new norm for households. Which leaves many in a very challenging spot financially. One where planning for retirement becomes even more daunting than it should be.
Managing debts should always be a financial priority. This applies to everyone, even those who are not actively managing debt but may be looking at taking on personal loans or mortgages. But it especially applies to those who are burdened by debt.
Regardless of where you currently are in your financial journey, but especially when you are just getting started, it’s important to avoid paying high-interest rates on credit cards and personal loans whenever you can.
Instead of having money going towards interest payment, this money is better spent being invested in your retirement fund.
Here are a few tips that will help you manage and take control of your current and future debts:
- If you have the means to pay cash, use that instead
- Always shop around for lower interest rates on any type of loan
- Pay more than the minimum payments on credit cards
- Look for debt consolidation and repayment services when in need
- If you are paying by credit card, avoid using it for everyday purchases
Step 5: Calculate a target retirement income number
Do you know how much money you will actually need to retire in order to live comfortably?
This is a tricky question and unfortunately, most people do not have an answer for it.
Luckily for you, there are ways to get a fairly accurate estimate of the amount of retirement income you’ll need to live a comfortable lifestyle throughout your retirement years.
Calculating your retirement income replacement percentage is one of those ways. This calculation is more complicated than others, but it is more accurate because it takes into account investment returns, inflation, and social security in addition to your income.
The general rule of thumb when it comes to this calculation method is to replace 80 percent of your current income to maintain your current lifestyle and a similar standard of living. 80% is used as a target because you will likely be paying fewer taxes during your retired years. This will eliminate FICA tax which includes social security and medicare tax.
When you sign-up and build your free financial plan with Savology, your plan will automatically do the calculations for you so that you have an accurate estimate of your projected retirement income and your project retirement age based on your current situation.
Step 6: Maximize your retirement contributions
Maximizing your retirement contributions is one of the best ways for you to achieve your retirement savings goal.
It’s important to know that there are limitations to how much you are able to directly contribute to your retirement funds.
The cap on 401(k) contributions was $19,000 last year. The maximum for a traditional RIA was $6,000. Together, that’s a total of $25,000 that you should be putting aside every year.
It’s also important to know that you are unable to take disbursements from any 401(k) plan until you’re 59 ½. However, early withdrawals from Roth IRAs are allowed, meaning you can use it to get through your fifties if need be. However, the best case scenario is to keep the money there until when you really need it and are officially retired.
If maxing out your annual contributions isn’t realistic, do your best to get as close to doing that as possible. Even setting a goal of saving $10,000 in one year gets you in the right direction. Once you start saving, it’s always easier to find more ways to save and invest.
Step 7: Diversify your investing instead of spending
After eliminating high-interest debts and maxing out your retirement accounts, you may still have a few dollars leftover.
Generally, you have two options. You can use this money as “fun money” and go on a spending spree, or you could invest that money. If you’re serious about retiring early, the latter is the option you’ll want to move forward with.
Investing, specifically diversified investing, is a key component to retiring early. Done properly, it will ensure that you can live comfortably throughout your retirement.
Another sound option would be padding your emergency fund, or even building one if you do not have one. An emergency fund can still be invested in the same manner, but it’s typically in high-interest liquid accounts where you can withdraw the money quickly should you need it. Emergency funds are like self-insurance to ensure that you avoid dipping into your retirement funds early, and without penalties.
Step 8: Traps and pitfalls to avoid
It’s inevitable to make mistakes and fall into financial traps when you’re navigating your financial journey. No matter what, they can and will happen.
But you’ll be in a much better spot financially, and in relation to your retirement goal, if you’re able to properly manage those risks and know how to avoid common pitfalls.
An easy example is your spending in relation to the money you are making. It’s always easier said than done, but living within your means is an absolute must. If you significantly increase your income doubling it midway down the road to your planned retirement, put that money to work for you. Use it to pay off high-interest and revolving debts, build up your emergency fund, and invest into your retirement funds or portfolio.
Don’t buy a new car just because you can. Don’t splurge on clothes just because you can. Don’t buy a bigger house just because you can.
Instead, focus on living within your means and spending on items that align with your values and your financial plan. Live modestly while you’re working so you can retire in style at an early age.
Treat your early retirement plan as a marathon, not a sprint. It takes discipline to save for twenty or thirty years and you won’t always do it perfectly. Avoid the “quicksand” trap of going completely off the rails when you make a mistake. Remember, they happen and will likely happen again. Stay focused on your plan and everything else will fall into place.
Step 9: Always have a back up plan in place
Sometimes your “Plan A” doesn’t go according to plan. In fact, rarely ever does your plan follow through in perfect order. This is why it’s so critical to plan things out as thoroughly as you can, while also having a backup plan in place.
For example, your retirement investments could take a big hit and get depleted if the stock market crashes right before your planned retirement. Taking disbursements at a time such as this could significantly cut down on the number of years you’ll be solvent. If and when this happens, you might need to continue working for a few years longer to continue earning an income and ensure that your investments rebound.
Another common consideration is longevity. With modern medicine and overall healthcare, people are living longer lives. Retiring at fifty could mean forty years without a full-time paycheck. You might want to look at taking a part-time job or other means of earning an income through your semi-retired years. There are plenty of online opportunities you could take advantage of to help finance your early retirement.
The next consideration when it comes to your plan B is to cut your expenses further. You should make it a habit to consistently review your income and expenses and look for ways to improve the way you are managing your money. This should never be a one and done exercise. The more frequently you can do this, the more you will improve the relationship with your money.
Lastly, if all else fails, go ahead and take that second job we mentioned at the beginning of this article. You can use your earned income from this job to pay off debt and contribute additional money to your retirement accounts. A solid three, four, or five years of that at the beginning of a twenty-year plan could be the boost you need to get you on track.
Importantly, you need to plan things through as thoroughly and clearly as you possibly can, while also understanding that your plan may fail. It sounds funny, but you need to make it as fail-proof as possible, while still preparing a backup plan should it fail.
