Here's a serious question: How much money is in your retirement fund?
Now here's a serious answer: Not enough.
For most workers retirement is the pot of gold at the end of their career. We chip away a little bit at it every day, looking forward to those years when we can travel, live well and not get up before the stroke of noon. With that golden sunset coming up years down the line, it's reasonable to ask… how can I get there a little earlier?
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Like, maybe by 35?
That might not be realistic, especially not for debt-burdened millennials, but early retirement is still a real possibility for people who are smart with their money and can get a jump start on their savings. If you'd like to see what it would be like to combine your 38th birthday and retirement party into one, these principles will probably help you on your way to getting there.
1. Set Your Goal
What is "early" for you? The average American retires around age 63, according to the U.S. Census Bureau. Unfortunately, most of us haven't saved up nearly enough to meet that event horizon no less to accelerate it by quite a bit. In fact, for 30-somethings (who should have their retirement savings cranked up to 11), median retirement accounts hover around $12,000.
All of this means that you need to start your early retirement planning by sitting down and asking, what exactly is "early" for you? Are you going to try and skip out from the office a bit ahead of schedule, say at age 50 or 55? Or would you like to aim for the ambitious goal of personal financial freedom by your mid-30s?
Your goal will determine exactly what changes you'll need to make to get there.
2. Understand the Challenges
When most people think about early retirement, they generally think about their nest egg. How much will you need in order to live on year to year?
That is, of course, the place to start. But don't forget a few other critical issues that you'll need to solve even if you've met the basics of replacing your income. These include:
a. Health care
If you're young, retiring means that you can't count on employer-provided health plans anymore. For older early retirees it's important to remember that Medicare doesn't kick in until 65. For everyone, this is a problem that demands a solution.
Health care is perhaps the single most expensive part of retirement. It's a cost that goes up as you age, and when you need medical care, that treatment can become non-negotiable. Make certain that you have a lifelong plan for insurance in place before walking away from the workplace. One which anticipates the fact that, even under Obamacare, private insurance will get more expensive the older you get.
b. Social Security
First, Social Security won't begin to pay until you hit retirement age. You can collect your checks anywhere from age 62 onward. Early retirees should remember that. Make sure you know how to get the maximum benefits.
Second, the younger you retire, the lighter those checks will be. The Social Security Administration pays based on your lifetime earnings. If you manage to escape the working world early you very well might reduce those earnings to the point where it takes a big bite out of your future Social Security income.
Under no circumstances can you forget your annual debt to Uncle Sam.
However you've structured your early retirement account, odds are it involves some long-term investments. You will have to pay taxes on any profits not in a tax-advantaged account of some kind, as well as on your withdrawals from tax-deferred accounts.
Don't plan to live on a comfortable rate of return unless your numbers account for the big bite the IRS will take out of it.
Yes, this is a very real issue. While most of us may hate the grind of getting up and going to work every day, retirement can lead to its own form of stagnation. If you retire at age 40, what exactly will you do with the decades to come?
This isn't to dissuade you from the project, but to mention that you should plan for what you'll do in retirement. Many, if not most, early retirees continue to work. They simply find jobs that they love instead of ones that they need. It's a project that you will probably come to appreciate once you've got nothing but time on your hands.
It will simply be much harder to do if you spend decades of loafing first.
3. Create a Comprehensive Plan
Once you've decided when you want to retire, and you've got a good sense of the issues you need to solve in order to do it, it's time to start making your plan.
Remember, a retirement plan above all else cannot depend on speculation, future income or other unproven assets. You will be ready to retire when you actually have the money in the bank to meet all of your future needs, although you can anticipate returns from some categories of very safe financial products. Anything less and you set yourself up for catastrophe.
4. Figure Out How Much Money You'll Need
The first thing you'll want to know is, what's your financial goal? How much money do you actually need to have in savings to hit your retirement goal?
Grant Sabatier over at Millennial Money points out that the average saver can start to feel comfortable once they have between 25 - 30 times their annual expenses saved up in retirement funds. This means that if you anticipate spending $50,000 per year in personal living expenses, you'll need between $1.25 million and $1.5 million in savings before you can retire.
Sabatier's method anticipates a very basic rate of return, on the order of a savings account or other highly secure product, and some underspending. More conservative savers can multiple their anticipated annual cost of living by how many years they have left before age 90 or 100.
5. Crank Your Savings
Generally speaking, if you don't change your standard of living you will need to replace about 70% - 80% of your current income once you enter retirement. This figure anticipates that you'll no longer be making retirement account contributions, some tax changes and other minor adjustments to your regular cash flow. Make sure you learn how to save if you have problems taking extra money out of your paycheck.
So first things first, start setting aside as much of your paycheck as you possibly can. Work hard to get your annual retirement contributions as close to either 20% or 25% of your total income. This will accomplish two things:
First, it will compound your money and grow your retirement savings faster.
Second it will help you develop a lifestyle based around spending less. Remember, you will hit early retirement the day you have enough saved to pay for all of your needs for the rest of your life. If you can build a comfortable lifestyle with fewer needs, that brings retirement all the closer.
Simply put, for many people, early retirement means learning to live on less. You may have to sit through the commercials on Hulu, but you'll get to do it in the middle of a weekday afternoon.
6. Consider Moving to a Cheaper Location
Odds are that housing is the biggest expense in your portfolio (except, perhaps, for student loans). Moreover, if you're under the age of 35 and reading this the numbers say you probably live in a big city.
One guess how you can dramatically increase your retirement savings.
Now, this is a piece of advice which may conflict with both earning and lifestyle concerns. If retiring early means moving someplace you'd be miserable, wait. And if trimming your rent means taking a big pay cut, again, it's probably a long-term loser.
But if you can cut down on housing costs, either by changing apartments or finding a cheaper city altogether, you might live that early retirement dream a lot sooner than you'd imagined.
7. Research Stable Financial Products
This is where we reiterate just how dangerous it is to count on stocks, future earnings or other forms of income outside of your control when you retire. However, there are some financial products that you can count on and build into your retirement plan.
Treasury bonds, certificates of deposit and annuities are all examples of safe, reliable investment products that you can build your retirement account around. Their rate of return will be low, but they provide money that you can count on. This reliability will be essential when you hit 55 and haven't had a job in 20 years.
You don't want to start filling out applications at Applebee's because something went wrong with your savings.
Also, more conservative funds (like ETFs and mutual funds) can play a role in your savings. They should play a minimal one. Any time you put money in the stock market it has a risk of zeroing out. But a conservative portfolio, for example one indexed to the market overall, can add some nice growth to a retirement account.
8. Begin Making Daily Adjustments
Small investments can add up fast. Even after you hit your big-picture benchmarking of saving 20-25% of your income per year you should still be thinking about your retirement with every purchase.
Early retirement shouldn't just be a goal, it should be your hobby. It should be something you do every single day. While your friends help rate dogs on the subway, you should kill a few minutes by putting $5 aside to roll into your retirement fund.
Think about how you can contribute to your retirement constantly. If you can find even $10 extra dollars per day to add to that account, that's $300 per month. For someone in their 20s, invested wisely, that will add up to hundreds of thousands of dollars in a few decades.
That's good retirement money.