It’s no secret that many people—either because they want to or need to—are putting off retirement. The percentage of workers who expect to retire after age 65 has increased from 11% in 1991 to 37% in 2016, according to the Employee Benefit Research Institute.
But what if you want to buck the trend and retire earlier than the norm? It’s not an easy trick to pull off, but it’s doable.
Of course, every investor is unique, and there are no guarantees that a particular strategy will lead to your desired results. But people who retire early tend to have a few common traits, says Joshua Ebey of United Wealth Management in Baton Rouge.
First and foremost, they tend to live well within their means, which means they’re very good at keeping to a monthly budget. If they have a 401(k), they probably max it out every year.
A Roth IRA can be particularly valuable. Assuming you follow the rules—which include not making withdrawals before age 59.5 or prior to the account being open for five years, whichever comes later—the distributions generally will be tax-free.
And they tend to have little or no debt, particularly mortgage debt. A debt-free 55-year-old with a healthy 401(k) can expect to receive Social Security at their full retirement age, and is more likely to be able to retire than someone who is 60 and has the same assets, but still has 15 years on a mortgage, Ebey says.
“The lower your expenses are, the easier it is, and the sooner you can retire,” he adds. “You have to start from a position of financial strength before you enter the retirement phase of your life.”
Ebey generally recommends retirees keep six months of liquid savings in the bank. Without that cushion, an emergency might compel you to draw down your retirement savings.
“Invest in assets that have enough volatility to create a yield that at least keeps up with inflation. What this means is that you may have a portfolio that is skewed towards equities with a sizable cash position, which is roughly three to five years of living expenses.” —Jeff King, wealth management adviser, Northwestern Mutual
Advisers often say that most people can afford to spend 4% of their nest egg per year of retirement. But for that to work, Ebey cautions, you’ll likely want a portfolio that can deliver returns better than 4%; cash or only low-risk investments probably won’t cut it.
If you want to retire in your 40s or 50s, you should probably save about a third of your annual income, suggests Jeff King, a Baton Rouge-based wealth management adviser with Northwestern Mutual.
“My recommendation is to invest in assets that have enough volatility to create a yield that at least keeps up with inflation,” King says. “What this means is that you may have a portfolio that is skewed towards equities with a sizable cash position, which is roughly three to five years of living expenses.”
THE 80% RULE
Some advisers like to talk about the “80% rule,” that is, save enough to retire on 80% of your current income. The idea is that you won’t be spending as much money on work-related things like lunches out and dry cleaning, and you’ll no longer be putting money away for retirement. But King says he has never met anyone who didn’t want to maintain their pre-retirement lifestyle.
Jason Windham, president of The Shobe Financial Group, often asks clients to test-drive their retirement by living on their planned retirement budget for six months.
“People have some idea that they can live on a much smaller amount in retirement than what they’re currently living on,” he says. “And they can, on a shoestring [budget], but that’s not the type of lifestyle that they’re accustomed to or the type of lifestyle they want.”
Clients often think they’ll be able to downshift into semi-retirement by consulting part-time, Windham says. But after being out of their industry for a while, their contacts grow cold and they find they’re not in high demand.
The 4% guideline might be OK if you retire at 65 when Social Security is available, he says. But if you retire at 40 or 50, spending only 2% or 3% of your savings might be safer.
And if your calculations show that you can just barely make it, you’re cutting it way too close, Windham warns. One market downturn or illness could blow up your whole plan.
A taxable investment account, managed carefully to minimize taxes paid, could help cover the “early” part of “early retirement” before one is old enough to draw from more traditional sources like IRAs and Social Security, says certified financial planner Chad Olivier.
Real estate rental properties can be a good source of additional income, he adds. Clients might borrow to buy the properties, but they use the cash flow to pay off the loans so they can enter retirement with little or no debt.
Don Chance, finance professor and chair of MBA studies at LSU, doesn’t think buying rental properties is such a hot idea, unless you enjoy doing the maintenance.
“There is no reason why rental properties should offer better income in retirement than would bonds,” he says. “But they will require repairs.”
