By Dustin Giannangelo
CEO Fusion Wealth Management
When people think about retirement age, the most common age that comes to mind is 65 years old. Let’s break that stereotype and tell you that being financially independent does not have to be tied to a specific age. Many individuals retire early every day and so can you, however, what separates these individuals (that have retired early) from everyone else is that they had a well thought out strategy. They did not attempt to get rich quick, and they built their wealth over time.
They understood these 14 rules on how to retire early and took action to accomplish them. Now, when you begin to plan your retirement, the most prominent question that comes to mind for most people is, how much do I need to save? Let us look at 14 rules to help you retire early and create financial independence.
Depending on what age you would like to retire and how many years until that date, the answer will vary. You need to figure out what is the exact amount of money you will need that can generate the proper amount of income.
Depending on the lifestyle you would like to live, the income need can be drastically different. It used to be that if you wanted to derive the proper amount of income to last for 30 years, you used the4% rule. The 4% rule states that you should never withdraw more than 4% of your total investment portfolio per year. Not only is the 4% rule highly flawed, but if you want to retire early, you could end up needing at least 40-45 years of income.
Your first task is to figure out how much monthly income you are going to need in today’s dollar amount to retire early. Once you have determined the amount of monthly income, you will need to use a simple online calculator to figure out the total amount of money necessary to produce the monthly proceeds for at least 40 years.
Once you know the total amount of money that is needed, it will give you a long-term benchmark to start saving for retiring early. Now, these calculators will not be 100% accurate, and you should always solicit the advice of a financial professional. However, this is an excellent starting point, and it will give you great information to bring to a financial planner to build something tangible.
Typically, a person’s mortgage payment is the most significant payment they have every month. If you can eliminate that monthly payment, you will have removed your most significant monthly burden out of the equation in retirement, thus, creating peace of mind that is very important when striving to retire early.
Some individuals prefer to sell their home because this can help fund their retirement, and others choose to pay down their mortgage to stay in their home. In the context of retiring early, both methods can be used to create success. Your goal when striving to reach financial independence is to have minimal monthly expenses and a substantial rainy-day fund.
However, there is one crucial thing that you should remember. If you depend on home equity to fund your retirement, then it is essential to sell your house only when the housing market is going strong. Now, you cannot predict the future, but you need to have a concrete, realistic dollar value you need from the sale of your home to successfully fund part of your early retirement.
Let us look at an example of how to pay off your mortgage in 15 years. If you have a 30 year, $300,000 mortgage, with an interest rate of 4.5%, then your principal and interest payment are roughly $1,520 a month. If you add $780 a month on top of your mortgage payment, equaling $2,300 per month, then your mortgage would be paid off in half the time at 15 years. Therefore, creating a path to having your mortgage paid off to retire early.
While planning for early retirement, it is vital that you are acutely aware of your tax situation. You need to make sure that you are not getting a significant amount of money back or even worse having to write a big check every April.
Creating a tax liability could severely damage or prevent you from retiring early. Millions of people owe back taxes to the IRS, plus daily interest on top of the amount they owe. If you get yourself into this situation, your probability of being able to retire early will be low.
Make sure you engage with a tax professional that can help you with your taxes on an annual basis. If you are receiving a big tax refund every single year, that is not a good thing. You are giving Uncle Sam a tax-free loan and missing out on having your money work for you year round. If you are writing a check every year to pay your taxes, this is not favorable either. You want to be as close to zero, not owing or receiving any money back, every year.
When you do retire early, you will have to be creative when taking distributions from your retirement accounts because you will be penalized 10% for any withdrawal before 59.5 years of age. One way around this is by using the 72-T rule. This rule permits penalty-free withdrawals from IRA’s, 401k’s, and other tax-advantaged retirement accounts when structured appropriately. Again, consult your tax professional and wealth manager to discuss this strategy.
Gaining financial independence and retiring early causes your mindset to shift dramatically. It is no longer about how much money you can accumulate, but how much income can you generate. Therefore, you need to create as many passive income streams as possible.
It is imperative that these income streams keep pace with at least 3% inflation as well. If not, your income will slowly erode over time, and the likelihood of you running out of money is statistically high. Inflation tends to be the silent killer of people’s retirement income, and it is a necessity to think about when forecasting your future income.
