Most Americans look forward to retirement. These will be the days when their lives no longer revolve around work. Enjoying life in retirement could range from helping with the grandkids, teaching at the local community college, to playing a weekly round of golf with buddies. And of course, this is the time when you can travel the world!
According to a 2018 Gallup poll, the average American expects to retire when they are 66 years old. Using today’s average life expectancy, this leaves more than 17 years in retirement for retirees to leave their legacy and enjoy their ‘golden years’.
But what if 17 years is not enough? Unfortunately, we haven’t found the fountain of youth, so our only other option is an early retirement. How do you retire early? What does it take financially? And most importantly, can I make this happen?
We’re excited to provide a 2-part newsletter that will focus on items to consider when retiring early, risks & pitfalls when planning for early retirement, and how to create a roadmap for successfully retiring early.
Items to Consider When Retiring Early
How are you going to support your everyday expenses?
According to a 2016 study by the Social Security Administration, the average retiree earns 87% of their retirement income from social security benefits, earnings, and pensions. For those looking to retire early, these income sources tend not to be available. Since we’re discussing early retirement, earnings are unlikely. Most social security retirement benefits are not available until age 62 and most pensions typically begin paying out at age 65. Worse off, if you retire prior to 59 ½ most 401(k), 403(b), 457, and IRA distributions are unavailable without penalty.
Preparing an income plan (hopefully without withdrawal penalty) during these early years is a must! There are many different options ranging from rental income to 72(t) payments to cash from the sale of a business. No matter the source, having a smart plan for guaranteed income during these early years is paramount.
What about expenses?
For a successful early retirement, large outstanding debt obligations can quickly derail the delicate balance of income vs expenses. These include mortgages on primary and/or vacation properties, carrying credit card balances, or any other lines of credit.
Many early retirees have worked diligently through their lives to eliminate these debts, however a concern that does come up is planning for unexpected expenses. For most retirees, large unexpected expenses occur at a least once a year. If not planned correctly, replacing the stucco on your house, buying a new car, or non-covered dental surgery can create unnecessary tax liabilities and agita in general.
Now onto your investments.
As we discussed above, the average retirement lasts 17 years. If our early retiree exits the workforce at age 55 instead of 66, we’re talking about a retirement of 28 years for an average person. A healthy individual or couple retiring early could easily need their assets to support a 40+ year retirement! This creates a rather delicate balance of risk vs reward for their investment assets. As we look on the return side of the equation, one commonly overlooked financial consideration for retirees is inflation. According to the Minneapolis Fed the long-term rate of inflation has been 3.23%. That means it will take a 3.23% return on your investments just to maintain your purchasing power. In addition to keeping pace with inflation, you’ll likely be using these assets for living expenses. Let’s conservatively say that you have the ability to live off a 3% withdrawal rate and now we’re looking for a 6.23% return. Lastly, taxes must be considered. Estimating a 20% tax rate (a mix of capital gains & ordinary income) on gains, and we now require a 7.48% return. As we rack our brain about investment options, we also have to consider the risk of those investments so that a short-term loss does not send us back into the workforce!
Whew! This early retirement sounds stressful!
Luckily, a well-organized plan and careful budgeting can help us obtain this goal. Let’s consider some tips for all ages to help build a roadmap for early retirement.
Part 2 of our letter will offer some tips and strategies to move you closer to that early retirement!
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