How do I know if I can retire early?
Some people go to great lengths to set their spending, savings and investment goals so that they can retire early.
For Justin McCurry — who retired at age 33 with $1.3 million so he could spend more time traveling with his wife and three children — retirement came more than 30 years early. And not by chance.
While the main goal is to figure out how much you’ll need and get to that magic number, there are other considerations.
Hitting that number can be so exciting that you want to get started right away, McCurry says. But not paying attention to details of your post-work life can undermine or even undo some of the hard work you’ve done, he says.
Check your math and risk
First, you’ll need to calculate your expenses, think about what kind of lifestyle you want to live, and come up with a figure for the annual income you think you’ll need. But the hard part is figuring out how big of a nest egg you need to save to secure that income.
A classic retirement rule of thumb is the “4% rule”. It means that if you have saved 25 times your annual expenses, you can expect to withdraw 4% per year and not outlive your portfolio.
But this formula is based on someone retiring at 60 and living for about another 30 years. Early retirement means you’ll be drawing away from your savings for many more years than a typical retirement.
“We reviewed our spending and added and subtracted items to our budget,” says McCurry. Work clothes and commuting are out and travel is in. “We decided to use a 3.5% withdrawal rate after we’re in our 30s, to be more conservative.”
His family of five now lives on $40,000 a year.
Arrange for cash flow
Since early withdrawals from traditional retirement vehicles like IRAs and 401(k)s will incur a penalty, early retirees need to figure out how to get money regularly with the least amount of adversity.
A substantially equal periodic payment plan (SEPP) allows you to withdraw about 3-4% of your money annually before age 59½ without incurring taxes or early withdrawal penalties. Although bound by a strict IRS formula, there are three methods used to determine payment. These payments, once started, will continue for five years or until you turn 59½, whichever is later.
While it might work well if you’re bridging a small gap between retirement and age 60, McCurry didn’t think it would work for him.
“I was 33 when I left work,” he says, “I didn’t want to be locked into a fixed annual salary for the next 27 years.”
Instead, it created a Roth IRA conversion ladder.
The IRS allows money converted from a traditional IRA to a Roth IRA to be withdrawn penalty-free and tax-free. The problem is that you have to wait five years. If you roll over $30,000 in 2018 (and pay any taxes due), you can draw $30,000 in 2023. By rolling over a withdrawal amount over five years, you can build an income ladder.
Prepare for health care
Health care is not only a significant expense, but also unpredictable: both your health and the system.
As the years pass until Medicare kicks in, you will need to purchase your own health insurance. This can be expensive. But retirement also reduces your income, which could qualify you for some kind of assistance.
McCurry and his family receive coverage through the Affordable Care Act and, given their income and family size, even qualify for a nearly $10,000 subsidy.
Set up your home
A change in where you live can make a huge difference to your costs, McCurry says.
“People usually live where they live because their work took them there,” he says. “But they say ‘I can’t afford to retire here.’
Consider downsizing or moving to where housing costs less.
Get your new home organized before retirement, advises McCurry. Even if you plan to travel for a while right after retirement, it could be worth it to arrange your future home before you go — maybe even earn passive income from renting it out.
“Maybe you want to pay cash, but if not, it’ll be easier to get a lease or mortgage when you’re working,” says McCurry. “Sure, you can show a $2 million balance sheet to a mortgage broker, but they might still say they need to see your income.”
Stress test your design
Don’t forget to factor in other unknowns like inflation and market returns.
“We often run multiple scenarios with different assumptions — for inflation or growth rates, for example,” says Jennifer B. Harper, a certified financial planner and director of Bridge Financial Planning. Then he says he applies a “Monte Carlo” analysis, a model that looks at multiple outcomes to provide a probability distribution or risk estimate for an investment, to show ranges of possible projections.
“It’s not perfect,” he says, “but it’s a lot better than modeling growth in a straight line for everything.”
CNNMoney (New York) First published September 27, 2018: 2:12 pm ET
