Takeaways
- Millions of young professionals want to retire before the traditional age of 65.
- Retiring early starts with making a financial plan on how to retire.
- Creating an automated savings process can increase adherence to retirement savings.
- Financial experts advocate for saving 10X your current income before retiring.
- Producing passive income to replace your regular income can accelerate your success.
Millions of professionals in their twenties and thirties want to retire early. Roughly 44% of people under 40 years old want to retire by 60 years old, according to a recent survey [1]. While some might shrug this off as unrealistic, millions of investors aim for early retirement.
What is Retirement?
Retirement is the act of leaving your full-time job and stopping work. Retirement as a concept is getting a makeover. Today’s workers don’t want retirement to be a singular stopping point in their late 70s. Instead, they want to enjoy more time in their prime years with mini-retirements, sabbaticals, and time between career transitions.
Some cohorts of savers have even started a massive movement aimed at achieving the goal of retiring early. This movement is called the FIRE or financial independence retire early. Whether you want to focus on fully retiring by 40 or not, you can retire earlier if you plan appropriately. Retiring ten years earlier than most savers can make quite a difference.
7 Steps to Retire Early
Here are seven steps to enjoy early retirement and leave the workforce ten years earlier.
1. Start Saving Now
The most vital part of creating a savings plan for early retirement is to put that plan into action by beginning to save now. Getting started creates financial momentum, and you will focus on your goals even more as you execute your savings plan.
Every dollar matters when you are planning to retire early. Allocating a substantial portion of your discretionary income to this goal is paramount to your long-term success, and you need to budget appropriately to reach your savings goals. The next step is figuring out how much you need to retire.
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2. Create a Retirement Goal
Knowing how much you need to save for retirement is half the battle. While personal finance experts do not provide an exact number on how much you need to have saved to retire, there are financial rules of thumb that allow you to estimate how much you need to accumulate.
Each person’s financial situation and idea for retirement is different. Therefore, what you need to save for retirement can vary significantly based on what you want retirement to look like. If you wish to travel, that requires one type of saving plan. If you aim to retire early but still work part-time, that requires a different savings plan.
Many financial advisors advocate saving at least 10X your salary for retirement or replacing 70% of your pre-retirement income with passive income, retirement savings, or other income streams like social security payments. These metrics are proportional to your earnings, but you need to consider your lifestyle during retirement, especially if you are trying to retire early.
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For example, if you earn $100,000 and want to retire early, you should save at least $1,000,000 according to the 10X rule. Alternatively, you could build a passive income portfolio to replace $70,000 of your income. Both approaches leave you well-positioned to retire early.
3. Build a Life Plan
Now that you know how much you need to save for retirement, you must build a life plan to achieve your goal. Your plan should start with the end in mind and strategically consider how to achieve your financial goal.
In most situations, this involves throttling back your expenses and increasing your savings. But it also means meeting with financial advisors or robo-advisors to help with retirement planning and scenario analysis. It means knowing the best portfolio allocation for someone retiring in their 40s versus 50s.
4. Budget to Win
Budgeting is aligning your income and expenses with your financial goals. If you plan to retire early, your budget should accurately reflect this goal. As a result, you need to coordinate your income and expenses to contribute as much as possible to your retirement savings goal.
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To use the earlier example, if you need to save $1,000,000 to retire, you need to figure out how much you need to save per month by creating a budget. There are different types of budgets, such as a passion budget, to help you get the biggest bang for your buck when you are spending and still lead a fun life while saving for early retirement.
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5. Consider Barista FIRE
The financial movement devoted to financial independence and retiring earlier is called FIRE. Advocates of FIRE are hyper-savers and masters of lifestyle design. They share the common goal of wanting to retire early. Taking notes from this community could help you along your retirement savings journey.
Of course, there are different flavors of the FIRE movement. One of those flavors is called Barista FIRE. This approach advocates saving as much as possible early to reap the rewards of early retirement. Barista FIRE also advocates working part-time to create an alternative income stream after you have fully retired. Working part-time keeps you engaged in the workforce and financial freedom to work on things you love – writing, painting, reading, starting a business, or developing relationships with friends and family.
6. Create Passive Income
No matter when you plan on retiring, creating passive income streams is a smart money move. Passive income streams created from investing or business activities that require little to no labor are considered unearned income by the IRS [2].
For most investors, this involves investing in dividend-paying stocks, real estate, or starting a business. If you plan on retiring early, working to replace your earned income with unearned income will allow you to yield the same income levels while freeing you from having to be in the office or work from home. Instead, you can concentrate on doing passion projects, traveling, and enjoying the things you love in life.
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7. Income Stream Triggers
When planning for an early retirement, it’s crucial to consider the timing and availability of all the income streams available to you. For example, if you are saving all your retirement funds in a tax-advantaged account (like a Traditional IRA or 401(k)), you need to consider penalty rules for early withdrawal and the related tax consequences.
Smart Tip:
Retirement plans that are not tax-advantaged don’t suffer the same early withdrawal penalties. Retirement accounts like a Roth IRA, which contain post-tax contributions, allow you to withdraw from these accounts at any time. Check with your financial advisor about penalties.
For example, if you have a substantial part of your savings in your employer-sponsored 401(k) account, you will incur penalties for withdrawing those funds before you are 59 ½ years old. Planning on having those funds available when you are 60 should be a primary factor when contemplating your income streams during retirement.
Creating a financial plan with a financial advisor can remove the risk of uncertainty with your long-term financial planning. As the income streams and investments increase in size and scope, having someone in your corner will help with retirement planning.
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Smart Summary
Retirement planning can seem like a financial problem to defer into the future. But if you start saving and planning for success now, it will become part of your financial ecosystem. By becoming an early adopter of retirement savings, you can outpace your expectations. Saving early and often is a smart money move.
[1] World Economic Forum. World Economic Forum Report Highlights Retirement Trends as Life Expectancy Increases. Last Accessed September 26, 2023.
[2] IRS. Topic No. 425, Passive Activities – Losses and Credits. Last Accessed September 26, 2023.
