How to Retire Early: 6 Steps for Early Retirement Planning

Vault’s Viewpoint

• Early retirement planning requires you to estimate your potential expenses to figure out the size of your nest egg.
• Consistent investing and increasing your contributions over time are keys to retiring early.
• Consider getting help from a financial advisor as you map out your path to early retirement.

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What Is Early Retirement Planning?

Early retirement planning is an approach to financial goal setting designed to help you quit your job before what many consider a regular retirement age.

Depending on your situation, you might consider early retirement anytime before age 62—when you can begin taking Social Security benefits. Others might say retiring early qualifies as any time before eligibility to withdraw from tax-advantaged retirement accounts at age 59 ½.

Regardless, the idea is to stop working decades before you would if you stuck to a traditional career path. You might find other work to do during your early retirement, or you might just live off your accumulated investments. No matter your goals, the key is making a retirement plan and then sticking to it as you work to retire early.

How to Retire Early in 6 Steps

Taking the steps to retire early isn’t always easy to start. But as you continue to make progress, you’ll be more likely to eventually achieve success with an early retirement plan.

Step 1: How Much Do I Need to Retire Early?

Start by figuring out how much money you need to retire early. There are two parts to making this calculation:

• Estimate your retirement expenses
• Determine the nest egg you’ll need to cover those expenses

Think about the lifestyle you want during retirement. Are you interested in travel? Will you downsize to a less expensive living situation? Do you plan to be debt-free?

One rule of thumb suggests that you start by assuming you’ll need an annual income that amounts to between 70% and 80% of your current income. If you make $60,000 a year, that means between $42,000 and $48,000 a year during retirement.

You can also look at it from a monthly income perspective. Perhaps you run the numbers and determine that you need $4,500 per month to be comfortable. With that approach, you’d need $54,000 annually to meet your needs.

Finally, consider that your needs might change from year to year. For exampl,e, you might need more money to cover healthcare costs as you get older.

Once you have an idea of what you need during an early retirement, you can then figure out how big your nest egg should be.

• Start with the 4% rule to get a ballpark sketch of what you might need. If you want $54,000 a year, you would divide that amount by 0.04 to get $1.35 million.
• Consider how you might build other income streams to get your monthly number. If you need $4,500 a month to meet your retirement goals, are you planning to use business or rental income to help supplement?
• If you’re building other income streams, you might need a smaller nest egg to retire early. Perhaps you can get $2,000 in monthly revenue from other sources. Now you only need $30,000 a year during early retirement or $750,000 in your nest egg.

Don’t forget to consider that you might need to spend more out of your nest egg and other sources during the early parts of retirement. Later, as you begin withdrawing from tax-advantaged accounts and even later as you receive Social Security benefits, your reliance on taxable accounts might change.

Step 2: How Much Should I Set Aside Each Month?

Now that you have an objective for building your nest egg, it’s time to decide how much to set aside each month. There are a number of online retirement calculators that can help you figure out how long it will take to reach your goals.

Perhaps you decide that you need $750,000 saved up to retire from your traditional job at age 50 and focus on part-time work or other sources of income. If you’re 30, and you assume 8% returns compounded annually, you need to invest about $1,375 per month.

By starting at age 25, or deciding to retire early at 55, you’d only need to invest $875 per month. Five years can make a difference in how much you need to set aside each month.

Step 3: Where Should I Put My Early Retirement Savings?

Once you know how much you should set aside each month to help you reach your early retirement goal, it’s time to decide where to keep that money.

Your total nest egg doesn’t need to be in one account. In fact, it might make sense to use different types of investment accounts, based on your overall retirement timeline. One common approach to retirement investing includes:

• Contribute enough to your employer’s plan, such as a 401(k), to get the maximum match, if a match is available.
• Put money into an individual retirement account (IRA). If you qualify, consider a Roth IRA for tax purposes later. Additionally, since contributions—not earnings—to a Roth IRA can be taken out without paying an early withdrawal penalty, some suggest that a Roth IRA could be available for early retirement. You need to make sure you don’t dip into earnings, though, if you want to avoid penalties. Max out your IRA contributions if you’re able.
• Set aside money in a taxable investment account that can be accessed without an early withdrawal penalty. If you don’t qualify for a Roth IRA, having some money in a taxable account might provide you with access before you turn 59 ½.
• Consider a health savings account (HSA) if you qualify. Contributions come with a tax deduction and you can invest a portion of your contributions. Plus, withdrawals for qualified medical expenses can be made at any time without penalty—or paying taxes. An HSA can be part of your long-term strategy for healthcare costs.

“The Health Savings Account is my favorite tax-advantaged account. It’s the perfect account for planning for retirement, whether you’re aiming for a traditional retirement or hoping to retire early. I’ve invested my HSA money to grow over time, and I hope that the earnings can be used, tax-free, to cover healthcare costs in retirement. Plus, in a pinch, later on it can be used as an alternate traditional IRA. It’s truly a win with a tax benefit now and a tax benefit later.”

— Miranda Marquit

When considering where to keep your nest egg, think about when you will need access to the money and make a plan for your potential tax bill.

Step 4: Do I Need to Work with a Financial Advisor?

A financial advisor can provide you with guidance in helping you decide how to divide up your contributions. Even just sitting down with a retirement specialist and paying a flat or hourly fee for them to review your plan can be helpful.

Additionally, your financial advisor can help you manage your asset allocation over time so that your portfolio continues to support your objectives. Even if you don’t have someone manage your investments for you, consider meeting periodically with a professional who can review your situation and make adjustments as needed.

Step 5: What Adjustments Should I Make to My Budget?

After you know what you need to do to make early retirement happen, it’s time to look at where you’re at now—and what changes you should make.

Start with your current situation. Do you have enough wiggle room in your budget to invest the amount you need to grow your investment portfolio? No matter your goal, you’ll need to come up with a way to:

• Spend less and invest your savings for retirement, or
• Earn more and put the excess into your portfolio.

To supercharge your efforts, it might make sense to do both, especially if you want to retire in a shorter timeframe. Review your budget to prioritize investing for early retirement and look for ways to cut back on unnecessary spending while boosting your income.

Step 6: What Tweaks Should I Make Over Time?

Because circumstances change over time, plan to make tweaks. Maybe you need to put a little less toward early retirement while you’re paying down debt. Then you can ramp up the savings later. Perhaps you realize that you can retire with less than you expected. Maybe you need more than you thought and decide to start a business for cash flow.

Revisit your plan regularly and adjust as needed to stay on track with your plan for early retirement.