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So You Want To Retire Early? Here Is How To Make That A Reality! Thumbnail

So You Want To Retire Early? Here Is How To Make That A Reality!

Early retirement for many would be a phenomenal goal to achieve. Especially if you are getting to a stage in your career where you feel burned out and unmotivated. However, it can seem like a daunting decision to retire from your job much earlier than you had originally anticipated. Not to mention, you'll most likely be doing it with a lot of skeptical onlookers. After all it's not very common for a person to be able to call it quits in their early 50s. But if you're focused on that goal and you've done a good enough job to prepare yourself financially, you could make it a reality. In this blog we're going to look at all of the areas you should begin to prepare yourself for if early retirement is on your horizon. 

Key Takeaways:

  • Get clear about how much retirement will actually cost

  • Create an income stream for yourself

  • Reduce your enhanced risks before retirement starts

  • Self-awareness is the key to early retirement success

Is a blog post not your style? Would you rather learn about early retirement via video instead? That's great because we've got covered! Enjoy this PharmD FP Video about 3 Tips you can utilize as you begin to prepare yourself for early retirement.

Get Very Clear About What Your Early Retirement Will Cost

You have probably been saving for retirement since your first job out of pharmacy school. Some even earlier than that. You most likely have picked a percentage of your income to be placed into a retirement account each year, with the hope of their being enough money in said account(s) to comfortably live off of when you retire. But how do you know if what you're saving now will be enough? How do you know when you've accumulated enough? Is $500,000 your magic number? Or maybe it's $2,000,000. The question "How much do I need to have saved for retirement"  gets asked a lot. And the correct answer to this question should be directly aligned with what your anticipated lifestyle will cost in retirement.

Understanding and being able to closely predict what your expenses will be in retirement is even more important for those who want to retire earlier in life. You can get by "guesstimating" what retirement might cost you when you retire at age 70. After all, the average life expectancy in the United States is 77.8 years. So not getting very clear about what retirement will cost is not as important. But if you're contemplating pulling the retirement trigger in your earlier 50's, your margin for error goes down dramatically. Especially if you have a history of longevity in your family. 

The easiest way to predict what your retirement will cost is to first have a real good understanding how how much you spend right now. If you have a clear idea of where your money is spent each year, you can then extrapolate that information and apply it to your own retirement projections. Doing this will give you a better idea of what expenses will remain after you retire and which expenses won't. You can then apply inflation adjustments on those numbers up to your goal retirement age and after. 

Doing this will give you a very clear picture of what the total cost of an early retirement may be. This will give you a clear benchmark you'll want to pursue from a savings and investing standpoint. I need at least $2,500,000 in order to retire at age 50 based on my projected expenses. I currently have $300,000 saved. Now you can solve how to bridge that savings gap. 

Finally, getting real clear about what an early retirement will cost is a great reality check. If it's a goal that you just can't afford, at least you'll know that and will be able to pivot from there. So get very clear about what your projected retirement expenses will be. It's the bedrock of good retirement planning. All other decisions will be made based on this information, so getting it right is critical to being able to retire early with confidence. 

Create An Income Stream

Normally, people end up waiting to retire until they've met the age requirements where they can begin to receive social security and Medicare. You can start receiving social security at age 62, though it'll be at a reduced benefit. Medicare is accessible at age 65. It's why mid to late 60's is a common age range for people to retire. However, if you decide to retire at age 50, you are more than a decade away from getting social security and a decade and a half away from Medicare benefits.

So what is a strategy you can implement to reduce the cost pressure of not having access to either of these benefits? The best way to do this is by creating an income stream for yourself that can cover these two areas of your financial life until you get to an age where you can access them. An income stream that is reliable and large enough to provide you with cash each month to cover your basic expenses in retirement as well as health care costs is extremely valuable. In the past most people could rely on a pension. Most pharmacists are not lucky enough to have something like that. So where can you look to produce an income stream for yourself?

The most common place to start is getting a part-time job. I understand that retiring early is your goal because you don't want to have to work anymore. However, a part-time job could be something that doesn't resemble "work" to you at all. It could be a hobby that you get paid for or a side hustle online that doesn't require a large amount of your time or effort. As long as it's something you're comfortable with and can do with limited stress.

Another option you could look into as a way to create a reliable income stream could be tapping into your home equity. If you've paid off your mortgage, you may be sitting on hundreds of thousands of dollars in equity that is available for you to use. Even reverse mortgages are becoming more popular and reputable. It's an asset you own and in the right situation could be a great way to produce a steady income during those early years of retirement. 

Finally, one of my favorite options to create an income for yourself is through an income annuity. I don't sell income annuities and have zero financial interest in whether someone buys one or not. That being said, I really like an income annuity for people who find themselves in this situation. The reason why I am a fan of income annuities is because of mortality credits. Essentially, mortality credits are a way for you to be paid someone else's money that dies sooner than expected. You can also structure income annuities to pay-out over a specific period of time as well. So if you retire at age 50 and you want to turn on your social security at age 65, you can buy a 15 year income annuity. Also, since the annuity company is the one that is guaranteeing those payouts, investment risk and market performance gets taken off your plate, which is one less thing to worry about during your early retirement.

