What does it mean to retire young?
Retiring young means to retire before you reach the age of 65. According to the Social Security Administration, early retirement is defined as retiring when you reach age 62. Under the “Financial Independence Retire Early” or the FIRE movement, people may retire much earlier than age 62. Some people who follow the FIRE movement have retired in their 30s, 40s, or 50s.
What are the steps to take to retire early?
To retire young, you will need to take a number of steps. Some of the steps that will be important for retiring early include the following:
- Determine the retirement lifestyle you want
- Create a retirement budget
- Evaluate your current financial situation
- Make a retirement checklist
- Commit to making changes to your current lifestyle
Those who are retiring young
On average, most Americans predict that they will retire when they reach age 66. Just 12% report that they plan to retire young or before they reach age 60.
Of people who are currently retired and are still living, 24.9% are under the age of 56. For people who are retired and who are under the age of 61, the total percentage of current retirees is 44%. Surprisingly, 1.4% of current retirees or a total of 921,566 people who are already retired are between the ages of 17 and 29.
Retirement financial assessment
To start planning to retire young, you will need to complete a financial assessment for retirement. When you plan your retirement budget, figure out how much you can reasonably afford to spend each year based on what you have saved and on your life expectancy after you have retired.
Project your monthly income based on your rate of savings and what you will likely have accumulated by your target retirement date. You should also account for your health care, including your arrangements for any long-term care needs and your HSA accounts. Include the costs of your housing in your budget. This should include your rent or mortgage payments, homeowners’ insurance, and the costs of maintenance and repair.
After you have created your retirement budget, you will next need to take an inventory of your retirement plan assets in order to retire early. You can use a retirement income calculator to figure out how long your current income and savings will last.
Next, estimate the amount of your Social Security benefits by using a U.S. government SSA retirement estimator on the Social Security Administration’s website. Finally, add up your pensions and any other income sources that you have.
After you have created a retirement budget and have inventoried your retirement assets, you will next need to think about the tax implications of retiring early. Consider your estate plan and any taxes and penalties that might be assessed if you take withdrawals from your IRAs, Roth IRAs, and other accounts.
Comprehensive retirement checklist
To retire young, you will want to follow a comprehensive retirement checklist. Start by inventorying your current assets and analyze your net worth. Eliminate the debt that you carry and spend less than what you earn. Under the FIRE movement, many people spend substantially less than what they earn so that they can save extremely high percentages of their incomes.
You should also save ample amounts of money for emergencies. Your emergency savings consists of money that you have set aside so that you will be able to make ends meet if something catastrophic or unplanned occurs that keeps you from earning an income for a prolonged period of time.
According to financial experts, you should plan to save a minimum of three to six months of your income for emergencies. You can keep your emergency savings in a liquid account such as a high-interest savings account or a money market account so that it is easily accessible.
You should also prepare for the unexpected by having a good insurance plan. Some of the potential types of insurance that you might want to get include the following:
- Auto insurance
- Health insurance
- Short-term disability
- Long-term disability
- Renter’s or homeowner’s insurance
- Life insurance
Write out your retirement plan and budget. Set your financial goals and determine your needs for each. Create a budget and track your monthly expenses. Make sure that you follow the budget that you create, eliminating unnecessary purchases. Factor in the amount from the U.S. government SSA retirement estimator to determine what you will likely receive in Social Security benefits after you retire.
Make certain that your health insurance needs will be taken care of. Research Medicare and learn how long-term care works. Assess all of your sources of income in retirement, including your Social Security benefits, pensions, investments, IRAs, and other accounts. Make certain that you understand the tax implications of your retirement income. You will need to become an expert on funds withdrawal so that you can keep more of your income.
Create and adhere to your investment strategy based on your goals to retire young. Contribute to your 401k, traditional IRA, and Roth IRA. Make certain to diversify your investments to account for risk and watch your fees. Maintenance fees and low rates of interest can limit your savings. Make sure to review your statements carefully and make certain that you always have the most competitive rates.
Automate your savings. Set up automatic transfers of money into your account from your paychecks or your bank account. This way, saving becomes effortless and adds up over time. Increase the amount annually and add additional income, such as funds from bonuses or raises, when possible.
Evaluate the risk that you have in your retirement accounts. Risk is your ability and willingness to tolerate volatility in the stock market. If you are young, you will likely have a higher risk tolerance than if you are older and nearing retirement age.
Optimize your portfolio and change your risk profile as you get older. If you are young and are planning how to retire early, you can afford to be more aggressive in your investment choices. As you grow closer to your retirement date, you will want to become more conservative.
Aggressive investors may choose higher risk securities for the chance of getting much higher returns. Moderate investors choose a balanced approach of mixing both high- and low-risk investments. The focus is on diversification. Conservative investors typically choose low-risk investments such as bonds, money markets, and similar capital-preserving assets.
Add up the current market values of all of your savings and investments. Determine what will be a realistic annualized rate of return on your investments. You should conservatively assume that inflation will be 4% each year. A realistic rate of return would range from 6% to 10%. You should estimate on the lower end to be safe. Create your estate plan and update it as needed.
