22 September 2021

How to Know If You’re Prepared for Early Retirement

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While many Americans fear they will never be able to retire, a fast-growing group of people in the Financial Independence, Retire Early (FIRE) movement are not only planning to retire, but also plan to do so decades before they’re eligible for social security benefit payments.

One of the guiding tenets of FIRE is to save up to 75% of your annual income in order to retire much earlier than the typical retirement age.

Retiring early will allow you to forego the headaches of working life, but you’ll also miss out on the additional earnings that might make your retirement more comfortable. With that in mind, plan carefully and make sure you have a sound financial plan ahead of retirement.

1. You have an emergency savings fund 

Before you retire, you should monitor your cash flow and have at least three to six months of personal finance savings in an emergency fund.

If you’re hit with an unexpected expense in retirement, you can get cash from your emergency fund. That’s a better option than your pulling money from your retirement savings, a move that could trigger an early withdrawal penalty.

Keeping your emergency fund in a high-yield savings account or money market account could earn you an annual percentage yield (APY) up to 10 times higher than a traditional savings account. These deposit accounts are FDIC-insured and often come with no monthly service fee or minimum balance requirements.

2. You have enough money in your savings account 

Before you retire, your savings should meet or exceed the Rule of 25, which designates a retirement savings goal of 25 times your expected annual retirement expenditures.

That means, if you estimate you will spend $50,000 annually in retirement, you’ll need to save $1.25 million before saying goodbye to your job.

To figure out how much you should save for retirement, calculate your current expenses as well as your expected expenses in retirement. These numbers will help you estimate your annual retirement expenditures.

3. You are debt-free 

Debt is a drag on anyone’s budget, regardless of your retirement status. Mortgage, student loans, car loans, credit cards and other debts make it hard to save and invest for retirement. And, if you enter retirement with debt, it could negatively impact your lifestyle and your financial level of comfort.

By contrast, paying off a mortgage for any real estate and paying off your debt balances means you won’t have to worry about making payments in retirement. You’ll have more flexibility in your retirement goal budget, less money-related stress and a greater ability to enjoy retirement.

Starting your retirement life debt-free and with sufficient savings will better position you for the extra years not working.

4. You can access your money penalty-free 

One dilemma facing those wishing to retire early is an inability to access their money. They have enough money in their 401(k) or IRA account, but it may be years or decades until they can pull money from their account penalty-free.

Most retirement accounts have minimum age requirements with penalties up to 10% for making early withdrawals. For example, 401(k) and IRA accounts have a minimum age requirement of 59 ½, in most cases.

Diversification of your savings and investment is essential if you wish to retire early, and you may wish to open an individual taxable investment account. While these accounts don’t possess the tax benefits of traditional or Roth IRAs or 401(k)s, they are free of age requirements on withdrawals.

A high-yield savings account can also provide you with a measure of flexibility versus a checking account. With a high-yield savings account, your money can grow in an FDIC-insured account – without the risk exposure of investing in the market – and you can access it penalty-free at any time. Compare savings rates for several high-yield savings accounts simultaneously at an online marketplace like Credible.

The bottom line 

Early retirement planning comes down to saving enough money to cover your annual retirement expenses. Accurately determining how much those expenses will amount to is a common obstacle for many. Take the time to calculate your anticipated annual expenditures - maybe consider consulting with a financial advisor or certified financial planner - including your housing, health insurance, transportation, car insurance, food, utilities, life insurance and health care.

With an accurate picture of your post-retirement financial needs you’ll be in a better position to choose a suitable retirement date, one that isn’t so early you risk running out of money or so late you end up working longer than necessary.

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