Not only should you be investing in the stock market when you are accumulating wealth, but you need to be investing in the market during retirement. Work with a wealth management professional that can help you build a custom retirement income plan. Through the use of more conservative investments like bonds, blue chips stocks, and other investment vehicles, you will be able to generate a passive stream of income. Make sure you are not susceptible to these myths about diversification when investing.
Real estate is another asset that can create a future passive income stream as well. Buying a rental property and having it paid off when you reach financial independence can help support your income. At a bare minimum, you need to find a renter that can pay the mortgage payment and taxes. Ideally, you will want to have a renter to pay the mortgage, taxes, plus generate income above the expenses. Then, you will have created another source of income to save for retirement.
While planning, you will need to consider the location you want to retire. For instance, the cost of living in San Francisco is going to be much different than in Phoenix. Retiring early in a cost-effective city or country is going to make things less daunting than retiring in New York City.
However, this does not mean you have to retire in a location that is the most cost-effective, but you will need to be highly aware of the real cost of living in whichever destination you choose. Future housing costs need to be understood if you plan on moving once you have retired, whether you rent or buy.
For example, if we take the value of a dollar for 2018 in California and North Carolina, there is a big difference. California’s buying power is only $0.88 for every dollar, and North Carolina is $1.10. Based on the buying power of your money, you can see that it will cost a lot more to retire in California than in North Carolina. Also, make sure you understand how this could affect your investments in a rising rate environment.
If you are dead set on retiring in a more expensive destination, you can count on even the daily necessities, such as groceries and gasoline, to cost more. Therefore, it is essential that you take this into account when doing your calculations to reach financial independence.
Regarding your finances and your pursuit of achieving financial freedom, you are the CEO. Which means you should be the individual with the vision, not the person doing all the work. Great CEO’s know how to build and guide their team to success.
However, this does not mean that you don’t have to put in the work. You need to understand the importance of delegating to experts. Focus every day on what you are good at and enjoy. Be the visionary for your financial independence and trust the professionals to help you get there.
There is a reason why accounting, legal, and financial planning occupations exist. It is because to be successful at one of these professions; it requires for it to be a full-time job. Most people that attempt to bypass one of these professions do it because of cost savings. However, their attempts at self-diagnosing and self-managing will likely lead to irrational emotional decisions that will cost them more money in the long run.
Being that you are the CEO of your finances, you should hire the most qualified individuals in each one of these professions. If you engage highly skilled professionals, they will more than cover their fee. Think like a CEO and hire a team that will help you take your plan of retiring early to the next level.
One thing that a lot of people have on their agenda when retiring early is travel. Not only is traveling one of the most exciting things people look forward to, but it can be one of the most expensive parts of your early retirement. It is the one thing people wish they could do more, but the costs add up very quickly.
Being that this is the case, it is vital to have a plan of attack on how to do this most cost-effectively. The most expensive trips usually involve having to get on an airplane and fly to your destination. Therefore, a strategy needs to be put in place to help subsidize your travels.
One way to do this is to open up and begin to use credit cards that give reward points towards airline flights. Most people own a credit card already, and their cards do not provide the best rewards or give minimal cash back. You need to research the best credit cards currently offering the best reward miles for airline flights. Also, when doing your research, consider which cards give the most upfront free miles when signing up and make sure the miles accumulated do not expire.
You do, however, need to be disciplined and make sure you are paying your credit card off every single month. Do not spend extra money just to get airline miles. How to retire early is all about discipline, and we are looking to earn enough free travel over the next 15-20 years. Do not give in to the temptation to spend your flight miles now or reimburse your points for cash today. Think of this as your as 401(k) for your future retirement travels.
Early retirement means that you should have enough money to address your health concerns right now and in the future. Healthcare cost historically has an inflation rate of 5.35% which is nearly double the amount of inflation each year. Meaning, you need to budget for a growing cost of healthcare each year to retire early.
If you plan to retire by 50, you need to make sure your investable assets can cover the medical cost gap until Medicare becomes available at 65. The options available are COBRA Coverage, your spouse’s plan, the public marketplace, private insurance, or healthcare abroad.
When you choose a plan, be aware that once you are eligible for Medicare, it does not pay for everything. Ultimately being able to afford your healthcare cost adequately now and in the future means using the best tools out there to achieve your goal of retiring early.
