A typical retirement scenario for our parents and grandparents went like this: Work until 65, retire, collect Social Security and maybe a workplace pension.
Today, retirement is a lot more varied. Some people work past 65 for various reasons, and other people want to retire earlier than 65. There’s even a movement called FIRE (Financial Independence Retire Early) focused on helping people attain financial independence so they can retire on their own schedule.
Retiring early requires some additional planning to help ensure that your needs will be covered throughout your lifetime.
Define early retirement
There are two key things you need to decide in order to plan an early retirement: when you want to retire, and what you want to do with your retirement.
When do you plan to retire? When you’re 60? 55? Earlier? Knowing your target can help you figure out what you need to do before that — and after.
What does your early retirement look like? You might work part-time as a consultant for your former employer, or as a consultant in your field. Maybe you’ll start your own “encore business” doing something you’ve always wanted to do. Perhaps you’ll volunteer with a charity that you’ve supported over the years. You might just want to kick back and enjoy life.
Knowing what you want your early retirement to look like will help you think through how you can best set yourself up for success.
Create a retirement budget
Once you’ve decided to retire early, it’s time to begin creating a retirement budget. Even though this budget will often change over time, it’s important that you estimate what your spending might look like and how much money you’ll have coming in.
There’s a crucial difference, though, between creating a retirement budget for a more “traditional” retirement and an early one. For an early retirement, you’re budgeting both for more years and potentially more phases.
For example, if you’re planning an encore career, you’re probably planning for additional income. If you’re planning to travel, you’re probably planning for additional expenses. And no matter what you want your early retirement to look like, common sources of retirement income like Social Security or tax-advantaged retirement accounts may not be available until later in your retirement experience.
In other words, you aren’t creating a retirement budget. You’re creating retirement budgets.
For each one, start with potential sources of retirement income that apply to each phase. Those might be earnings, Social Security, 401(k)s, cash and savings accounts, and more.
Then, look at your potential spending during retirement. In addition to the basics like rent or mortgage payments, food, and utilities, make sure you include taxes, retirement activities like travel, and healthcare costs.
These budgets will likely evolve over time, hopefully getting more precise as you get closer to the next phase. Even then, you’ll want to refine these budgets as time goes on.
Save early and often
Hopefully, you’ve been contributing to your workplace retirement plan — at least enough to earn the full employer match if one is available.
Once you make the decision to retire early, make a concerted effort to contribute as much as possible to your workplace retirement plan each year. This is a key element in your retirement savings plan, as this money grows tax-deferred — or in the case or a Roth account, tax-free.
However, with a few exceptions, money held in a traditional retirement account cannot be withdrawn prior to age 59 ½ without incurring a penalty. Likewise with Roth accounts, though you can generally withdraw the amount of your contributions to the account at any time. Thus, you’ll want an investment account you can draw from penalty-free to support your early retirement.
Tapping into retirement accounts like an IRA or a 401(k) early not only depletes your retirement nest egg, but it also generally comes with a 10% penalty on top of any income taxes that might be due. The combination of taxes, penalties, and lost gains on the money that was previously invested can add up and cause a major dent in your retirement savings.
If early retirement means that you’ll be retiring prior to age 59 ½, it makes sense to also save and invest in taxable investment accounts.
Have a plan for healthcare
One of the biggest expenses for retirees who retire at a “normal” retirement age is healthcare. Healthcare expenses are estimated at $157,000 or more over the length of retirement for someone aged 65, even accounting for Medicare.1
For someone who's working, healthcare costs are typically mitigated by employer-provided insurance.
For those retiring early, it is critical that you have a plan for healthcare coverage to cover the gap between leaving your employer and your Medicare eligibility at age 65.
Some options to consider include:
- COBRA. This allows you to maintain your health insurance coverage from a former employer for up to 36 months after leaving that employer. While the coverage is the same as with the employer, the cost is higher since you're responsible for paying for the full coverage.
- Retiree medical coverage may be offered by your former employer as part of a buyout offer or retirement benefits.
- If you’re married and your spouse continues to work after you retire, you can likely be covered under their plan.
- If you end up working during retirement, even on a part-time basis, you might be able to negotiate insurance coverage with the new employer.
- For many who retire early, obtaining coverage through their state’s health insurance marketplace might be their best option. Coverage and costs vary so shop carefully.
While you’re still working, consider enrolling in and fully funding a health savings account (HSA) if you are eligible. The money in your HSA can be carried over as a tax-free source of funds to cover some of your medical costs in retirement.
Never stop reviewing and planning
Continue to review your retirement income and retirement spending plans on a regular basis, at least annually, to help ensure that you remain on track for a financially successful retirement.
And most importantly, be sure to enjoy it!
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