Retiring early might seem like a wayward dream to most people. After all, the average retirement age in the U.S. is 63, according to an analysis by financial technology company SmartAsset. And a survey by the Employee Benefits Research Institute found only 8 percent of employees expect to retire before age 60.
Certainly, striking it rich can help you leave the workforce early. But you don’t have to be an entrepreneur, celebrity or professional athlete to build enough wealth to retire early. Although there isn’t just one path to an early retirement, here are some essential retirement-planning steps to take if you want to retire early.
Do the Math
Early retirement doesn’t just happen. Laying the groundwork years before you want to leave the workforce is a key part to retiring early.
“You’re not going to get there without a plan,” said Todd Tresidder, who retired nearly 20 years ago at the age of 35. Tresidder said that he had always desired financial freedom and began his career with an eye toward early retirement.
You can get an idea of what you’ll need to retire by knowing how much of your current income you’ll have to replace once you’re no longer working. Generally, people need to replace between 55 percent and 80 percent of their pre-retirement income, according to an analysis by Fidelity Investments. The less you earn, the greater the percentage you’ll need to replace in retirement to cover expenses.
The amount can vary depending on the lifestyle you want to lead in retirement. However, it’s important that you factor in the cost of all your expenses, including your healthcare premium — which could be much higher than your current premium if you’re getting subsidized coverage through an employer.
Once you have an estimate of the annual income you’ll need in retirement, you can determine how much you need to save to reach financial independence.
Boost Your Savings Rate
The standard 10 percent to 15 percent of annual income financial advisors recommend saving is based on the assumption that you’ll be putting away that amount over a period of 40 years and withdrawing 4 percent a year in retirement.
“If you’re going to retire early, you have to change the time your assets have to grow and how long assets will last,” Tresidder said. “You’re not going to compound your way to wealth.”
Individuals who are planning to retire by 40 or 50 need to save more than 15 percent annually. In fact, Doug Nordman, founder of The-Military-Guide.com, recommends saving at least 40 percent of your income from age 20. That savings rate assumes that you have an investment portfolio with a 6 percent annual rate of return.
Nordman, who penned “The Military Guide to Financial Independence & Retirement,” retired from the U.S. Navy’s submarine force in 2002 at the age of 41 by saving at least 40 percent a year for 20 years. Based on Nordman’s math, aspiring retirees’ assets need to be equal to 25 times their expenses in order to withdraw 4 percent annually from savings in retirement.
It’s important to note that the assets in your portfolio should have a growth rate that’s greater than the inflation rate. For those seeking early retirement, Nordman recommends holding a portfolio of passively managed index funds with low expense ratios and an asset allocation of at least 80 percent stocks.
Said Nordman of how he achieved his goal, “We saved aggressively and invested in mutual funds.”
You’ll likely need to save money in a taxable account, such as an investment account, in addition to a workplace retirement account or IRA. The maximum you can contribute to a 401k is $18,000 a year. So, if you earn $45,000 or less a year, you’ll only reach an income savings rate of 40 percent with a 401k. The maximum you can contribute to an IRA is just $5,500 if you’re under 50.
Additionally, if you withdraw retirement money before age 59½, you might have to pay the 10 percent early retirement penalty. To avoid this fee, leave some money out of retirement funds to access before you hit 59½.
Related: How to Retire Before 50
Develop Multiple Income Streams
To retire early, strive to have multiple streams of income — not just investment or retirement accounts from which you can draw money. Tresidder suggests individuals can achieve early financial independence by building equity directly through businesses and real estate. However, they might need to borrow money to acquire these assets.
“Getting in debt to reach financial independence is counterintuitive, but income-generating debt, such as a mortgage for a real estate rental, can help you leverage your savings and build wealth faster,” said Pauline Paquin, founder of ReachFinancialIndependence.com. She used her real estate investments to ditch full-time work at just 29.
Paquin’s first investment was a $400,000 rental property, which she purchased with a 25 percent down payment. Later, she was able to buy two more properties in cash. “I make enough in passive income to cover my lifestyle and then some,” she said.
Chris Carosa wanted to find a way to create passive income for his early retirement at age 45 but wasn’t interested in managing rental property.
“I wanted something that was ‘one-and-done,’ meaning I would exert a defined unit of energy to create something, then sit back and watch the cash come in,” he said. Carosa, a veteran investment advisor, said he could only think of one way to do this: write books.
“A single book only produces a small amount of steady income — even bestsellers, most of which give you a lot of money quickly, but then peter out,” he said. “With a stable of books, now you’re talking real money.” Carosa has written several books to create passive income, including “Hey! What’s My Number? How to Improve the Odds You Will Retire In Comfort.”
Cut Your Expenses
If you want to retire early and stretch your savings for several decades, you will have to cut your expenses. Tresidder said he was able to amass enough savings to retire by age 35 because he had a big paycheck and few bills.
“I was a hedge fund manager but continued living like I was in college,” he said.
Like Tresidder, Paquin achieved her goal of financial independence by challenging all her purchases. “Every $100 you don’t spend today is a day you can live without having to work in early retirement,” she said. “So, every time I would think about purchasing a $100 item, I would say to myself, ‘Would you rather have that or quit your job a day earlier?’ The latter usually won.”
Nordman and his wife also tracked their spending in an effort to reach their 40 percent savings goal. They then used this information to develop a budget that eliminated unnecessary purchases while retaining all the expenses that truly mattered to them.
In addition to tracking expenses and living modestly, Carosa worked to eliminate his biggest expense before retirement: his mortgage. “I did this by first refinancing (to take advantage of lower rates) to a 15-year mortgage,” Carosa said. “Then I began a regimen of paying two months of payments every month. This proved successful, and the mortgage was paid off in my early 40s.”
You could also cut your mortgage by downsizing before retirement. Transition from a three- or four-bedroom home to a two-bedroom home or apartment. Savings might top $1,000 per month. Still, Nordman warns that cutting expenses only works to a point. “People have to avoid crossing the line into deprivation,” he said.
In addition to cutting expenses, you might need to find ways to boost your income by negotiating a higher salary, seeking a higher-paying job or picking up side gigs. You might also be able to retire early if you cut your expenses in retirement by moving to a place with a low cost of living. You don’t necessarily have to move overseas to do this. Some of the best places to retire on a budget can be found here in the U.S.
Plan for Part-Time Work in Retirement
Although retirement might seem like the answer to your workplace woes, the move does come with some downsides. You might lose self-esteem without your full-time gig. Some folks feel lost when they separate from their work pals, and there’s evidence to suggest that early retirees suffer negative health.
“If your sole focus is to exit the rat race, you could end up sacrificing some of your life,” said Tresidder. For this reason, it’s important that individuals discover their true reasons for wanting to leave the workforce.
According to Tresidder, working toward negative goals rarely leads to feelings of happiness. The motive for early retirement should be moving toward something — whether that’s time to pursue interests or opportunities to give back to the community through volunteering — rather than running away from something. Like many who retire early, Tresidder still works — but only because he wants to.
“I don’t have to work to put food on the table,” he said. “But a meaningful life is not eating bonbons all day and playing golf.” Tresidder now uses his time to teach people how to achieve financial freedom for themselves.
If you don’t need income from a job, you can do work you truly enjoy in retirement. And working longer might help you live longer, according to a study from Oregon State University. Plus, working part time can help provide an extra stream of income to get you through your long retirement.
“You have to be willing to embrace the adventure and go for it,” Tresidder said.