Many people have heard of the term HSA (Health Savings Account), and it is a brilliant way to save for medical expenses and reduce your taxable income if you qualify by having a qualified High-Deductible Health Insurance Plan (HDHP) defined by the United States government. If you are eligible, then you can contribute each year $3,450 for individuals and $6,900 for families (2018 limits). If you are over 55, you can add$1,000 extra per year.
HSA’s are very attractive because of their three tax advantages; pre-tax deductible, money grows tax-free, and money can come out tax-free (if it is for medical expenses). When investing in an HSA, it is similar to investing in an IRA. If you do not spend down the account down on an annual basis, your funds will rollover to the next year.
Growing your career and skillset is one of the most critical points when you are looking to retire early. The most effective way to increase your wealth is to create continued success in your career and to be continually growing your knowledge. Creating opportunities and receiving promotions will stem from your willingness to develop yourself professionally.
The willingness to make sacrifices to achieve professional success is critical. You must develop a goal-centric mindset and create a measurable path that will affect your career trajectory. The road to success will have many distractions, ignore them and stay focused. The empowering thought is that you get to control your actions and only you can prevent your success.
Growing your career and skillset is undoubtedly the engine that can quickly drive your early retirement plan. The best way to do that is by creating professional development and career advancement training for yourself. It is crucial to hold yourself accountable by setting up this training. Personal growth should be a constant thing if you want to achieve your goals.
Create a plan using SMART (specific, measurable, achievable, realistic, timely) goals that will help you accomplish your objectives. Setting proper goals will allow you to stay on a defined path to achieve your career success. By outlining and writing down your professional development plan, you can be sure that you are on track to attain your professional goals.
To retire early, you must look to one of the most significant modern avenues to achieve long-term compounding growth, the stock market. Many people are very timid about investing in the stock market because of the risk of losing money. Understanding the truths about investing would calm the fears of many people hesitant to invest. Your view should be long-term when investing in the financial markets to maximize your wealth, and you should not be afraid of afraid of military conflicts or other global events that could crash the stock market.
Historically, the S&P 500 stock market from 1923 to 2016 has averaged12.25%. Many people will claim much has changed since the 1920s which is a fair point. However, if we look at roughly the last 30 years, we see similar returns. For example, from 1987 to 2016, the S&P 500 has an average returnof11.66%. The performance of these two periods mirrors each other tightly.
Develop a personalized plan for investing based on your goals and objectives. Make sure your goals are concise and do not allocate your funds blindly into the stock market without a plan. The more comprehensive your goals are, the better. Work with a professional wealth management team that can help you articulate and develop a proper strategy.
When you do start investing, use tax-efficient vehicles to start, such as 401(k)’s, Traditional IRA’s, and Roth IRA’s when investing in the markets. Once you have maxed out the contribution limits each year, you can start putting monies into taxable investment accounts. The important thing is to be putting money consistently away every single month. Set up an automatic withdraw that will pull the funds from your checking account monthly, so you become a disciplined investor.
One of the most crucial challenges, as you plan for the future and to retire early, is that you must make trade-offs. It is easy to get caught up wanting all the new flashy things that come out every year. Whether that is a brand new car, a smartphone, or a bigger house, discipline is crucial when you see all of your friends making these type of purchases.
Striving for delayed gratification is no easy feat. However, the willingness to make sacrifices today will pay significant dividends that will put you on a path to financial freedom. It is not an easy thing to go against the grain of society where being significantly leveraged is acceptable. The sacrifices both big and small along the way are what sets you apart from the norm to be able to retire early.
Begin to think about your monthly expenses, what you are spending frivolously on, and what is not a necessity that you can cut out of your spending. Expensive dinners are the easiest way to cut back, and for a fraction of the cost, you can prepare a great meal at home. No longer is it necessary to spend $50 on dinner when you can make an excellent one for $10.
Are you considering buying a new car? Would your current vehicle still run just fine if you had the mechanic do a little work on it? Always choose the more cost-effective route when it comes to a car. A vehicle is a necessity today, but it is still an asset that severely depreciates every year. If you are forced to purchase a new car, always buy used, a minimum of at least three years old, and let someone else take the sticker price loss. When you buy a used car, your depreciation value will be much lower than if you bought it brand new.
