How to Retire Early

How do I retire early?

Lots of people dream of having more free time in their later years. Maybe you want to travel the world. Maybe you want to finally launch your own business. Or you might feel led to do volunteer work. Whatever the reason, the question is the same: What would it take for me to retire at 55? Or even 50 or 45?

The answer depends on your financial situation, but if you’re serious about learning how to retire early, here are some things that could help you get there:

1. Determine what kind of lifestyle you want in retirement.
2. Create a mock retirement budget.
3. Evaluate your current financial situation.
4. Invest in a bridge account.
5. Invest in real estate.
6. Get serious about lifestyle changes.
7. Play it smart when you retire early.
8. Meet regularly with a financial advisor.

If you’ve already checked off some of these steps—awesome! You’re ahead of the game. If not, then it’s time to roll up your sleeves and get to work. In more ways than one!

Before you start running the numbers on how to retire early, you need to know what you want to do in retirement. That dream will determine your budget.

Market chaos, inflation, your future—work with a pro to navigate this stuff.

Do you want to travel the world? Then you’ll need a big budget. Want to travel to see grandkids? Open a business? Do volunteer work? Take the family on a huge vacation? Each of these dreams carries a different price tag.

Here’s a pro tip: You need to get specific about the amount you think you’ll need to live on every month in retirement. The best way to do that is to create a mock monthly retirement budget. To make things simple, just ask yourself: If I retired today, what would my budget look like?

Notice that this budget doesn’t include a mortgage payment. That’s because you want to pay off the mortgage (and any other debt) before you retire. Debt will eat away your retirement fund and keep you working long after you want to retire.

Your budget will look different at different phases of your life, like when you drop life insurance and when you add long-term care insurance. You may want to travel a lot at first (which will cost more) and stay closer to home as you age. Medical expenses will vary during a long retirement too—we’ll talk more about that later.

Oh, and one last thing! Remember that since things like gas and groceries usually get more expensive over time (thanks, inflation), the amount you’ll need to budget to maintain the lifestyle you have now will look a little different than it will in 10, 15 or 20 years.

Don’t worry, we have a free tool that tells you exactly how much money you’ll need to retire and how much you need to save each month to make that number a reality!

Planning for an early retirement is sort of like planning a long road trip. Simply knowing your destination isn’t enough—you have to know where you’re starting from and how far you need to go to get there.

If you’re not sure where you stand financially, Ramsey’s 7 Baby Steps are the perfect place to start. When you know what step you’re on, you’ll know exactly what your next best move is. Here’s a quick look at the Baby Steps:

• Baby Step 1: Save $1,000 for your starter emergency fund.
• Baby Step 2: Pay off all debt (except the house) using the debt snowball.
• Baby Step 3: Save 3–6 months of expenses in a fully funded emergency fund.
• Baby Step 4: Invest 15% of your household income in retirement.
• Baby Step 5: Save for your children’s college fund.
• Baby Step 6: Pay off your home early.
• Baby Step 7: Build wealth and give.

And Dave’s latest book, Baby Steps Millionaires, proves that following the Baby Steps is the quickest right way to build wealth. It takes the average Baby Stepper less than 20 years from the beginning of their journey to reach a million-dollar net worth. How quickly you get there is up to you!

No matter what Baby Step you’re on, there are plenty of things you can do to close the gap between where you are and where you want to be. Here are just a few to think about:

1. Pay off your house early. According to The National Study of Millionaires,  it took millionaires about 10.2 years on average to pay off their homes. There’s a reason for that! Just imagine how much faster you could reach your goals if you didn’t have a mortgage payment to worry about and invested that money instead.  
    
2. Lower your retirement budget. That means you decide to live on less each month than your original number. You may have to take fewer trips to Maui or cut back on some expensive hobbies.
    
3. Get a second job. Let’s say you get a part-time job that brings in an extra $1,000 a month. If you invested that extra income into good growth stock mutual funds month after month, year after year, that could add hundreds of thousands of dollars to your retirement nest egg. Now that’s progress!

If you’re debt-free (everything except the house) and have a fully funded emergency fund (enough to cover 3–6 months of expenses), you should be investing 15% of your income for retirement. But if you want to retire early, you need to put every extra dollar you can toward that goal. 

But there’s a slight problem. If you’re saving for retirement through tax-advantaged retirement accounts like your 401(k) or a Roth IRA, you won’t be able to take money out of those accounts until you reach age 59 1/2 (unless you want to pay a hefty early withdrawal penalty that will quickly eat into your retirement savings . . . yeah, we didn’t think so).

So, what’s the solution? After you’ve maxed out your retirement savings options and paid off your house—and only after that—it’s time to build a bridge! No, not an actual bridge. We’re talking about a bridge account that will help you bridge the gap (get it?) between your early retirement and the time when you can start taking money out of your retirement accounts without a penalty.

That’s where a brokerage account (also known as a taxable investment account) comes in.

Brokerage accounts are your best option to serve as your bridge account. It’s true that brokerage accounts don’t have the same tax benefits as Roth (tax-free growth and tax-free withdrawals) or traditional (tax-deferred contributions) retirement accounts.

Instead, any profits you make from selling investments inside a brokerage account will be taxed as capital gains in the same tax year you sold them. And if your investment pays dividends, you’ll probably owe taxes on those payouts too.

