How to Retire Early

Wondering how to retire early? 

Lots of people would like an early escape from the rat race, whether it is to travel, pursue a passion project, start a business, volunteer, or just stop working.

However, retirement planning is tricky enough when you plan to work until your full retirement age. 

It is even more so if you want to stop working years or even decades sooner. Can it be done? 

Absolutely. But unless you are independently wealthy, and few people are, it will take work and discipline. Here are four key steps to take.

Step 1: Estimate Your Retirement Expenses

If you want to retire early, the first step is to estimate how much money you will spend each month once you retire. Start by adding up expenses for things you cannot avoid, such as housing, food, clothing, utilities, transportation, insurance, and healthcare. 

Ideally, you will enter retirement debt-free.

 That means no mortgage, no credit card balance, no outstanding medical bills, and no student loans or other debt; however, if you are still paying off any debts, be sure those payments are included in your budget. 

Next, add in any discretionary expenses you will have, including those for entertainment, travel, and hobbies. 

Add everything together to ascertain how much you will need each month to maintain the retirement lifestyle you envision. 

Of course, keep in mind that your budget will change as you reach distinct phases of retirement

 you may decide to drop your life insurance policy, for example. This preliminary budget will be a good starting point, so it is worth taking the time to make it as accurate and realistic as possible.

Step 2: Calculate How Much You Need to Retire

Now that you have an estimate for your monthly spending, the next step is to calculate how much money you need to save. 

There are several ways to estimate this. One approach is to have between 25 and 30 times your expected yearly expenses plus the cash to cover one year's worth of expenses. Start with your monthly expenses and multiply by twelve to obtain an annual estimate. 

Next, find your "target" range. Here's an example. Assume your monthly expenses will be $5,000 or $60,000 per year. Using this approach, you will need between $1.5 million and $1.8 million to retire plus $60,000 in cash.

Another approach is to take your estimated annual expenses and divide them by 4% to see how big your nest egg should be. If you're likely to spend $60,000 per year, you will need $1.5 million ($60,000 ÷ 0.04).

If you want more wiggle room in retirement, try dividing by 3% (or somewhere between 3% and 4%). With the same $60,000 per year budget, you will need $2 million ($60,000 ÷ 0.03). 

It's always better to have a cushion. To see how close, you are to your retirement goal, subtract your current nest egg from your target number. 

For example, if you need $1.5 million and you already have $500,000, you'll need $1 million more before you can retire. 

Step 3: Adjust Your Current Budget

Here's where the discipline comes in. You will have to work to make up that $1 million shortfall—particularly if you want to do it quickly. You have three options here:

• Spend less
• Earn more
• Do both

It is essential that you create a budget so you know where your money goes and where you can cut back. There are lots of budgeting apps that can make this tedious process a little easier.

Step 4: Max Out Your Retirement Accounts

Regardless of when you plan to retire, it's wise to start early and save frequently. Retirement accounts like individual retirement accounts (IRAs) and 401(k)s are a terrific way to do this.

While you are still working, do everything you can to max out your retirement accounts. 

A traditional IRA allows you to contribute to your retirement, the earnings grow tax-free, and you get a tax deduction in the tax year you contribute; however, when the money is withdrawn in retirement, it's taxed at your income tax rate in the year of the withdrawal.

Conversely, a Roth IRA allows certain distributions or withdrawals to be made on a tax-free basis, and your earnings grow tax-free; however, Roth IRAs do not offer a tax deduction in the years they're funded.

For 2023, an individual can contribute up to $6,500 each year to a traditional or Roth IRA. 

If you are aged 50 or older, you can add a $1,000 catch-up contribution for 2023, for a total contribution limit of $7,500.4If you have a 401(k) at work, you can contribute up to $22,500 in 2023. 

If you are aged 50 or older, you can contribute an additional $7,500 in 2023. Be sure to invest enough to take advantage of any match your employer offers; it's free money. 

What Is a Good Monthly Retirement Income?

What is considered a good monthly retirement income will vary depending on the individual. Many factors will affect what is a good retirement income, such as one's current lifestyle, expected lifestyle in retirement, dependents, such as children or grandchildren, outstanding debts, and health. 

In general, it is considered that 70% to 85% of an individual's income from their last job before retirement is a good retirement income. 

How Much Can I Contribute to My 401(k)?

In 2023, you can contribute up to $22,500 to your 401(k). If you are aged 50 or older, you can contribute an additional $7,500. 

At What Age Should a Person Be Debt-Free?

Some experts recommend individuals be debt free by the time they are 45. 

This age is suggested because it is the last half of a person's career when they should have no debt obligations, other than their mortgage, and should ramp up savings for retirement. 

The Bottom Line

To work towards early retirement, estimate your retirement expenses, determine your target nest egg, and then save and invest to make it happen. 

Early retirement may be possible for you, but it requires careful planning and decision making.