3 Key Early Retirement Strategies

By | March 28, 2015
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3 Key Early Retirement Strategies

1. Start Saving Generously as Early As Possible

I know this may seem obvious, but starting a deliberate plan to save as much as you can as soon as possible is the most important step you can take to set you on the path to early retirement and financial independence. While a good rate of return on your investments will certainly help you achieve your goals, your rate of return is nowhere near as important as your savings rate. This is an important concept to keep in focus. Also, another important thing to realize is that your income level isn’t nearly as important as how much of it you save. See the table below for an example of how your retirement savings accounts will grow under four different savings scenarios.

Notes:

– In the first three scenarios savings begin at age 21 and the fourth they begin at age 35. All estimates include an average annual rate of return of 7%. Also, these scenarios can apply to both individual and family retirement savings.

– Scenario 1 includes a beginning saving rate of $2,000/yr and savings increase by $1000/yr annually. (Ex. year 2 savings = $3,000, year 3 = $4,000, etc.)

– Scenario 2 includes a beginning saving rate of $5,000/yr and savings increase by $1000/yr annually. (Ex. year 2 savings = $6,000, year 3 = $7,000, etc.)

– Scenario 3 includes a beginning saving rate of $5,000/yr and savings increase by $1500/yr annually. (Ex. year 2 savings = $6,500, year 3 = $8,000, etc.)

– Scenario 4 includes a late start (age 35) beginning saving rate of $25,000/yr and savings increase by $2,000/yr annually. (Ex. age 36 savings = $27,000, age 37 = $29,000, etc.)

3 Keys to Early Retire

So, can you still retire early if you didn’t start saving in your early 20’s? Don’t worry, we didn’t and were now well on our way. My family’s situation is more similar to Scenario 4, and we’re diligent about following these next two tips to make it possible.

2. Live Below Your Means

3 Key Early Retirement Strategies

Irrespective of where in the world you call home, today’s popular culture is very consumer oriented. Consumerism is woven deep into our society. The primary reason for this is that a community of good consumers makes for great quarterly reports on Wall Street. For example, consider the term most commonly used by news castors, talk show hosts and politicians when referring to everyday people… “consumers”. Another example is the famous speech given by then president George W. Bush on the eve of the 2008 financial meltdown when his main message to all the worried people of our nation was for everyone to “go shopping more”.

With all the consumer-oriented news you’re continually receiving, it can be challenging to break from the mold and truly live below your means. Buying a new car or a nice piece of jewelry may earn you status points with your colleagues and neighbors, but not with your online personal finance community. Let your little secret be that your golden nest egg is growing at a much faster pace than those around you who are flaunting their bling-bling.

In addition to speeding up your savings for early retirement, living below your means will also ensure that you’ll be able to thrive on a reasonable annual budget through your entire retirement. Three of the main parameters that determine how long your retirement savings will support you are (1) the size of your retirement savings account, (2) the number of years you plan to live with your primary income coming from your retirement savings, and (3) your projected annual expenses during retirement. If your goal is to retire early, the 1st and 2nd parameters are likely going to be larger than they would be for most planning to retire when their between ages 60-65. Your ability to break the mold of consumerism and live below your means is the most important trait for you to master in order to keep your annual expenses during retirement in check (3rd parameter) to ensure a long and happy retirement. Also, it’s good to keep in mind that once you raise your standard of living, it’s really hard to go back.

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3. Invest in Non-Retirement Accounts

Most guidance on the best approach to investing your retirement savings in the various types of savings account options is tailored for the standard retirement scenario where people retire between the ages of 60 and 70. Most of you are aware of the following standard retirement account funding progression:

  1. Emergency fund
  2. 401(k), 403(b) up to employer match amount
  3. Roth IRA
  4. 401(k), 403(b) up to max
  5. If applicable phase in college savings once retirement savings are on track
  6. Then last up in the standard approach is funding non-retirement (taxable) accounts

Related: Here’s a good post on how to build a simple low expense portfolio from www.mattmoneyman.com

This approach is spot on for the majority of people planning on retiring between ages 60 and 70.

