This article comes from Entrepreneur.
Whether you’re looking to retire by a specific milestone birthday or achieve financial freedom to pursue purposeful work and passion projects, working toward an early retirement could be a smart money move for you.
Here are four considerations that every aspiring pre-retiree should understand.
The first step to retiring early is to define what “early” means to you. What’s your timeline? When someone wants to retire early, it’s always best to start by creating a retirement timeline. This helps to identify what retiring early can look like and if it’s possible. Once you have a retirement timeline, you can then look at how to position your assets into 5-year “buckets”.
Because some retirement funds like Social Security and annuitization will not be available to you until a certain age, seeing your assets within these buckets on a timeline will help you determine where you need to focus your retirement investments to ensure you have income for the rest of your life.
Figure out what income you need until you’re eligible for those other checks coming in.
How much you need in retirement will depend on a handful of factors – including your goals, your health and the economy throughout your retirement. There are also some factors that are unique to early retirement, like health care expenses and how much you can spend each year.
To get a ballpark understanding of your needs, run some numbers – you can use a retirement calculator to estimate how much money you’ll need and by when. Make sure you consider the following:
Here’s where the real work starts. Typically, saving toward a normal-age retirement requires you to save 15%-20% of your income annually. For early retirement, that savings is closer to 40%-50%, which means following even a frugal lifestyle may not be enough to help you reach your goal.3 Own a car? Maybe it’s time to consider a bike commute.
Start by restructuring your “wants” and “needs” with consideration to what matters most to you – and then use those “want” and “need” buckets to inform your investment strategy. As you develop your retirement portfolio, aim to have your needs met through guaranteed income streams, while the rest can be supplemented with other investments.
All retirees will have to pay taxes on Social Security, 401(k)s and 403(b)s – but retiring early requires some additional tax strategies.
One common strategy is to convert your traditional IRA to a Roth. However, if you’re in a high-tax state, you could be paying more money to the government than it’s worth.
Instead, you may be better off allowing your tax-deferred accounts grow while you’re still young and use taxable accounts in the meantime, especially if you think you’ll be in a lower tax bracket in retirement.
There are other tax strategies that can seem appealing but could also limit your early retirement goals. For example, IRA owners can withdraw funds early under rule 72(t), if you agree to take out consistent payments for the longer of 5 years or until you turn 59½.
Sounds great, right? The drawback is that if you deviate from these regular payments or even miscalculate your withdrawals, you will need to pay the 10% penalty, plus interest.
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