Is early retirement part of your American dream? It’s still possible, but new economic realities have changed the rules for success. If you want your money to last your entire lifetime, thoughtful planning is essential. That goes for everyone, whether your target age for early retirement is 40, 50, or even 60.
For many decades, people followed the “4% withdrawal rule” to calculate how big a nest egg they needed to retire, assuming a 30-year retirement. This conventional wisdom held that your portfolio should equal 25 times your annual retirement spending. In other words, if you plan to spend $100,000 a year when you retire, you need a $2.5 million portfolio. Experts calculated that level of savings would sustain a 30-year retirement.
However, as with any rule of thumb, there is always more to than meets the eye. Consider these five dangers of early retirement.
- The math doesn’t hold up.Longer time horizons increase dependence on market returns…and markets are volatile. The “4% Rule” was based on a 30-year period, and if you plan to retire early, you’re simply going to need more money. You may need a nest egg that’s 30 times your annual spending or more.
- Times change.Both the economic growth rate and interest rates are currently below the historical simulations used to create the 4% withdrawal rule. Market returns may fall short of past results for years to come.
- Stuff happens. When you stretch out your retirement, you increase the chances that an adverse event—health challenge, major house repair, stock market downturn—will require that you raid your savings. The earlier the spending shock hits, the bigger the effect on future earnings.
- You may get bored and drift.That may seem inconceivable when you think your retirement bucket list could keep you happy for decades! But it’s common for retirees to feel their life lacks purpose when they no longer report to a job.
- Your health may decline. The Institute of Economic Affairs in the United Kingdom found that retirement increases the probability of having at least one diagnosed physical condition by 60%. The chances of suffering from clinical depression jump 40%. These adverse effects increase with the time you spend in retirement. A health crisis can significantly drain your savings.
You don’t have to give up on early retirement, but you do need to take a realistic look at your circumstances and expectations:
- Include all financial factors when you calculate your required nest egg. Do you have a pension? Trust fund? Expected inheritance? How soon will you start drawing Social Security? What are the tax implications of taking income from your investments, including your 401(k)?
- Test your plans sensitivity to expected market returns. This is especially important as you modify your investment portfolio to reflect your retirement income needs.
- Factor in at least one unexpected spending shock. Analyze your health insurance coverage to make sure it’s adequate. Have you factored in possible increased premiums when your employee benefits end?
- Consider a tighter retirement budget. What is non-negotiable spending and where can you cut corners? A 4% withdrawal rate may be unrealistic even for those retiring at a more traditional age.
- Stretch your savings with a part-time job, consulting, or monetizing your hobby. A gig in retirement can also give you a reason to get up in the morning.
After a clear-eyed financial assessment, it’s possible you may decide that a few more years in the cubicle are worth a financially sound retirement.
FJY Financial can help you craft an early retirement plan that balances economic reality with that retirement bucket list you’re dreaming about.