Want to take up power gardening or adventure travel before you drive the TV remote in your latter years? Early retirement is within reach.
Retirees who've successfully left the grind before 65 often follow several vital steps. Some are fairly obvious and others are more nuanced. But to get to the leisure life, you'll need to plan well ahead and be a star saver during your working years.
All successful early retirees have one thing in common: They "have discipline about accumulation," said John Campbell, east region head of wealth planning for U.S. Bank Private Wealth Management (part of U.S. Bancorp. These people don't give in to the "herd mentality" when it comes to spending.
"Smart retirees are less consumption-oriented more accumulation-oriented," said Campbell.
Step 1: Early Retirement: Save Early, Save More
Your nest egg needs to grow bigger, faster to retire early. How? If you're in the early part of your career, begin putting money in an IRA or other retirement account right away, especially if your employer matches some of your contribution.
Those matches are free money. If you're not taking them, you're throwing dollars away — dollars that will grow over time.
Compounding interest and returns are magical. Over 30 years or more your initially puny retirement account will put on plenty of heft.
But you might need to live in a cheaper apartment, maybe go out for less pricey dinners and drive an older car.
Early retirees "pay themselves first" before they pay for anything else, said Dan Casey, owner of Bridgeriver Advisors in Bloomfield Hills, Mich.
This means don't keep up with the Joneses, instead "live beneath your means," said Casey. And even as your income rises you need to maintain the habit of frugal living.
Step 2: Stay Out Of Debt, Pay Down Your Mortgage
Everyone knows credit card debt and other short-term debt is costly and will hammer your financial future. But it's still worth noting. So don't buy the boat or RV on credit, or step up to a luxury SUV with the big car loan.
Do pay down your mortgage. Sure some financial advisors will tell you that if you have a low, fixed interest rate you'll make more investing your money than paying down your mortgage.
Perhaps. But if you just pay a little extra toward the principal of your mortgage each month or each year you'll pay it off years earlier and save tens of thousands of dollars (use a mortgage pay-down calculator to run some numbers).
Most retirees don't want a large mortgage payment hanging over them every month when they're not earning anymore. Paying it off gives them "emotional piece of mind," said Casey.
"The psychological satisfaction of having the mortgage paid off can't be beat," said Wade Pfau, an author and professor of retirement income at The American College of Financial Services. Plus, being mortgage-free gives retirees more flexibility to cut spending in a down market and not tap investments that will recover when the market picks up again.
Step 3: Invest All Your Bonuses
Investing found money, like bonuses, inheritance and tax refunds, seems like a simple concept. But many people don't do it.
Retirees sprinting for early retirement do it every time.
Sure, buy yourself a small gift with that unexpected income. Then use the rest of the money to pay down your mortgage or add it to your investment and retirement accounts.
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You likely weren't expecting that money for your day-to-day expenses so you won't miss it.
Better to tuck it away and let it grow. For example, consider investing it in something that produces passive income — see the next step.
Step 4: Build A Passive Income Stream
In California and other high-cost real estate markets, cities are changing zoning laws to encourage accessory dwelling units (ADUs). These are small rental properties built inside or next to your primary residence.
In tony areas, a small ADU (500 to 600 square feet) can rent for $2,000 a month. Or some retirees are building ADUs — thus staying in the neighborhoods they love — and then moving into them and renting out the big house for even more income.
Other retirees own stand-alone rental properties. "At least 30% of my clients have some sort of rental-generating income," said Casey.
And some retirees get clever about short-term rentals. One older couple who met later in life never combined households. Thus they own two houses in desirable vacation areas. When they're not residing in one of the houses its being rented for $400 to $500 a night via Airbnb. The houses are residences and income generators, and the properties earn the upkeep money for maintenance and property taxes.
And homeowners can rent out garages and storage space, as well as rent their homes for events to make more income.
Yes, rentals generate taxable income. But rentals also generate a lot of expenses that can mitigate some of those taxes.
Step 5: Don't Put All Your Money In An IRA or 401(k)
This one sounds counter intuitive. Everyone tells you to put as much money as possible in your retirement accounts. But if you get to retirement early it will cost you to tap those accounts. There are some workarounds, but they're complicated.
Instead build an investment account for the gap years, from when you leave the workforce until you can start pulling money from your retirement accounts. You'll need income for those years, "build a dividend portfolio for that gap," said Casey. Meanwhile leave your retirement account to keep growing. And maximize your Social Security by not tapping it until age 70.
At 70, by law you'll also have to start making at least minimum withdrawals from your traditional retirement accounts and those are taxable dollars. So you'll need to do some tax planning, keeping your income within a lower range to generate the lowest tax bill.
Step 6: Do A Retirement Plan, Know The Costs
Make sure you know why you're retiring and what your retirement will look like. "You want to have something that you're retiring to rather than something that you're retiring from," said Pfau. "You need a plan for how you're going to spend that extra eight hours a day."
Also, take a serious look at what it will cost for you to live the life you want after work. Be realistic, and be sure to account for inflation.
Plus make sure you've thought about health care for the period before you get to Medicare. "If you had heavily subsidized health care while working, better be ready for much higher premiums" when you leave the workforce, said Pfau.
Build up your Health Savings Account (HSA) account before you leave the workforce so you can cover deductibles and copays for those gap years. Also, if possible get your income down the last two years before you leave your job. Affordable Care Act (ACA) premiums are based on your income. Think about all medical costs and golden years planning: Do a will, and a trust, and evaluate long-term care insurance and life insurance options.
Set a goal and take the necessary steps to get there. "If you target nothing, that's what you'll end up with," said Campbell.
