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7 Tips for Retiring Early

Adam Hoopes, CFP®

Director of Financial Education

Last Updated
July 19, 2022
Young businesswoman with a determined smile

Are You Prepared for an Early Retirement?

After years in the workforce, you may begin dreaming of retiring early. While an early retirement can be an ambitious goal, there are certain steps you can take today to help make that dream a reality. The following tips can help you prepare for an early retirement.

Tip #1 – Understand your current financial situation and goals for the future.

The first step in preparing to retire early is to gain an understanding of where you currently stand on the path toward achieving your goals. Assess the following:

  • Assets – Where are your current accounts, and how are they invested?
  • Liabilities – What obligations have the potential to take away from your retirement?
  • Income sources – What assets are available to fund your retirement? These may include Social Security, pension(s), rental income, etc.

Tip #2 – Determine how much income you’ll need in retirement.

Once you understand your current financial situation, take some time to visualize what you want your retirement to look like. Consider your overall lifestyle, not just one-time goals. Ask yourself questions such as:

  • Where do I want to live?
  • How will I spend my time each day?
  • Who will I surround myself with?
  • What tasks or opportunities will offer me a sense of purpose and fulfillment?
  • What people and/or causes do I wish to support?

The answers to these questions can help you envision your ideal retirement. With your vision as a guide, work with your wealth manager to estimate your monthly expenses during your first year of retirement. Then use this information to determine the amount you’ll need to withdraw from savings each year to support your desired lifestyle. Lastly, multiply this amount by the number of years you can reasonably expect to live in retirement in order to determine whether your current savings will be enough.

Tip #3 – Have a plan for all your outstanding debt.

While paying off debt is an important step for any pre-retiree, it’s especially important if you plan to retire early. Carrying outstanding debt not only reduces the amount of assets you can set aside for retirement purposes but also increases your expenses (due to the interest you pay).

If you’re hoping to retire early, it’s time to get serious about paying off debt. To do so, consider implementing one of the following payoff strategies.

  • The snowball method – This involves paying off your smallest debt balance as quickly as possible, then moving on to the next-smallest debt. The benefit of this approach is it can help you gain a sense of accomplishment as you knock out one loan after another.
  • The avalanche method – Using this method, you begin paying on whatever loan has the highest interest rate. Once that’s paid off, you move on to the loan with the next-highest interest rate until all loans are paid off. This approach allows you to pick up speed as your go because each payment saves you more money than the one before.

Once your debt is paid off, you may be able to free up enough funds to establish a passive form of income, such as an investment property or a high-dividend investment that provides recurrent income to help support you in retirement.

Tip #4 – Plan for inflation and market volatility.

If you retire early, you may end up living for 30 years or more in retirement. During that time, inflation and market volatility will likely have a big impact on your retirement savings, which is why it’s important to be prepared.

One common misconception among many soon-to-be retirees is that they should transfer all their riskier, growth-focused assets into conservative investments, such as CDs and bonds, as they near retirement. However, if you retire and move all your investments into short-term vehicles, you’re going to potentially miss out on a lot of growth while also losing a significant amount of purchasing power to inflation over the coming decades. You need to invest for the long term while also funding your lifestyle.

At Creative Planning, we typically recommend maintaining three to five years of living expenses in a short-term, semiliquid investment account. This is generally a mix of bond funds that can provide capital for opportunistic rebalancing and a monthly income. Having a short-term allocation to bonds can prevent you from having to sell out of equities at a loss when markets are low.

Any assets not needed to fund your short-term needs should be invested in a diversified portfolio with a focus on growth and inflation protection. While this portfolio should be in line with your overall risk tolerance and investment objectives, it can be invested in riskier assets than your short-term account. Throughout retirement, your wealth manager will help you identify opportune times to transfer assets from your long-term savings to your short-terms savings in a tax-efficient manner.

Tip #5 – Determine the optimal time to start your Social Security retirement benefit.

Social Security uses your 35 highest years of earnings to determine the retirement benefit amount you’ll qualify for at full retirement age (FRA). Depending on your birthyear and when you start your benefit, you could receive as little as 70% or as much as 132% of your earned amount. You should consider the following when evaluating when to begin taking benefits:

  • Your health and your spouse’s health
  • The tax implications of starting early or later
  • What additional income sources you’ll have in retirement
  • Your overall cash needs

Tip #6 – Plan for healthcare expenses.

Healthcare is one of the biggest expenses most people face in retirement. In fact, a 65-year-old couple that retired in 2021 can expect to spend approximately $300,000 on healthcare and medical expenses throughout retirement.1 If you retire early, you’re likely to pay even more throughout your lifetime. That’s why it’s important to plan for healthcare expenses before you retire.

One of the most tax-efficient ways to save for healthcare expenses in retirement is by contributing to a health savings account (HSA). HSAs offer three distinct tax advantages:

  • When used to pay for eligible medical expenses, HSA withdrawals are tax free
  • HSA funds grow tax free in the account
  • Because your contributions are made with pre-tax dollars, they reduce your taxable income

In addition, HSA contributions made via payroll deductions are not subject to Social Security and Medicare taxes and there are no required minimum distributions from your HSA account. Also, because HSAs allow for investments in mutual funds (once certain asset levels are achieved), assets invested have the potential to grow over time and enhance your overall retirement savings.

As you near retirement, you may also want to consider purchasing a Medicare supplement plan to help pay for retirement healthcare expenses not covered by Medicare. There are many options for supplement plans, and it’s important to make sure you have a clear understanding of your coverage, deductibles and out-of-pocket costs in order to choose a plan that meets your specific needs. Your wealth manager can help you evaluate your options and select a plan that’s right for you.

Tip #7 – Have a plan in place.

The essential key to retiring early? Having a plan in place. Your comprehensive financial plan serves as a map toward accomplishing your goals and living your desired lifestyle in retirement. It should incorporate all aspects of your financial life, including investment management, estate planning, tax planning, insurance planning, retirement income planning and more.

Are you considering an early retirement? Creative Planning is here to help. We can help you plan for the future by integrating all aspects of your personal financial life into a single, comprehensive plan designed to help you achieve your specific retirement goals. If you’d like help planning for an early retirement, or with any other financial matter, please schedule a call.

Footnotes:

  1. https://www.fidelity.com/viewpoints/personal-finance/plan-for-rising-health-care-costs
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This commentary is provided for general information purposes only and should not be construed as investment, tax or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.

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