Do you dream of escaping the hustle and bustle of your work life? You may have heard about early retirement but have never taken the time to see if it’s an option for you.
To retire early, you have to balance your lifestyle expectations with your savings, investments and expenses.
Early retirement is no easy task. It takes planning, commitment and discipline. And it will likely require you to make financial sacrifices today so you can leave the workforce ahead of schedule.
Here are five steps to take to put yourself in a position to potentially retire early.
The first step in retiring early is to ignore the general noise around when most people retire and figure out what “retiring early” means to you. For instance, the regular retirement age according to the U.S. Social Security Administration is 67. However, you may choose to retire early depending on how much you have saved.
“It’s important to note that there is no single number of assets dedicated for retirement that fits everyone,” says Giovanni Valle, CFP®, Financial Planner at Avantax. “I’ve seen people be completely fine retiring with Social Security income and no assets and others need a million [or] $5 million, all depending on the lifestyle you’re comfortable living during retirement.”
Decide when you’d like to retire so you have a concrete time frame.
How to retire at 40
According to 2022 data by Gallup, Inc., only 3% of retired Americans were ages 40 to 49. While rare, Valle has some tips for those who have such ambitious goals.
“My advice for someone wanting to retire by 40 is to recognize that you will likely have to make trade-offs in your current lifestyle, including saving at least 50% of your income and figuring out ways to earn more income,” Valle says. “Know the basics of limits regarding different types of accounts such as various retirement accounts, taxable investment accounts, or HSA accounts.”
If you withdraw funds from an individual retirement account (IRA) before the age of 59 and a half, you will likely incur a 10% early withdrawal penalty. Roth IRA earnings face the same penalty for early withdrawals, but Roth IRA contributions are available for withdrawal at any time penalty- and tax-free.
How to retire at 55
From 2016 to 2022, only 6% of Americans between the ages of 50 and 54 were retired, according to the same Gallup study. This percentage shows that even if in an older range, retiring “early” is still rare.
Valle does caution that since 55 is still a bit younger than the traditional retirement age, saving at least 25% of your income can help better position yourself for early retirement.
Once you reach age 55, know what resources are available to fund your retirement.
“My advice for someone wanting to retire at 55 is to be aware of the rule of 55,” Valle says. “This rule allows penalty-free withdrawals from a 401(k) and 403(b) account with your current employer if you leave your job the calendar year you turn 55 or later, including if you get laid off or quit your job.”
It’s worth noting that longer life expectancies will contribute to a need to save longer. According to the Centers for Disease Control and Prevention (CDC), the current life expectancy is around 76 years old. As it has over the years, life expectancies may change. Valle recommends keeping a 30-year time horizon in mind.
When preparing for retirement, it’s important to know how much you need saved to support your preferred lifestyle. The Spending in Retirement Survey by the Employee Benefit Research Institute (EBRI) shows how retirees typically spend their money.
The survey revealed that housing is the largest reported expenditure for retirees, followed by food, transportation and then medical and health insurance.
The amount you need to retire depends on several factors, including your retirement length and lifestyle. However, there are three common rules of thumb to estimate how much you need in your post-work years.
One is “The 4% Rule.” This rule states that retirees should aim to withdraw 4% of their retirement savings each year to maintain enough in their savings to last a 30-year retirement. Estimate how much money you’ll need each year to cover your expenses and live comfortably, and calculate how much is 4%. For example, if you need $75,000 a year in retirement, you might aim to save $1,875,000 ($75,000 is 4% of $1,875,000). This rule assumes a portfolio with a healthy mix of stocks and bonds.
Another rule to consider is “The 80% Rule,” which states that you should have enough saved to replace 80% of your pre-retirement amount. This rule is based on the assumption that while work-related costs may decrease in retirement, healthcare and leisure activities may rise.
Lastly, a third rule you may hear in retirement circles is “The Rule of 25,” which is based on your annual expenses. Find out how much you’d need to withdraw each year to cover your expenses. Then, multiply this amount by 25. Let’s say you’d like to withdraw $20,000 a year in retirement. This means you need $500,000 saved up for your golden years.
Use your investment calculator to determine how much your money might grow and return over time, based on contribution frequency, rate of return and time horizon.
After you have an age set for when you want to retire and an estimated savings amount needed, here are a few other factors you should consider in your retirement planning.
The first is your current financial situation. Even if you have a retirement amount in mind — let’s say $1 million — you may currently have additional debts you have to pay, such as education or mortgages. Consider the time it will take to pay off these debts in your retirement equations. To expedite the debt-repayment process, you may explore a second job or additional income streams.
The next is to keep a careful eye on your budget. The 2022 Employee Benefit Research survey stated that 27% of retirees spend more than they can afford. So, even if you reach your retirement-saving goal, not sticking to a budget can derail your efforts.
Last but not least, explore taking advantage of tax-advantaged retirement accounts to meet your retirement number. This could mean working towards maxing out your IRA and contributing at least enough in a 401(k) to get any company match since that’s essentially free money from your employer. These accounts have tax advantages that you can tap into.
As of 2024, the following annual contribution maximums for tax-advantaged accounts are:
It’s important to regularly review your retirement plan to make sure it still fits your needs. Consider reassessing it at least once a year or during significant life changes. This will help you make any necessary adjustments to ensure you’re on track for a comfortable retirement.
You can retire at any age you choose, but you may receive Social Security retirement benefits beginning only at the age of 62. If you opt for these benefits before your full retirement age, your benefits will be reduced. The full retirement age varies based on your birth year, typically ranging from 66 to 67.
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At the end of the day, early retirement is a dream that is attainable if you have the right combination of savings, assets and Social Security benefits to support your lifestyle and life horizon. To learn more about how to plan for retirement, explore our retirement education and tools.
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