Many people dream of early retirement. However, that can mean different things to different people and organizations.
- Some define early retirement as retiring before you become Medicare-eligible at age 65.
- Social Security defines early retirement as retiring before you can start receiving your full benefit amount, which is age 66 or 67, depending on when you were born.
- If you have a pension, your pension plan may define an early retirement age at which you can start receiving your benefit at a reduced amount.
- Others may think of early retirement as age 59 ½, the age at which you can generally start withdrawing 401(k) and IRA assets penalty free.
Your own definition of early retirement may be even earlier, such as age 55 or even 50.
If retiring early is a dream of yours, how can it become reality? It will take commitment and maybe a bit of sacrifice to pull it off, especially if you don't plan to work in retirement. You’ll likely need to save and grow your retirement funds over a shorter period. You may even need to commit to a more modest lifestyle – now and in retirement – to help maximize your savings. You can start by connecting with a financial advisor, who can help you evaluate your options and plan for the future with confidence. It’s best to start planning as soon as possible – preferably when you start working – to give you time to prepare and save.
Why do people retire early?
Some people dream of early retirement, while others are thrust into it because of disability/illness, caregiving responsibilities or job loss. In other instances, companies offer financial incentives or packages to those close to retirement age while others may inherit a large sum of money. And, there are those people who just want to do something different – open their own business, work a part-time job instead of a full-time job, or do contract work so they can have a flexible schedule to spend more time with family.
Whatever your situation may be, our financial advisors will work closely with you to understand your hopes and concerns and to develop a strategy to meet your unique needs.
How do I get started planning for early retirement?
To develop a strategy for early retirement, you need to understand where you're at today and where you're trying to go.
If you haven't already done so, begin by creating a budget. You'll want to have a good understanding of how much of your income you're saving and how much you're spending, as well as what you're spending your money on. Dividing your spending into needs and wants can also help you identify areas where you may be able to cut spending, which you may need to do since retiring early means you'll likely need to save much more than the 10-15% rule of thumb estimate.
In addition to your budget, you'll want a full picture of your assets (how much you own) and your liabilities (how much you owe). Your assets can potentially serve as a source of income during retirement while your liabilities result in both current and future expenses. In fact, you may want to minimize the amount of debt you maintain, especially high-interest debt like credit cards, if you want to retire early. It reduces how much you can save and could result in retirement expenses.
Next, you'll want to define your vision for retirement. When do you want to retire? Where do you want to live? How and with whom do you want to spend your time? And, what type of lifestyle do you want? The answers to these questions will help determine when your retirement income needs to start and how your retirement spending may differ from your current budget.
Finally, you'll want to think about what other goals you may have. For example, do you have or want to have kids? Do you want to pay for some or all their education? Do you want to leave a financial legacy for them or others? The decision to retire early may impact your ability to meet your other goals, so you'll want to start thinking about the priority of your goals and what is most important to you.
What are some basic factors to consider for early retirement?
There are numerous factors to consider if you want to retire early.
- You'll likely need to plan for a long lifespan. According to the Society of Actuaries Longevity Illustrator, there is more than a 60% chance a 60-year-old couple (non-smokers of average health) will see one spouse reach age 90. Depending on how early you retire, that could be 30 or 40 years that you need your investment portfolio to last.
- You'll need to develop a plan to create retirement income.
- The earliest you can claim Social Security is age 62, so if you plan to retire before then, you'll need another source of income to meet your spending needs. You should also note that if you claim Social Security before your full retirement age (66 or 67 depending on when you were born), your benefit can be reduced by as much as 30%. And since your Social Security benefit is based on your highest 35 years of work history, early retirement could result in a shorter work history, which also reduces the benefit you receive. Also, keep in mind that a reduction in your benefit impacts the benefit amount for your spouse. Your Social Security claiming age is an important decision. Make sure you understand your Social Security options.
- Social Security was not meant to cover everything, though – on average, it provides about 40% of preretirement income, so you'll need investments and other income sources to bridge the gap. But, you'll want to be cautious about taking withdrawals from your investment portfolio at an early age. For one reason, withdrawals from your traditional 401(k) or IRA before age 59 ½ are subject to a 10% early withdrawal penalty unless you qualify for an exception. Additionally, the earlier you take withdrawals from your portfolio and the larger the withdrawal amount, the greater the risk of running out of money. You'll likely need to withdraw much less than the 4% rule of thumb estimate, which generally assumes you start taking withdrawals at age 65. Be sure to run your specific numbers to ensure you have a sustainable withdrawal strategy.
- To defer or reduce withdrawals from your investment portfolio, you may want to consider working at least part-time to help cover your expenses. For more and more people, retirement activities are increasingly likely to include work. In fact, some 60% of retirees and pre-retirees say their ideal balance between work and leisure in retirement includes working in some way, whether it be part-time, cycling between work and leisure, or even working full-time after retiring. Not only can employment help you financially, but it can also provide you a sense of fulfillment in retirement. If you do plan to continue working, you'll want to factor that into your Social Security decision because your benefits will be reduced if you earn above a certain amount while collecting benefits.
