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A Step-by-Step Guide on How to Retire Early

How to Retire Early

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Jen Smith
Updated December 13, 2021
5 Min Read

Has the novelty of “dress shirts with pajama pants” finally worn off? Are you ready to permanently mute yourself and shut off the video on your Zoom meetings? Then you might want to start thinking about how to retire early.

Over the past decade a movement of people have been popularizing the term FI/RE, financial independence/ retire early. In an effort to fight back against the idea of working away most of your life and enjoying the leftovers these individuals aim to work hard and live frugally in the front half of their life to be able to enjoy more of the latter.

While many notable early retirees were employed in high-income fields, started in their early twenties and hit their “FI” number in their thirties, the movement is fast becoming accessible to people with more average earning and age profiles. That’s because what’s defined as “retirement” is becoming more flexible.

How to Retire Early in Five Simple Steps

Retirement means different things to different people. Retiring early isn’t impossible, even if you don’t make a fortune, but that doesn’t mean it’s easy. Doing one thing right might get you to your goal but it won’t be enough to keep you there. You need a combination of factors coupled with careful planning to achieve early retirement.

That said, the actual formula for early retirement is quite simple. You can create a plan for early retirement in just five simple steps. 

Step 1: Decide what you want to do in retirement 

Hating your job shouldn’t be the only reason you want to retire early. You need something positive to look forward to and something that’ll motivate you when things get difficult.

You can only drink so many margaritas on the beach before boredom sets in so make you plan beyond your initial vacation. Look for activities, hobbies, and new ventures that are constructive, that keep you contributing to society without feeling like you’re working another job.

You don’t have to have a plan set in stone but start to dream and brainstorm about the type of retirement you want to have. Do you want to volunteer more regularly? Move a state? Travel full-time? Start a business? Invest in real estate? All these decisions will play a role in the next step of the journey. 

Step 2: Calculate how much you need to save

It’s important to decide what you want to do in retirement first so you can get an accurate idea of what you’ll need to save to fund that lifestyle. Someone who wants to start a business or invest in real estate during retirement can rely partially on that income so they won’t need to save as much as someone who wants to travel or volunteer full-time. 

To determine what you need to save many early-retirees use the 4% rule

The 4% rule is a “safe withdrawal rate” guideline that originated from the Trinity Study. The study showed that most portfolios that, regardless of asset allocation, used an annual withdrawal rate of 4% lasted at least 30 years. While more data continues to confirm those findings, the authors of the study continue to stress that the 4% rule is just a guideline to help you determine a savings goal, not a hard and fast rule.

To find your goal number you’ll add all your expenses for the last year to get your annual spending. Then you’ll multiply that number by 25. 

For example, say you spend $50,000 per year: $50,000 x 25 = $1.25 Million

4% of $1.25 Million is $50,000 so you should be able to withdraw that amount every year for at least 30 years without running out. You can then plug your numbers into an investment calculator to see how fast you can get there and how much you’ll need to save monthly.

Step 3: Invest aggressively

Arguably the most integral step to retiring early is investing aggressively, both in amount and your actual investments. Retiring early means you have less time to invest and a longer period of time in which you need your portfolio to last. That translates to needing to invest a high percentage of your income while you’re working, in most cases 50% or more. 

If you’re starting with $30,000 and want to retire in 15 years with $1 million, at a 7% average return you’ll need to invest $2,948.30 each month, that’s an entire paycheck for some people. 

You’ll also want a balanced portfolio leaning heavier towards stock for as long as possible. Avoid a portfolio that’s 100% in either direction of equities or bonds. Many early retirees have portfolios that are 60% stock and 40% bonds but weigh heavier toward stocks while they were working toward early retirement.

Lastly, you’ll need to plan where to invest. In 2021, maxing out your IRA and 401(k) will limit you to $2,125 per month. So in the example above you’d have to invest $823 per month in a brokerage account without any tax advantages. 

Also keep in mind that trying to access retirement accounts before 59 ½ will incur a 10% penalty. You can get around that penalty with a Roth IRA. The Roth IRA allows you to withdraw contributions at any time. You can set up what’s called a Roth conversion ladder from other tax advantaged accounts into your Roth IRA to withdraw them long before 59 ½.

Step 4: Widen the gap

You may find that the amount you need to save for retirement every month makes your current budget for living very tight. That’s why widening the gap between your income and expenses is important throughout your working years and beyond.

Look at your expenses and figure out ways to cut them so they’re as low as possible. Avoid the trap of putting your entire life on hold to reach early retirement. You still want to experience life and spend money but only on things you truly value.

You’ll also always want to be working on increasing your income. Whether through raises, promotions, getting a new job, or starting a side business. Remember that things like starting a business and lowering your expenses don’t just help you save more now, they can allow you to lower your goal number for retirement and retire even earlier.

Step 5: Have a Plan B

You can plan as much as possible but you can’t predict the future. Instead of letting that idea scare you from pursuing early retirement, let it motivate you to always have a Plan B in place. A Plan B can protect you in the case of a recession where you may not want to withdraw from your account for a year or more or if you need to withdraw more for a medical emergency.

Your plan could include having a back up plan for income, working on eliminating major expenses, or anything else that can help you weather a storm. 

A side business or passive income stream you have casually can be optimized for more income in a down market. Paying off your house can minimize a huge expense and keeping any licenses or updating your resume can help you reenter the workforce for a time should you ever need to.

Don’t let the fear of the unknown keep you from early retirement or enjoying your hard-earned rest. Just make sure you have a contingency plan to protect you from the unplannable.

You Can Retire Early Even If You’re Not a High-Income Earner

Early retirement isn’t an option for everyone but it’s available to more people than you’d think. Avoiding lifestyle inflation, investing a portion of every dollar that you make, and looking for ways to increase your income short-term and long-term are powerful tools to build wealth, especially when you combine them.

Couple those practices with a solid plan for savings and a back up plan for unprecedented events and you can create a clear path to financial independence and early retirement.

Even if you don’t plan on retiring early you can still take these principles and apply them to your own retirement plan to achieve retirement faster or take back the control of where and how you work. Who knows, when work becomes optional you’ll find you may not hate it as much as you once did.