When my wife and I got married, we sent friends and family a simple wedding invitation with a response card. Guests could choose between beef and fish. We mailed them a few weeks before the big day, informally tallied the RSVPs, and kept a running tab of entree selections.
Like a lot of things, weddings aren’t that simple anymore. We have a save-the-date magnet on our fridge for an upcoming wedding that’s a full year away. We know the bride and groom’s names, their wedding date, and where the celebration will be. There’s even a link to a custom wedding website that details the proposal, the venue, and their love story.
But wedding save-the-dates, like anticipated retirement dates, are just that—placeholders until you’re closer to the real thing. As the date approaches, your perspective can change. You may want to move up your wedding date to take advantage of an opening at your venue, or push up your retirement date to travel. Either way, you need to be flexible, understand your options, and adjust your plans (and expectations) as you go along.
The magic number for early retirement
There’s no universal definition of “early retirement.” Some pension plans allow individuals penalty-free access to their retirement funds as early as age 50. But in terms of Social Security and Medicare, the early retirement ages—when you’re first eligible to receive benefits—are 62 and 65, respectively.
Early retirement sounds pretty good to most people. But the discipline and sacrifice needed to adequately prepare for it may be significantly less appealing. Here are some questions to ask yourself to determine if you’re up for the challenge. The sooner you know if early retirement is a worthwhile (and realistic) goal, the easier it will be to prepare.
Can I save about a quarter of my income during most of my working years for retirement?
Vanguard generally encourages people to save 12% to 15% of their income, including employer contributions, for retirement. If you want to retire early, that range jumps to 20% to 25%.
If your annual income is $75,000 and you contribute 20% a year to retirement savings, you’ll reduce your take-home pay by $15,000 a year (almost $600 a paycheck if you’re paid biweekly). Only you can determine if that’s a pay cut you can live with long-term.
Am I willing to compromise on big-ticket items?
I don’t mean choosing a 60-inch TV over an 80-inch TV. I mean controlling the biggest expenses—housing, cars, and vacations.
For example, most mortgage lenders believe your monthly mortgage payment (including principal, interest, taxes, and insurance) should be 28% or less of your total income before taxes. This is a generous guideline.
If your mortgage takes up 28% of your income, and you save 20% of your income for retirement, you’ll only have 52% left to pay for your daily living expenses (utilities, food, clothing, entertainment, child care, health care, transportation, etc.) and save for other goals, such as padding your emergency fund or paying for a child’s education.
If you want to retire early, there’s not much wiggle room in the percentage of income you have to save during your working years. But you can spend less on housing and other big-ticket items to give yourself a greater percentage of income to live off of.
Will I have guaranteed income to rely on?
Guaranteed income, such as pensions and veteran’s benefits, is a stream of money you can count on for the rest of your life. Guaranteed income generally isn’t subject to market movements and may even be payable to your spouse upon your death.
You may also be eligible to collect Social Security. Just keep in mind that although you can file for benefits as early as age 62, waiting longer (up until age 70) will give you higher monthly benefits.
Some investors create their own source of guaranteed income by purchasing an annuity at retirement. While annuities pay monthly or annual income for life, there are a few potential drawbacks to consider. Annuities are insurance contracts, so it’s important to understand all of the fees and charges before you commit. When you purchase an annuity, you surrender control of your money. This means it won’t be accessible in an emergency, and in most cases, it can’t be used to fund an inheritance.
It’s also possible to draw down your retirement savings to replace your paycheck in retirement. Having a plan that factors in your goals, the percentage of your portfolio you plan to withdraw each year, and the order of your spending is key to making the best long-term use of these assets.
Am I willing to stick to my post-retirement budget … before I retire?
The average retirement spans 20–30 years. If you retire early, you’ll be extending that timeframe—so it’s important to think long-term.
I encourage clients to come up with a reasonable retirement budget that’s designed to see you through your extended retirement. Then test it for a year or more. (You’ll still be working, so it won’t be a true test of your retirement spending habits, but it can still be a worthwhile exercise.)
For example, if you plan to live off about 80% of your pre-retirement income, you may find you can comfortably live on less. Or you may discover that your ideal retirement lifestyle is likely to be costlier than you anticipated.
Am I prepared to pay for health care?
If you retire before age 65, you won’t yet be eligible for Medicare. But you’ll still have a few options:
- You can extend your employer’s insurance plan for 18 months after you leave your job under federal law (COBRA). Continuing your current coverage can be straightforward—but expensive. COBRA usually costs $400–$500 a month. You pay the same premium you paid while you were working), plus your employer’s contribution, plus a 2% administrative fee.*
- You can obtain insurance coverage under the Affordable Care Act. Depending on your income, you may qualify to save on an insurance plan or you can buy coverage on the Health Insurance Marketplace at full cost.
The month you turn 65, you’ll be eligible for Medicare. Because much of the cost is subsidized by the federal government, it’s usually less costly than private medical insurance.
Do I have a plan for my future free time?
I think it’s safe to assume that everyone—even the most satisfied professional—dreams of early retirement at some point. When your work-life balance feels off-kilter, the prospect of having nothing but time can sound enticing. For some, the reality of early retirement lives up to the dream. But for others, it can present challenges.
Set yourself up for success by having an idea of what you want to do in retirement. How do you want to structure your days? Where will you spend your time? If you don’t have a plan, you may feel lost in early retirement as you adjust to your new way of life.
There’s no easy way to guarantee a happy retirement. But if you can put the qualities that served you well professionally to use when you’re retired, you’ll be more likely to maintain a strong sense of purpose and satisfaction—feelings that are linked with happiness in retirement.
Do I have support?
Timing your retirement is a big decision. It’s a major event that requires years (likely decades) of planning. A financial advisor can help you not only determine a realistic target retirement date, but also help you create a plan (and stick to it) so you can meet your goal.
If you have a spouse, you’ll need his or her support too. You don’t necessarily have to plan on retiring at the same time, but the changes you’ll need to make to your spending and saving habits to prepare for early retirement will affect both of you.
Save-the-date for retirement
I don’t have any sage advice for planning a wedding. (I’m afraid I wasn’t even much help planning my own.) But I do know that when it comes to planning for an early retirement, the earlier you start, the better off you’ll be.
*For more information visit http://cobrainsurance.com/.
All investing is subject to risk, including the possible loss of the money you invest.