- You'll also need a plan for healthcare coverage. Most people won’t be eligible for Medicare before age 65; so if you plan to retire before then, you'll need to find other health insurance to avoid a coverage gap. Finding health insurance during that gap may be expensive, but not having coverage could be even more costly and lead to poor health and well-being. There are four primary options for health insurance coverage before 65: your former employer's retiree health benefits, your spouse's plan, COBRA (only for a limited time after leaving your employer), and ACA Marketplace plans. Not everyone will have access to each option, and the coverage and costs will vary. Even when you become eligible for Medicare, you'll typically have premiums and/or deductibles, co-pays, or co-insurance you need to account for in your plan. And, don't forget to plan for potential long-term care costs which can be substantial and are generally not covered by Medicare.
- You'll need to estimate your total retirement spending needs. Start with your current budget and adjust it for differences in retirement. For example, if you plan to stay in your current home, when will your mortgage be paid off? Once it's paid off, your spending needs are likely to decrease significantly, but you'll still need to budget for the costs of home ownership, such as property taxes, homeowners' insurance, and ongoing maintenance. You should also expect healthcare expenses to increase as you age, while other expenses, like entertainment and travel, may decline as you get older. Be sure to adjust your spending for inflation as well.
How do I create a savings and investment plan?
Your savings and investment plan should consider both how much you need to save and grow your investments to achieve your goal as well as how comfortable you are with taking investment risk. The sooner you run your numbers to get a realistic assessment of what it will take to retire early, the better, especially since you have less time to save.
Your savings plan will likely include maximizing contributions to your IRA and 401(k)or other employer-sponsored plan, remembering that once you reach 50, you can take advantage of catch-up provisions. You'll also want to think about the type of retirement accounts your funding, and you may even need to save additional amounts in taxable investment accounts.
Your investment strategy should include an appropriate mix of equity and fixed-income investments based on your time horizon and risk tolerance. The further you are from retirement, the more your investments should be geared towards those that provide growth opportunities, such as stocks and stock mutual funds. This is because you'll likely need higher returns to retire early, and you have more time to weather short-term declines. You'll still likely want some allocation to bonds, though, for diversification purposes. As you near retirement, your portfolio should start becoming more balanced between stocks and bonds since you won't have as much time to recover from a market downturn.
Your Edward Jones financial advisor can partner with you to develop a savings and investment plan strategy you have confidence in.
What additional considerations should I explore with a financial advisor when considering early retirement?
It's as equally important to prepare for the unexpected as it is to plan for the expected, so you'll want to be sure to discuss potential risks that could put you off track for your early retirement goal.
Your financial advisor can also help you identify strategies to mitigate these risks. For example, it's generally a good idea to keep three to six months' of living expenses in an emergency fund to cover unexpected expenses or to help you make ends meet after a job loss. You'll also typically need health, disability, and property and casualty insurance, and you may want to consider other types of insurance as well, like life or long-term care insurance.
While you can't predict the future, you can prepare for it, which includes addressing the key financial risks that can derail your strategy.
Should I prepare for the possibility of early retirement even if I don't plan to retire early?
Yes! Early retirement can be planned, but it’s often unexpected. In fact, according to the 2019 EBRI Retirement Confidence Survey, only one-third of pre-retirees plan to retire before age 65, but more than 70% of retirees actually do. As mentioned above, an unexpected early retirement can happen for several reasons – disability/illness, caregiving responsibilities or job loss. So, even if it's not your plan to retire early, you should prepare for that possibility to ensure your retirement security isn't at risk should the unexpected occur.
I've retired early but not by choice. What should I do?
In times of change, especially unexpected change, it's understandable and common to feel overwhelmed. Knowing your options and focusing on a few key strategies can help keep you on sturdy footing and feeling in control. If you find yourself unexpectedly retired, you'll want to review your financial situation as soon as possible.
Depending on your situation, you may be eligible for governmental benefits, such as unemployment or disability coverage through Social Security and Medicare, that can help supplement your income stream.
You should also review your budget to look for opportunities to reduce spending. Look at what you typically spend money on and determine if there are things you can live without. Consider items with reasonable substitutes like generic brands to save money. And explore whether there are any assistance or relief programs available to you that can lower your costs. You'll want to be sure to understand the terms of the relief programs, though, like whether fees or interest may be charged and how you'll be expected to make up missed payments.
If you still need additional income to meet your spending needs, you may want to consider spending uninvested cash in your taxable investment accounts or tapping your emergency funds. There is also the possibility of selling investments or claiming Social Security (must be 62 or older) if needed, but you will want to understand how each of these options may impact your later retirement years.
You don't have to go at it alone. One of the biggest misconceptions about financial advisors is that you should have your finances in order before meeting with one. But financial advisors are especially useful in helping you navigate difficult financial situations. If you would like help, work with your local Edward Jones financial advisor to determine the course of action that is best suited for your unique situation.
How can we help?
Whether you're planning for an early retirement or you find yourself there unexpectedly, your Edward Jones financial advisor is there to listen to you, understand your goals, and help you craft a strategy to achieve them. They'll walk you through various scenarios to help you explore your options and weigh the benefits and tradeoffs of each. If you're ready to begin, reach out to your local Edward Jones office and find a financial advisor to start your conversation today.
Katherine Tierney is a Senior Retirement Strategist on the Client Needs Research team at Edward Jones. The Client Needs Research team develops and communicates advice and guidance for client needs, including retirement, education, preparing for the unexpected and leaving a legacy. Katherine has more than 15 years of financial services and retirement experience. She is a contributor to Edward Jones Perspectives and has been quoted in various publications.