Early retirement sounds pretty
good when you're stuck in a cubicle counting down the hours until the
weekend. If you don't enjoy your job anymore and are looking forward to
spending more time pursuing your own agenda, early retirement can be
ideal. The challenge is that you need to save up for it and make that
money last for several decades. Here are the financial milestones you
should achieve before taking early retirement:
Get into the
habit of tracking your cash flow while you're working, and practice
living on your retirement budget for 12 months. It's even more important
to control your spending in retirement because you'll have a fixed
income. Monitoring your spending will allow you to understand where your
money is going and help control lifestyle inflation as the years go by.
You know how your expenses will change.
Certain expenses can be eliminated when you retire such as commuting
costs. But some retirees end up spending more money annually after they
quit working. Many people want to travel
now that they have the time, and that will significantly increase your
expenses unless you travel creatively. Other people spend money on
hobbies they have been putting off for many years. A retirement budget
needs to take into account all the activities that you would like to do
as well as the usual bills.
You have retirement health insurance. Medicare
won't kick in until you're 65, and you'll need to fund your own
healthcare until then. You can keep your employer-sponsored health
insurance for up to 18 months under COBRA, but you will probably have to
pay a lot more than you used to while working. If your spouse is still
working, then it's usually a much more affordable option to get coverage
though his or her employer. The Affordable Care Act provides another
option for early retirees, and you can shop for health insurance at your
state's health insurance exchange. After retirement, your income will
probably be lower, so you might qualify for tax credits to help cover
the premiums. However, health insurance isn't cheap, and you might get
sticker shock if you don't do your research before retiring.
You have no debt.
If you have consumer debt, then you're probably not ready to retire
early. It's also a good idea to pay off your mortgage before retirement
so your monthly expenses will be reduced. Downsizing or relocating to a more affordable area can be a good option to reduce or get rid of a mortgage.
You have adjusted your portfolio.
You need to make sure your asset allocation is properly targeted to
meet your risk tolerance. Some early retirees have all their assets in
stocks. That might be fine when you're still working because you can add
money when the market is down. But that asset allocation probably needs
to be adjusted after retirement. An early retiree also needs to be
careful not to shift too much money into bonds because you need stocks
for growth. When you're nearing retirement, reassess your risk tolerance
and update your asset allocation accordingly.
You have achieved financial freedom. One way to estimate if you're ready for early retirement
is to divide your investable assets by your annual expense. I call this
the financial freedom ratio. If your financial freedom ratio is above
25, then you're in pretty good shape. You can use the 4 percent rule to
withdraw from your portfolio, and chances are good that your money will
last for 30 years or more. Of course, if you retire very early, then you
probably need to be a bit more conservative and withdraw less until
you're near 65, the normal retirement age.
If you have a healthy portfolio balance, no debt and a plan to deal with health care,
then you might be ready to retire early. Try tracking your cash flow
and living on your retirement budget for a while before pulling the
plug. Once you retire, then you need to keep a good handle on your cash
flow to make sure you don't overspend. Early retirement is a dream for
many people, but it takes diligent saving and careful planning to make
it real.
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