In part one of “How to Retire Early,” we focused on the need to reduce expenses and control debt. Doing so can create the foundation for a retirement plan by making money available for investment.
Consider all sources of income. Typically, retirement income comes from a combination of an employer pension, personal savings and Social Security income. Compare what you are eligible to receive with what you will need.
If you have a shortfall, consider all of your options for making it up before you retire. You may decide to work part-time. It you have a marketable skill, you may even be able to develop a base of business that provides you with enough income to meet your needs without dipping into your retirement savings for a few years. Or maybe you have space you can rent out to produce more income.
You can begin receiving Social Security income when you are 62, but the younger you are when you begin, the lower the amount you will receive. However, you will also receive Social Security assistance for more years if you begin to receive it early.
Review the numbers before you make a decision. You can always retire and delay receiving Social Security income if you would like to boost your monthly income.
Save as much as you can in a qualified retirement plan. If your employer offers you a 401(k) plan or other form of qualified retirement plan, put aside as much money in it as you can. In most cases, employers will offer a percentage match for contributions.
In addition, contributions are tax deductible (if you meet income qualifications) and earnings from your investments in such plans can grow on a tax-deferred basis. If your employer offers a Roth 401(k) plans, you can pay taxes on your contributions, but never have to pay taxes on the earnings from your investments.
Once you retire, be prudent with your withdrawals. People who retire at 65 should save as though they will live for another 25 years or so, as life expectancy continues to increase. Those who retire earlier must have enough income to draw on for even longer.
Use other tax-advantaged ways to save. If you max out contributions to your employer retirement plan and still don’t have enough saved, or if you don’t have an employer retirement plan, consider contributing to IRAs or Roth IRAs. IRAs offer the same benefits as qualified retirement plans, but without matching funds, and the contribution limits are lower.
Annuities also offer a tax-advantaged way to save, as you won’t have to pay taxes on earnings until you begin receiving distributions. There are many different types of annuities, but most of them offer lifetime income. As payouts continue as long as you’re alive, an annuity can be a good deal if you live a long life; however, even if life ends shortly after you fund the annuity, the annuity will end as well.
Before purchasing an annuity, be certain the insurance company that’s selling it is highly rated and in good financial shape. Your retirement income could be in jeopardy if the insurer is insolvent when you’re expecting to receive annuity payouts.
Have a plan – and stick to it. Ideally, you need to save enough money so that your retirement account is self-perpetuating. Otherwise, you are likely to run out of money while you are still alive – and you may be in no position to return to the workforce when you do.
Even if your retirement savings are self-perpetuating today, they may not be tomorrow, as inflation will raise your cost of living over time.
It’s generally accepted in the industry that you can retire at 65 and spend 4% of your savings each year. If you look at the numbers and determine that you can’t live off of 4% of your savings, it’s probably a good idea to keep working until you’ve saved enough so that you can live off of 4% of your savings.