How Can I Retire Early?

Following are eight steps that can help you build a nest egg that’s substantial enough for you to consider an early retirement. Note that this article is focused on cash savings, as well as investments (including different types of retirement plans). We are not including the potential value of real estate or business assets here. Of course, the beauty of the Rule of 25 is that it’s flexible enough to include details that are particular to your plan.

Speaking of your plan …

1. Make an early retirement roadmap

The first step in your early retirement plan is to commit to this new path, and all that it will entail. An early retirement requires determination and, in many cases, making changes to how you think as well as some of your day-to-day habits. Divide your plan into two parts: Money and Vision.

 Start by doing the math, using the Rule of 25. Be brave. Based on your current nest egg, how much more would you need to save to get to your goal? Next: If you hypothetically needed to save $500,000 more to reach your goal, divide that by the number of years until your early retirement date. If you have 15 years until your early retirement, you’d have to save about $33,333 per year, or $2,777 per month, to save an extra $500,000. Use a calculator to explore different potential investment returns. While there’s no way to predict what your investments will earn over time, a conservative return rate of, say, 5% isn’t unreasonable considering that the average stock market return of the last decade was about 13.9%, although it’s always important to remember that past performance is no guarantee of future performance.

Also, that historic return rate assumes being invested 100% in stocks, so a lower rate of return would reflect the assumption that you’d also invest in bonds or cash, and/or that market returns might be lower in the future.

Schedule a few check-ins with yourself, and/or a partner or loved ones, to discuss what “early retirement” means, and what it might look like. Not working? Working a little? Working in a different field? Starting a business? Going back to school? Volunteering? Traveling?

It’s different for everyone, so the clearer you can get about the details now, the smarter you can be about how much money you need to make your plan work.

2. Find a budget you can live with

By now you’ve probably realized that having a budget you can live with is critical to making this plan a success. The essential word here isn’t budget, it’s the whole phrase: a budget you can live with.

There are countless ways to manage how you spend and save (a.k.a. budgets). There’s the 50-30-20 plan, the envelope method, the zero-based budget, etc. One suggestion: Search up what types of spending plans other people in the early retirement community are using.

Test a couple of them for a couple of months each. Find one you can live with.

The reason you need a budget to retire early is because few people have the stamina and self-discipline to stick to a plan unless they have specific numbers to work with.

Recommended: Typical Retirement Expenses to Prepare For

3. Take advantage of employee benefits

If your employer offers a retirement plan like a 401(k) or 403(b), that’s the first thing you want to take advantage of — especially if there is an employer match involved (e.g. your employer matches a percentage of your savings). These employer-sponsored plans allow you to invest in mutual funds, target date funds, and more.

The other reason to save and invest in an employer-sponsored plan is that in most cases the money you save reduces your taxable income. So the more you save, the less you might pay in taxes.

The caveat here is that you can’t access those funds before you’re 59½ without paying a penalty. So if you plan to early retire at 50, you will need to tap other savings for roughly the first decade to avoid the withdrawal penalties you’d incur if you tapped your 401(k) or Individual Retirement Account (IRA) early.

Be sure to find out, from HR and from your colleagues, if there are any other employee benefits you might qualify for: e.g. stock options, a pension, deferred compensation, etc.

4. Consider a Health Savings Account (HSA)

If your employer offers a Health Savings Account as part of your employee benefits, you might consider opening one.

Even though your 401(k) and IRA may have contribution caps, a Health Savings Account allows you to save additional money: In 2022, the HSA contribution caps are $3,650 for individuals and $7,300 for those with family coverage.

Your contributions are considered pre-tax, similar to 401(k) or IRA contributions, and the money you withdraw for qualified medical expenses is tax free (although you’ll pay taxes on money spent on non-medical expenses).

The downside of saving in an HSA is that your investment options may be limited. If you find they are too limited, you may want to consider saving more in your employer plan

5. Open a Roth IRA

The advantage of saving in a Roth IRA vs. a regular IRA is that you’re contributing after-tax money that can be withdrawn penalty and tax free at any time.

To withdraw your earnings without paying taxes or a penalty, though, you must have had the account for at least five years (the so-called 5 Year Rule), and you must be over 59½.

If you already have the bulk of your savings in a 401(k), you might want to consider doing a Roth conversion for some of that money. Although you’d have to pay taxes on the money you rolled over into a Roth (because a Roth must be funded with after-tax dollars), this would enable you to withdraw those contributions penalty free.

6. Pay off debt

Obviously, it’s very difficult to achieve a big goal like saving for an early retirement if you’re also trying to pay down debt. It’s wise to start your plan with a clean slate, and work first to pay off any and all debts you might have (credit card, student loan, personal loan, car loan, etc.).

That’s not only because being debt free feels better — it saves you money. For example, the interest rate you’re paying on credit card or store cards can be quite high, often above 10% or 15%. If you own $6,000 on a credit card at 17% interest, for example, when you pay that off, you’re essentially saving the 17% that debt was costing you each year.

7. Invest early and often

How do you invest to retire early? You can invest in stocks, bonds, mutual funds, exchange-traded funds (ETFs), target date funds, and more.

One factor to consider is how aggressively you want to invest. That means: Are you ready to invest more in equities, say, taking on the potential for greater risk in order to reap potential gains? Or would you feel more at ease if you invested using a more conservative strategy, with less exposure to risk (but potentially less reward)?

Whichever strategy you choose, you may want to invest on a regular cadence. This approach, called dollar-cost averaging, is one way to maximize potential market returns and mitigate the risk of loss.

8. Stay within your spending limits in retirement

The budget you make in order to save for an early retirement is probably a good blueprint for how you should think about your spending habits after you retire. Unless your expenses will drop significantly after you retire (e.g. if you move, if you need one car instead of two, etc.), you can expect your spending to be about the same.

That said, you may be spending on different things. You may be spending less on commuting and gas and work-related expenses and more on your new business or on travel. Whatever your retirement looks like, though, it’s wise to keep your spending as steady as you can, to keep your nest egg intact.