How to Retire Early

happy people sitting together at a table

How to Retire Early

It wouldn’t be unreasonable to think that, with the recent bout of inflation and economic uncertainty, most people considering an early retirement would be making other plans. However, if you ask many people, especially those younger than 50, they still have their sights set on an early retirement. Is this just a pipedream, or do they know something about how to retire early that the rest of us don’t?

The fact is that early retirement is not out of reach for those who seek it. While it’s not a slam dunk, it’s doable with a hefty dose of discipline and creativity. 

What holds most people back from envisioning an early retirement is the outdated notion that you must have a million or two million dollars in retirement savings to pull off a comfortable lifestyle. 

Obviously, the more savings, the better, but by applying some simple techniques in your planning efforts, you could be exiting the rat race sooner than you imagined.

To get started, call the wealth management experts at ARQ Wealth at (480) 214-9572.

What’s Your Vision for Retirement?

Before delving into the numbers, it’s essential to clearly define what early retirement means to you.

Ask yourself: 

  • At what age do I want to retire?
  • What lifestyle do I envision in retirement?
  • Where do I want to live?
  • What activities will I pursue? 

With a more detailed picture of your lifestyle ambitions, you can more accurately shape your financial goals and determine how much you need to save. 

What Will Your Vision of Retirement Cost?

A key factor in determining how much you need to save is the amount of money you expect to spend in retirement. 

Traditionally, financial planners have relied on a rule of thumb that says you will need between 70 and 80 percent of your working income to cover your expenses in retirement. However, many long-established financial planning rules of thumb don’t account for current conditions marked by higher inflation and rising healthcare costs.

Rather than basing your income needs on outdated guidelines, you must make realistic spending assumptions based on your expected lifestyle needs and financial circumstances in retirement. Specific actions, such as reducing your discretionary spending, downsizing your home, or relocating to a less expensive area, can significantly reduce your housing expenses. 

If your spending plan requires reducing your expenses, why not start cutting them now? If early retirement is a top priority, you could gradually dial back your lifestyle now, enabling you to increase your savings and smooth out your consumption as you approach your retirement target. 

What’s Your Financial Independence Number? 

Your ability to retire early will depend on the numbers—how much you’ll need to invest or save to create lifetime income sufficient to support your lifestyle. For decades, financial planners have relied on the “4% rule,” which suggests that you can spend down your retirement assets at a rate of 4% annually without running out of money.

Rules of thumb are helpful as a loose guideline when setting expectations for retirement income while individuals are still accumulating assets. However, we believe that a goals-based planning framework, which considers the current conditions of the market and the personalized needs of the retiree, will create a much higher probability of success than a simple rule.

It’s important to note that the 4% rule was established in the 1980s. Based on a 30-year time horizon, it worked well through the 1990s due to an enduring bull market and relatively high bond yields. However, bond yields have declined more recently, generating less income than in earlier decades. This has forced retirees to increase their draw-down rate and risk early depletion of their assets.

A Vanguard study found that a more dynamic spend-down strategy, such as drawing down more when markets perform well and reducing spending when markets perform poorly, can improve the sustainability of your assets. A financial advisor experienced in retirement income planning can help devise a spend-down strategy you’re unlikely to outlive.

What Can You Do to Boost Savings? 

Aside from cutting your expenses in retirement, the most direct path to early retirement is through a higher savings rate. Simply put, the higher your savings rate, the sooner you can retire. Here are some ways to boost your savings by increasing your income: 

Start a side gig: Many people aiming to retire early expect to pursue income-earning opportunities in retirement. You could start freelancing, consulting, or other part-time work now to build up your income stream, which could allow you to delay your Social Security benefits.

Monetize hobbies: Turn a passion, like photography or crafting, into a profitable side gig.

As planners recommend, your base savings rate should be at least 10% to 15%. However, to lock in an early retirement, you should aim for a savings rate of at least 25% to 30% or more. 

What is Your Investment Strategy?

Saving enough money is just half the equation. A proper investment strategy is essential to building wealth for early retirement and beyond. Creating a diversified investment strategy tailored to your risk profile and time horizon is critical. 

Many people make the big mistake of investing their retirement savings too conservatively. While safe investments may offer greater peace of mind, they risk losing their purchasing power, especially when they need it most, 20 to 30 years out.

Instead of running from volatility and risk, pre-retirees should embrace it because it is the crucial driver of returns for growing wealth and purchasing power. However, it does require a well-conceived, long-term investment plan with an optimal diversification strategy to minimize risk and volatility while capturing the returns of the market. 

What About Your Healthcare and Insurance Needs? 

Healthcare is a significant expense in retirement. It can be incredibly challenging for early retirees who are too young to qualify for Medicare. Planning early to prevent higher medical costs from derailing your retirement is critical. Here are some options to consider: 

Health Savings Account (HSA): These accounts provide a trifecta of tax benefits while paying for your healthcare expenses. Contributions are pre-tax, account earnings grow tax-free, and funds used for eligible expenses can be withdrawn tax-free. 

COBRA: You can extend your employer-sponsored health insurance temporarily.

Affordable Care Act (ACA): Explore the marketplace for insurance plans that fit your needs.