We talked about how important it is to live on less when striving to retire early, but now you need to redirect those funds into savings. It is easy to give in to temptation and start spending when you begin to save a fair amount of money. For example, you were able to save an extra $250 a month by cutting back on your bills, but now instead of saving that money, you spend it on wasteful things.
Creating the habit of saving can be a difficult task at first, but it will become empowering the more you save. Instead of having the addicting habit of spending, you will create an addiction to saving. The key is to start small and to work on aggressively increasing your savings at least a little every single month. Once you create this savings mindset, you will be well on your way to retiring early.
One strategy to implement now is automated micro deposits into your savings account that can accumulate towards a long-term goal of retiring early. For example, if you set up an automatic transfer of $12 each weekday going into your savings account, you’ll have over $3,000 saved up by the end of the year. Imagine if you save and invest that each year over the next 20 years at a 6% return. By the end of 20 years, you’ll have accumulated an additional $118,000 towards helping you retire early.
Another way to save towards early retirement is once you finish paying off a bill like a car loan, student loan, or home loan, immediately redirect those exact funds toward savings. Your current lifestyle has already adjusted to that payment, so it should be a straightforward task to redirect those funds towards your retirement.
In economics, there is the concept of fixed cost and variable cost. You can apply this same idea to your own life. Your fixed costs are things that remain relatively constant like utilities, cell phone bill, and your mortgage payment. Your variable costs are things that can change each month like entertainment, eating out, and weekend getaways.
You have already committed to early retirement so one could expect that you are controlling your variable cost to make sure your lifestyle does not get out of control but have you considered how to cut cost on your fixed bills? In some instances, this can be a reasonably simple thing to do if you know where to start.
Check for discounts on your property and casualty insurance. Ask an independent agent to review your insurance policies. Most people have their auto and home insurance on autopilot. Maybe every three to five years they will shop for a better rate. It is a mistake not to keep on top of your insurance policies. If you can reduce your fixed insurance costs, you have now created a way to cut costs and save.
Become your own bank. If you own investments in the market, have you considered setting up a portfolio line of credit that allows you to use your funds as collateral? When you need short-term funds but do not want to sell your investments and trigger a tax liability, this can be a great option. The cost of credit is much lower than a credit card by over 10% to15%, and you are not obligated to make payments on the loan. It allows you to continue to save, invest, and set yourself up to retire early.
One of the biggest threats is inflation. Historically inflation has averaged 3.22% since 1913, but over the past 30 years, we have had a rise as high as 5.44%. Looking internationally, we see that hyperinflation can also occur, evaporate your ability to purchase anything and destroy your nest egg. No matter where you are in the world inflation can and will affect you.
For most people’s retirement portfolio, inflation is the silent killer that goes unanticipated. The worst thing that could happen is that you run out of money during your retirement and have to make a drastic lifestyle change, or maybe even have to go back to work. Most people think about market corrections as damaging as damaging to their investments but never think about inflation. Ultimately, to protect yourself from this threat, you must plan for inflation.
Invest in stocks as a part of your portfolio to hedge against inflation. Stocks have been a stable hedge against inflation because they have a real claim on a company’s tangible assets, such as land and real estate. Companies are usually able to pass through the cost of increases to their customers which means the impact of its inflation is minimal if it stays below 5%.
Look at investing in TIPS (Treasury Inflation – Protected Securities) as apart of your portfolio. TIPS are indexed to inflation to protect your investments from the adverse impact inflation can have on your wealth. You will not make significant gains with TIPS, but it is a fantastic asset for the more conservative part of your portfolio. You are not looking for sizable gains here, only wealth preservation.
Committing to the goal to retire early is no small task. It will take dedication, sacrifice, discipline, but it will be well worth it in the end. Stay focused on your goal and do not let anyone sway your efforts. Many people will feel you are crazy and try to make you think negative thoughts.
You need competent professionals that can help guide, support, and make your plan a reality. Building a relationship with the right team that knows your personalized goals and can help you set up a measurable path is vital to your success. The first step is the hardest one, and once you have mentally committed, nothing can stop you from achieving your financial freedom.
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Fusion Wealth Management, LLC is not affiliated with Kestra IS or Kestra AS. Kestra IS and Kestra AS do not provide tax or legal advice and are not Certified Public Accounting (CPA) firms. FINRA's BrokerCheck