However, brokerage accounts do come with two really nice perks that make them perfect for planning an early retirement!

• First, there are no contribution limits—meaning you can invest as much or as little as you want into your account.
• Second, you can take money out of your account whenever you want. No need to worry about early withdrawal penalties! That’s exactly the kind of flexibility you want in a bridge account.

What investments should you choose for your bridge account? Dave recommends investing in low-turnover mutual funds inside these accounts. Turnover refers to how often the investments within the fund are bought and sold. Funds with a low turnover ratio of 10% or less—like an S&P 500 index fund—are ideal because they often have lower expenses and are less likely to lead to capital gains taxes, which would be passed on to the investor (that’s you).

Before you open a bridge account, make sure you talk to your financial advisor who can help you understand everything you need to know.

There is another path to early retirement that doesn’t involve a bridge account, and that’s investing in real estate. Real estate investing is not for everybody, but if done the right way, rental properties can provide you with a steady flow of income.

But before you try to make it big as a real estate mogul, there are some general rules you need to follow.  

First, invest in real estate only after you’ve already paid off your own home (in other words, after you’ve completed Baby Step 6). At that point, you’re completely debt-free with an emergency fund of 3–6 months of expenses saved. And you should also already be investing at least 15% of your income into retirement accounts, like a 401(k) or Roth IRA.

Second, always pay for investment properties in full, with cash—no exceptions! Remember, debt always equals risk—and putting down 100% reduces your risk dramatically. Not only that, but paying in full will also help you make money faster since you’ll pocket all the profits instead of sending a chunk of your income to some lender (plus interest).

And last (but certainly not least), don’t try to do this alone. When you’re ready to buy a property, make sure you hire a real estate agent who knows what they’re doing. A great agent knows the area so well that they can probably drive around town in their sleep and can help you get the best deal possible on a property. This is one of the biggest investments you ever make, so having a pro in your corner is the way to go!    

The question you need to ask yourself is, How hard am I willing to work now so I can retire early? Honestly, folks, this is where most people get stuck. They dream of an early retirement, but they’re not willing to do the hard work or make the sacrifices to get there. Remember, nothing of value comes without a price. Your sweat equity, time and sacrifice are the costs you pay to retire early.

For example, if your typical vacation costs your family $5,000, you may want to cut that in half and put the other $2,500 toward investing. Or what if you could cut your grocery budget by $100 a month? That’s an extra $1,200 a year toward investing. Here are other areas you may want to look for savings:

• Clothing
• Entertainment
• Cable/satellite
• Haircuts
• Gym membership (if you’re not using it)
• Subscription services (magazines, streaming video, audio books, etc.)

Can you imagine how much money you could be putting away for retirement every month if you cut just $15 from each of these budget categories? That’s $90 a month— $1,080 a year! What if you doubled that amount and cut $30 from each category? You determine whether you get to retire early. It’s all in your hands.

When you think you’re ready to say goodbye to your job, there are some practical things you need to think through—and possibly take action on—so you can take full advantage of your wealth potential. Before you retire, think about the following:

• Revisit your retirement dream. Are you still on the same page with your spouse? What are your expectations about travel? Hobbies? Giving? How do you picture your daily routine?
   
• Consider your retirement location. Before you retire, think about where you want to live. Will you have to move? Do you want to downsize? Which states have the highest cost of living? Which states offer the best tax breaks? Do you want to live close to family? You need to decide before you retire. An unplanned move after retirement can take a bite out of your retirement savings.
   
• Decide whether you’ll work. Some people still want or need a little extra income from work. What about you? Do you want to retire completely? Do you want to work part time or start your own business? Do you think you’ll miss the social interaction you get at work? Think through these questions before burning your business connections. It’s your future—and you get to decide how you want it to look!
   
• Keep a close eye on Social Security and health care. These are two wildcards that could change your retirement plans dramatically. You can’t count on Social Security to be a major source of income in retirement. It’s just gravy on the biscuit. You’ll need to plan your retirement budget as if Social Security isn’t an option.

Another major component to think about when you retire early is health insurance. If you leave your job before you qualify for Medicare, then you may need to buy private insurance. That’s a huge factor for your retirement budget.

• Determine how to manage income streams. An income stream is just a place you draw money from. Any savings outside of your emergency fund is an income stream. So are IRAs, 401(k)s, real estate, and cash in your pocket. However, you need to know when you can take money out of your retirement accounts. You’ll get hit with a big tax penalty from Uncle Sam if you withdraw money too soon. You can also be penalized if you don’t take out money early enough. Your financial advisor can help you make a plan so you don’t miss those important dates!

Yes, you need to keep an eye on your money. You need to ask questions about concepts and terminology that don’t make sense. Stay involved in your financial portfolio—but don’t make decisions before you’ve talked them through with a professional who knows their stuff and has the patience to explain it.

It’s a lot to think about and remember. That’s why it’s so important to work with a financial advisor when you’re trying to figure out how to retire early. Our SmartVestor program makes it easy to get connected with an investment pro near you. These folks are MVPs of the investing world. And once they understand your financial goals, they can help you come up with a plan to get there.

Find your SmartVestor Pro today!