Strategies for retiring young
There are several strategies that you can implement for how to retire early. The financial independence, retirement early, 4% rule or FIRE movement are examples for those who want to retire young. It involves extreme savings combined with investing so that you can retire early. With the FIRE movement strategy, people are able to enjoy early retirements at much younger ages than with traditional budgets and retirement plans.
To follow the FIRE movement, you will need to commit up to 70% of your income to your savings. Once your savings reach about 30 times your annual expenses, you can retire early. Once retired, the withdrawals that you will make from your savings must be small. The advice states that you should keep your withdrawals after you retire early to around 3 or 4% each year.
Using the FIRE movement as a strategy to retire young requires extreme diligence with your expenses, maintenance, and reallocation of your investments.
Another extreme method is the 4% rule. Followers of this strategy withdraw 4% of savings during the first year of early retirement and make adjustments for inflation for each year that follows. In this way, there is a chance that you will be able to live off of your savings for 30 years.
The 4% rule is based on the idea that your portfolio contains around 50% bonds that have interest rates that are high enough for you to live off of them despite inflation. It also assumes that the market will perform at a consistent rate, which is not true. However, depending on how the market swings and your ability to invest and save during an upward swing, you might be able to make this retirement strategy work.
Another example of retirement strategies to retire young is to consider taking your Social Security benefits before you reach your full retirement age. You are able to begin taking your Social Security benefits as early as age 62. However, the amount will be less than your full retirement benefit amount.
If you have an employer-sponsored retirement savings plan such as a 401(k) or a 403(b), there might be a provision that allows you to access your funds as early as age 55 without paying an early withdrawal penalty. This will depend on you leaving your employment after you have turned age 55 as well as meeting other criteria.
If you do not meet the requirements, you will not be able to take funds penalty-free from your 401(k) until you reach age 59½. If you withdraw money earlier, you will have to pay a penalty unless an exception applies.
Under IRS rule 72t, withdrawals from your IRA accounts and from other tax-advantaged retirement accounts are allowed without the 10% penalty. You must take the withdrawals at a minimum of five substantially equal periodic payments. Rule 72t determines the periodic payment amounts by your life expectancy, which are calculated using IRS methods. Finally, IRS rules also allow some civil service employees to access their retirement funds without a penalty as early as age 50.
Supplementing your retirement account
The retirement strategies for how to retire younger may also include finding ways to supplement your retirement income and revenue sources. Your active income includes the physical effort that you expend to make money. Some examples of adding active income sources might include adding a part-time job or a side hustle on top of your regular job.
Passive income sources include ways to originate income that involve little to no physical effort. Some examples of passive income sources that you might add so that you can gain financial security and retire early include the following:
- Fixed annuities
- Real estate investment income
- Interest income
- Investments in private businesses
Some types of passive income sources are strictly regulated by the IRS, making it important for you to talk to a professional when you are trying to determine your taxable income and your deductions.
There are several benefits of choosing to work longer instead of retiring young. When you choose to remain in the workforce longer, you may enjoy the following advantages:
- Longer period for your investments to accrue earnings
- Greater savings percentage
- Shorter asset distribution period
- Higher Social Security benefits payments
- Higher benefits
- Health benefits
- The ability to transition to retirement rather than setting a specific date to retire young
Strategies for retiring young also include increasing your retirement savings. You should aim to contribute the maximum amounts to your IRAs, Roth IRAs, 401(k) plans, and other retirement accounts.
It will be easier for you to reach financial security when you compound your savings. When you start saving early, the compound interest that you earn can help you to build wealth over time. The interest will be calculated on the previously earned interest as well as on your principal, which provides you with more potential for future growth.
Increase the amount that you save to become more financially secure. Small increases in your contributions can build up substantially over time.
Account for taxes and penalties
Becoming financially stable will require you to think about the impact that early retirement will have on your retirement accounts. To become financially secure, you will want to employ strategies to reduce your taxable income.
You can use tax deduction strategies to help you as you work to become financially stable. Contributing pre-tax dollars to your 401(k) plan or to an IRA can help you to lower your taxable income.
You should be aware of the wash sale rule. This rule applies when you sell or trade securities at a loss and purchase substantially identical securities within 30 days. If you do this, you will not be able to claim a deduction for your losses.
Research stable financial investments and platforms
You should stay informed by reading up-to-date financial news. Make certain that you read the leading retirement blogs, personal finance blogs, and financial websites to remain current. Reading the most up-to-date financial information can help you to learn how to become financially stable and to maintain your financial security once you have reached it.
As you work to retiring young, you might find that using investment apps can help you to reach your goals. The best investment apps can help you to organize your finances and manage them. Some also allow you to invest through them at substantial cost savings. You should find apps that are secure, have good reputations, and that are well-reviewed.
Finally, it is important for you to view the market as a long-term investment. Ignore short-term market fluctuations and aim to stay in for the long-term and avoid get-rich-quick schemes that you might encounter.
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Make the investing process effortless with M1
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