The most important things people can do to ensure a good retirement income are to diversify and hold very low cost investments, Chance says. People who are incredibly successful and invest very wisely might be able to retire early, but it’s extremely rare, and people like that rarely want to retire early, he says.
Mark Simmons, president of Simmons Asset Management, says he doesn’t know anyone who has retired early. He knows people who could, but they tend to be very successful and driven, and they can’t really turn off that competitive fire.
“Any time somebody tells me they want to retire early, it just makes the job [of preparing for retirement] harder for everybody,” he says. Market corrections tend to come around every couple decades or so, he notes; the earlier you retire, the greater the likelihood you’ll have to ride out more than one.
And Simmons doesn’t think retiring early necessarily is a good idea, citing research that associates early retirement with cognitive decline. Our brains like to be challenged, the theory goes, so it’s “use it or lose it.”
When people say they want to retire early, Simmons likes to ask why. Sometimes, what they really need is a career change.
TOP 10 WAYS TO PREPARE FOR EARLY RETIREMENT
1. Start saving, keep saving and stick to your goals. The sooner you start saving, the more time your money has to grow. Make saving for retirement a priority. Devise a plan, stick to it and set goals. Remember, it’s never too early or too late to start saving.
2. Know your retirement needs. Retirement is expensive. Experts estimate that you will need at least 70% of your preretirement income—90% or more for lower earners—to maintain your standard of living when you stop working. And yet, fewer than half of Americans have calculated how much they need to save for retirement. The key to a secure retirement is figure out your financial needs and devise a plan for meeting them.
3. Contribute to your employer’s retirement savings plan. Don’t be like the estimated 30% of private industry workers who had access to a defined contribution plan in 2014 but opted not to participate. If your employer offers a retirement savings plan, such as a 401(k) plan, sign up and contribute all you can. Your taxes will be lower, your company may kick in more, and automatic deductions make it easy. Over time, compound interest and tax deferrals make a big difference in the amount you will accumulate.
4. Learn about your employer’s pension plan. If your employer has a traditional pension plan, check to see if you are covered by the plan and understand how it works. Ask for an individual benefit statement to see what your benefit is worth. Before you change jobs, find out what will happen to your pension benefit. Learn what benefits you may have from a previous employer. Also, find out if you will be entitled to benefits from your spouse’s plan.
5. Consider basic investment principles. How you save can be as important as how much you save. Inflation and the type of investments you make play important roles in how much you’ll have saved at retirement. Know how your savings or pension plan is invested. Learn about your plan’s investment options and ask questions. Put your savings in different types of investments. By diversifying this way, you are more likely to reduce risk and improve return.
6. Don’t touch your retirement savings. If you withdraw your retirement savings now, you’ll lose principal and interest, and you may lose tax benefits or have to pay withdrawal penalties. If you change jobs, leave your savings invested in your current retirement plan, or roll them over to an IRA or your new employer’s plan.
7. Ask your employer to start a plan. If your employer doesn’t offer a retirement plan, suggest that it start one. There are a number of retirement saving plan options available. Your employer may be able to set up a simplified plan that can help both you and them.
8. Put money into an Individual Retirement Account. You can put up to $5,500 a year into an IRA, and you can contribute even more if you are 50 or older. You can also start with much less. IRAs also provide tax advantages. When you open an IRA, you have two options—a traditional IRA or a Roth IRA. The tax treatment of your contributions and withdrawals will depend on which option you select. Also, the after-tax value of your withdrawal will depend on inflation and the type of IRA you choose. IRAs can provide an easy way to save. You can set it up so that an amount is automatically deducted from your checking or savings account and deposited in the IRA. A new type of Roth IRA is called myRA, a retirement account created by the U.S. Department of the Treasury to help you save for retirement if you don’t have access to a plan at work.
9. Find out about your Social Security benefits. Social Security pays benefits that are on average equal to about 40% of what you earned before retirement. You may be able to estimate your benefit by using the retirement estimator on the Social Security Administration website (www.socialsecurity.gov).
10. Ask questions. While these tips are meant to point you in the right direction, you’ll need more information. Talk to your employer, bank or a financial adviser. Ask questions and make sure you understand the answers. Get practical advice and act now.
SOURCE: Employee Benefits Security Administration, United States Department of Labor