But, if you’re planning for an early retirement, it’s important you incorporate investing in taxable accounts much sooner in the process. This is because withdrawals from retirement savings accounts prior to age 59.5 will receive an early withdrawal penalty, which is usually 10%. This is a sure way to handicap your ability to live a long and prosperous retirement!

The amount of funds you’ll need in your taxable accounts will depend on the number of years you plan to make withdrawals prior to age 59.5. So, for those of you planning on an early retirement, be sure to make adjustments to the standard funding progression to avoid early withdrawal penalties and ensure your retirement savings will support you to a happy and healthy old age.

Have you used any of these strategies on your path to early retirement and financial freedom? Do you have any others you’d like to share?

7 thoughts on “3 Key Early Retirement Strategies

  1. Pingback: How Taxes Kick Started Our Financial Freedom - Tools 4 Retirement

  2. Chonce

    Great post! And thanks for including the chart, it really helps put things into perspective. I’m not sure when I’d be able to retire yet but I definitely don’t want to be working at 70. Right now I’m saving but not as much as I should because I’m working on getting rid of my debt. The good news is that time is on my side though and it really helps when you start early.
    Chonce recently posted…Things I Don’t Tell My Child About MoneyMy Profile

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    1. Derek Post author

      Sounds like your on the right track Chonce. Paying off debt is important, but so is saving for the future. It’s great to hear that your doing both.

      Reply
  3. Our Next Life

    All good advice! We are past the debt repayment stage of our lives, but always wonder — with the savings/investing waterfall approach, where does debt repayment fit into that? Or for folks like us, who are working toward early retirement (less than 3 years away!), what’s the precedence of paying off the house vs saving for retirement? We’ve read a lot of different opinions, and kind of figured out our own ideas (though no idea if they are the best strategy). We know that we want to retire with a fully paid off mortgage, so that’s impacted our planning. Okay, slightly off topic, but that’s what’s on our minds re: early retirement planning. 🙂
    Our Next Life recently posted…in early retirement, what’s to stop us from getting old too fast?My Profile

    Reply
    1. Derek Post author

      Good questions Our Next Life. To a certain extent, personal financial planning needs to be just that… personal. The waterfall savings/investment approach is a good benchmark, but it’s important we each take the path towards our financial goals that’s best tailored to our unique situation. For instance, for those with a fixed interest rate loan with an interest rate of less than 2%, making minimum monthly payments which would free up more money to be invested with returns in the order to 5-7% may be the best option. This approach would even apply to retirees, as there is often a need for reasonable returns on investment well into retirement.
      Congratulations on being in the home stretch towards your early retirement! 🙂

      Reply
  4. Phil Ash

    Thanks for mentioning the importance of taxable accounts. Wall St and most employers have people so fixated on 401Ks, but the selection of high-fee, low-performance mutual funds in most 401Ks usually leads to horrible returns. Of course, most people ignore their account statements and don’t even realize by how much they’re trailing the S&P. The key thing to do is simply compare your 401k return to the after tax return you could likely get in a taxable account. The decision is even easier if you don’t get a match from your employer. Also, consider that 401k earnings aren’t tax-free; they’re tax-deferred. You’ll still need to pay taxes upon withdrawal. Keep up the great work, Derek.
    Phil Ash recently posted…Stop Investing in Your 401kMy Profile

    Reply
    1. Derek Post author

      Thanks Phil. You make a good point that many company retirement accounts do not have good fund options which can lead people to invest in high fee low return investments. If available, the best options are usually index funds that closely track the market and have low fees. Tax deferred accounts are great options if you plan on paying a lower tax rate at the time of withdrawal, which will be the case for many retirees. As it is important to diversify investments to various investment categories, it’s also important to diversify to various types of accounts allowing for flexibility in your withdrawal strategy. Especially the avoidance of early withdrawal penalties.

      Reply

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