Question: I’m in my mid-30s, so I’m about half way through a normal working career span. How can I plan for early retirement and are there any pitfalls?
Answer: Early retirement – before age 65 – can be an option, depending on your specific financial situation, earning potential, career field and financial planning. As with any retirement choice, the sooner you start planning and saving the better.
To make early retirement viable, you should start planning now and might need to consider some non-traditional, i.e., riskier, investment or savings strategies. And then there are social and interpersonal considerations to leaving the full-time workforce early.
But let’s start with the basics.
Your pre-retirement resources check list should start with any employer provided pension or defined contribution plan such as a 401(k) you have in place.
Next, what other assets, investments, retirement savings (such as IRAs) or sources of capital do you have available? Finally, what can you expect from Social Security at a traditional retirement age?
Once you have a handle on where you are, financially speaking, you can start to project where you want to be in retirement, starting with your desired standard of living.
Conventional wisdom, according to Forbes Insight, states you should plan to retire on an income that is 80 percent of your pre-retirement annual earnings. Depending on your lifestyle preferences, that number could be higher or lower.
For example, if you anticipate your housing expenses will be lower, because of either downsizing to a less expensive home or paying off your mortgage, you can make a downward adjustment. Likewise, if you expect your health-related costs will be more expensive in the future, you’ll need to make an upward adjustment.
Once you have your projected income number figured out, you can calculate the size of the investment portfolio and other income that will be necessary to produce those earnings.
Forbes Insight suggests a comfortable retirement annual withdrawal should be about 4 percent of your total investment portfolio — that way, your portfolio never should run out. Of course that’s projecting an annual rate of return of somewhere between 6 and 10 percent. That also would allow for enough capital preservation to cover future annual withdrawals and keep your portfolio growing.
If you’re 30 years old and want to retire at age 50 with $40,000 in annual income from investments, and using the 4percent safe withdrawal rate, you’ll need $1 million in assets, according to Forbes Insight. Since 4 percent is 1/25 of your portfolio, you’ll need initial available assets valued at 25 times greater than your projected annual income requirement.
Forbes Insight also said $1 million in 1995 would have had to grow to $1.54 million by 2015 to maintain equivalent purchasing power. Using an inflation factor of 2.5 percent per year, Forbes Insight projects that $1.5 million amount would need to increase to about $2.4 million over the next 20 years to maintain the same purchasing power.
Given your individual situation, income, investments, retirement savings and goals, your amounts could differ. A certified professional financial planner should be able to help you with your specific questions.
As for ‘pitfalls,’ early retirement could present social and other considerations along with financial questions. For example, you might change your mind or miss the interpersonal engagement of working full-time. Or your financial needs might change significantly requiring additional income.
While early retirement might sound like a utopia, you should weigh carefully the pros and cons to determine the best path for you to reach your life’s goals.