Income Annuity

Reduce Your Enhanced Risks Before Retirement

As you think about early retirement and what you can do to prepare for this next stage of your life, you are going to want to focus your attention on 3 major risks you'll encounter. Bringing these to your attention will allow you to better manage and reduce the severity of these risks when they appear. And mitigating these now as much as possible before you get to retirement will be extremely beneficial.

The biggest risk you will experience during an early retirement is sequence of return risk. Sequence of return risk is experiencing unfavorable stock market returns during those early years of retirement while you are continuously selling those investments so you can generate income for yourself in retirement. How do you make money in the stock market? Buy low, sell high. However, if you are continuously selling since you're in retirement, you are at the mercy of whatever the stock market is doing at that time. And if your first few years of retirement experience poor market performance, you could end out doing a lot of damage to the long-term viability of your retirement portfolio. Selling investments at a loss and then spending that money means less of it will be in your portfolio when markets start to perform better again in the future. Meaning your better rate of return years will be with less money in your accounts. No one can predict what years the stock market will be up or will be down. Having a plan for sequence of return risk is a huge necessity. One possible solution could be enhancing that income steam we talked about earlier, so you put less pressure on the amount of money you have to take from your investments each month and year. 

Another big risk that we can't control is taxation risk. Let's assume that you have done a phenomenal job of saving for retirement in your employer's 401(k). You've amassed more than enough in that account to be able to afford to retire early. But what you can't forget is that the IRS owns a portion of that money. And their ownership of those dollars will either increase or decrease depending on future tax rates.

Ex: You have $4,000,000 saved in a 401(k). The effective federal tax rate now is 15%. This means that you own the IRS 15% of that $4,000,000. So you really only have $3,400,000 you can use to live off of in retirement. Now lets assume that tax rates go up after you start retirement. Your new effective federal tax rate is 25%, which means the IRS now owns $1,000,000 of your retirement savings. 

Taxation risk, especially if you have the majority of your retirement money in deferred accounts (accounts that will get taxed when you pull the money out) could cause a lot of problems. You might think you have a certain amount of money you can reliably retire on but if tax rates increase in the future, you may come up short.

So as you approach your early retirement date, make sure you are doing everything in your power to diversify yourself from a tax standpoint. If possible (and if it's in your best interest to do so) you may want to explore different types of accounts to save in. The two other most common type of investment accounts would be a taxable investment account and a Roth (IRA/401k) account. The last thing you want is for the IRS to make a change that you are not prepared for that disrupts your goal of early retirement. 

The last enhanced risk you should be prepared for is inflation risk. Inflation is a slow and silent killer for many retirees. This becomes even more true for early retirees. Most people believe that when you get to retirement you should have a very conservative investment portfolio. But this could be bad advice if your retirement outlook is 50 years. Conservative investing and increasing inflation would mean your purchasing power as a retiree gets knocked down. If this happens too many times, you'll be forced to spend more than initially anticipated, which could force you to have to go back to work. That would not be ideal.

Historically, one of the best ways to fight inflation risk is by always maintaining a proper allocation of your retirement money to stocks. This means you can't get super conservative with your retirement money. So understanding this and preparing yourself mentally to take on more investment risk than you might be comfortable with could help your long-term retirement success.

Risks in Retirement

Get Really Good At Becoming Self-Aware

Retiring early may sound like your future optimal outcome. And it may very well start that way. But what happens if you get into early retirement and it isn't all you thought it was going to be? What if it starts to change you? This happens more than you think. Do you have enough self-awareness to be able to identify changes in your life that are not positive and correct them?

You retired early, but many of your friends didn't. You may even find that your spouse wants to continue to work for the foreseeable future. The people you've come accustom to doing things with are not available during the middle of the day like you. This could lead to more isolation and less social interaction. Being self-aware will help you see this coming and allow you to course correct.

An early retirement could also mean more free time. Probably more free time than you've ever had. How do you plan to fill it? This is where bad habits might creep in. The type of bad habits that may limit the enjoyment of the other areas of your life. Are you prepared to be able to spot those trends in your life so you can make changes?

Now this might sit toward the bottom of your list of things you're concerned about when it comes to early retirement. But it's important to remember that retirement is ultimately about living a life of happiness and contentment. So preparing personal skills that will help keep you aligned in life with those two areas has significant importance. 

Bottom Line

There is A LOT to consider when you are planning for an early retirement and there will always be issues that will arise. That's just life. However, the better prepared you are at the beginning will go a long way in reducing the severity of those unexpected problems. It's never to early to start properly planning!

Derek Delaney is a Minnesota (Minneapolis / Rochester area)  Fee-Only financial advisor serving clients across the country. PharmD Financial Planning provides professionals and families with financial planning and investment management with a focus on tax-efficient retirement planning.

As a fee-only, fiduciary, and independent financial advisor, Derek Delaney is never paid a commission of any kind, and has a legal obligation to provide unbiased and trustworthy financial advice.

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