Part-time employment: You could look for part-time work with employers offering health insurance benefits.

Additionally, you should review your life, disability, and long-term care needs to ensure you have adequate coverage. 

What Can Be Done to Minimize Taxes?

Many people make the mistake of not considering the impact of taxes on their retirement income strategy. Uncle Sam is also interested in your retirement income stream. If you’re unaware of the tax treatment for various retirement assets, you could be blindsided by decisions you made years ago.

Just as diversifying your investments reduces risk, diversifying your taxes in retirement is equally important. If all your income is generated from a tax-deferred account such as a 401(k) or traditional IRA, your income will be fully taxed as ordinary income when withdrawn.

Planning now to minimize taxes in retirement can ensure maximum cash flow and keep more of your money working for you. Here are some tax optimization strategies to consider now: 

Utilize a mix of tax-advantaged retirement accounts

Add accounts with varying tax implications to your retirement strategy. In addition to tax-deferred accounts, such as 401(k)s and traditional IRAs, invest in a Roth IRA for tax-free income in retirement. Also, investing in taxable investment accounts can generate long-term capital gains taxed more favorably.

A significant advantage of tax-free income from Roth IRAs is that it is not included in the Social Security benefits tax calculation. 

Start a Roth conversions ladder

Convert a portion of traditional IRA or 401(k) funds to a Roth IRA to minimize taxes in retirement. You’ll be taxed at ordinary income tax rates on the conversion amount, but you can reduce the current tax hit by converting smaller portions over time and waiting to convert in years when you’re in a lower tax bracket.

Tax reduction strategies can be complex, and complying with the tax code is crucial. Therefore, working with a qualified investment manager is essential. Call an investment manager at ARQ Wealth now for help at (480) 214-9572.

What’s Your Withdrawal Strategy? 

The second phase of retirement planning—the distribution phase—is far more challenging than the first, the accumulation phase, because of the complexities involved in ensuring your income lasts a lifetime.

Here are the more widely used withdrawal strategies:

4% Rule: The 4% rule discussed earlier is widely used by financial planners. It assumes you’ve accumulated sufficient funds to draw down 4% annually (adjusted annually for inflation).

Dynamic withdrawal strategies: More planners are adopting the dynamic withdrawal method, which adjusts withdrawals based on market performance to preserve principle during downturns. 

Bucket strategy: This strategy divides your assets into three buckets—short, medium, and long—to manage cash flow. The short-term bucket contains cash to cover one to three years of expenses. The medium-term bucket contains short to intermediate-term fixed-income investments that can be converted to cash to fill the short-term bucket in three to five years. The long-term bucket, critical to preserving wealth and purchasing power, contains growth-oriented investments with a five to ten-year time horizon. 

Whichever strategy you choose, it’s essential to be flexible and regularly assess it to account for changes in expenses, market conditions, and personal needs. 

Why It’s Important to Adopt the Right Mindset 

There’s more to retiring early than sufficient funds and a sustainable withdrawal strategy. It requires a long-term commitment, patience, and a positive mindset. Along with making the right financial moves, it’s essential to develop habits and attitudes that align with your goals: 

Practice delayed gratification: You may have to practice delayed gratification to save enough to retire early. Even in retirement, you must focus on the long-term rewards rather than short-term pleasures. 

Stay disciplined: During your retirement plan’s accumulation and distribution phases, it’s vital to stick to your budget and savings plan, even when it’s challenging. Maintaining a clear vision of what you want your retirement to look like should provide your motivation. 

Celebrate milestones: Getting to early retirement is a long and sometimes arduous haul. Boost your motivation by acknowledging and celebrating small wins along the way. 

Embrace setbacks: In any worthy endeavor, you will experience setbacks. Count on it. So, viewing setbacks as opportunities to learn and improve is crucial to moving forward.

How to Retire Early How to retire early
How to Retire Early How to retire early

Conclusion 

Under most circumstances, early retirement is an ambitious goal. However, it is an attainable goal for those with the right mindset and willingness to put in the effort and make small sacrifices. The journey is as important as the destination, and there are no shortcuts short of receiving some unexpected financial windfall. 

With so much at stake, aligning yourself with a qualified financial advisor experienced in helping people achieve their life ambitions of early retirement would be essential. The advisors at ARQ Wealth can help you define your vision and plan your strategies while keeping you focused on your objective, enabling you to achieve early financial independence on your terms.

Picture of ARQWealth

ARQWealth

Similar Articles

There’s a reason why Scottsdale, Arizona, is always in the conversation about the best places to retire in the U.S. With its stunning desert landscapes,...

Arizona does not charge an estate tax, which is just one of many factors that make it such a popular destination for retirees. However, the...

Disclaimer: The opinions expressed in this blog post are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual. It is only intended to provide education about the financial industry. As always, please remember that investing involves risk of loss of principal and capital. ARQ Wealth Advisors, LLC is a registered investment adviser with the U.S. Securities and Exchange Commission. Advisory services are only offered to clients or prospective clients where ARQ Wealth Advisors, LLC and its representatives are properly licensed or exempt from licensure. No advice may be rendered by ARQ Wealth Advisors, LLC unless a client service agreement is in place. Likes and dislikes are not considered an endorsement for our firm.