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Thayer Partners Blog

An Introduction to Early Retirement

[fa icon="calendar"] Nov 21, 2015 8:00:00 AM / by Chris Wilmerding

Chris Wilmerding

resting_on_the_mountain_peak_after_early_retirement.jpgSo, you want to retire early? Leave the toil and trouble of working life behind and settle down so you can enjoy the finer things in life?

For many Americans, early retirement is a dream. The question is, how can you make this dream a reality without it turning into a nightmare?

To help you with early retirement planning, I’ve put together a brief introduction to this often hard-to-achieve subject.

Retiring Early: How Soon Can I Retire?

In reality, you could retire whenever you want to. However, the issue is that just because you can retire doesn’t mean that you should retire. Retiring early might be nice, but without the finances in place to fund your retirement, you’re going to run into issues sooner or later.

A major part of retirement planning is getting financially ready for retirement. If you want a comfortable retirement, you need to have some basic money management/planning challenges sorted out beforehand.

For example, when assessing if you’re ready for early retirement, take some time to assess your monthly household budget. Ask yourself the following questions and come up with solid answers:

  • What are your major expenses?
  • How consistent are they?
  • Is there room to eliminate expenses?
  • What will be major income sources after you leave your job?
  • How long can you count on each income source?
  • Do you have enough liquid assets or insurance to cover an emergency (hospitalization, damage to home, etc.)?

These are just a few of the basic money management issues that you have to take into account when planning for retirement. If you find that you won’t have enough income in retirement to cover your monthly expenses, then you probably should put off retiring early until you have a chance to build up your income sources.

Early Retirement’s Biggest Risk: Running out of Money

There are a lot of risk factors faced by retirees. In some ways, these risks are even greater for those who retire early.

For example, as I mentioned in a previous blog post, running out of money in retirement is one of the biggest fears Americans face in retirement. The thing is, the longer your retirement lasts, the harder it is to make the money you’ve saved for retirement last.

Another challenge that makes this harder is that when you retire early, you don’t have as much of a chance to build up the kind of retirements savings assets that others who wait until age 65 to retire might have.

Taking a decade off of your retirement age can make a huge difference in the size of your investment portfolio at retirement. Just say, for argument’s sake, that you set aside about $90,000 in a 401k by the time you were 25.

If that money has an average of 5% growth each year, that would be $4,500 added to the account’s value after the first year, for a total of $94,500. The next year, the compounded interest growth would be $4,725, bringing the value of the account to $99,225.

After 40 years when you’re 65, that money would grow to $633,598.98 even without you adding another penny to your 401k, a calculation that you can check using the compound growth calculator on investor.gov. If you take ten years off of your compound growth, your 401k’s value shrinks to $388,974.81 at age 55. That’s $244,624.17 missing from your retirement fund, and ten extra years of retirement to pay for.

Now, you probably won’t have steady 5% growth for your 401k year over year, especially after mutual fund fees and transaction fees. However, this should give you an idea of just how much retirement income you can miss out on by retiring too early.

With less money and more years of retirement to pay for, there is a greater risk of running out of money in retirement.

Getting Ready to Retire Early

Now that we’ve gone over how to tell if it’s too soon to retire and how retiring early can make it harder to save up enough money to fund your retirement, it’s time to take a look at some steps you can take to help yourself be better prepared for an early retirement:

  • Minimize Your Cost of Living, Now and in the Future. As pointed out in a  Forbes article about retiring early, “the less money you need to live on, the more you’ll be able to save, and the sooner you’ll be able to retire.” Common tips include buying less expensive cars with lower maintenance costs and high mileage, avoiding dining out, and skipping out on expensive vacations. An even more effective strategy, however, is to move to an area with a lower cost of living, if possible. Now, moving to a low-cost area might not be viable while employed, but it may be a great idea after retiring, as it could significantly improve how long your retirement assets last.
  • Eliminate Debt Before Retiring. Credit cards, student or home loans, and other forms of debt are a major financial drain when you have a job to pay these bills. In retirement, odds are that you’ll have less income, so financial debt will be even harder to deal with. A common tactic is to focus on high-interest debt first, then apply the money earmarked for those payments to the next-highest interest debt source to speed up how quickly the debt is paid off. You may even want to consult with a money management specialist to help you create a debt elimination plan.
  • Ramp up Your Retirement Savings and Set up Multiple Income Sources. Another bit of advice given in the Forbes article is that “If you plan to retire in 40 years, you can probably get away with saving 10% or 15% of your income every year. But if you plan to retire in 15 or 20 years, you have to up your game. 30%, 40%, or even 50% will be more likely.” If you hit the 401k contribution ceiling, consider setting aside money for a deferred income annuity or individual retirement account. This is very important to retiring early, as you won’t have as much time to build wealth as you would if you were to retire later in life.

Following the above suggestions can be very difficult. If you’re considering early retirement, I would personally urge you to contact a retirement planning specialist to go over your needs and your current financial situation first.

Retiring a decade or two early is a major decision, and retiring too early can be potentially dangerous to your finances if you aren’t fully prepared. Taking your time to prepare and review your plan for retiring early can help you make better decisions for a more comfortable retirement.

Avoid Running Out Of Money At Retirement

Topics: Retirement Income Planning, Early Retirement

Chris Wilmerding

Written by Chris Wilmerding

Chris Wilmerding is Principal of Thayer Partners, an independent investment management firm located in Westwood, MA providing financial planning and wealth management counsel to individuals and their families.

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