If retiring early is a goal for you, it’s worth taking a closer look to see what it means in practice.
Retirement doesn’t necessarily mean you want to stop work and spend all your time playing golf or walking the dog. Maybe you still want to work, but on something that means more to you, is more enjoyable, just not the work you have done in the past. And this probably means for less money, or where you do not feel that you are dependent on bringing that wage to sustain your current lifestyle.
So really we are talking about “financial independence” – you don’t necessarily want to just play golf or walk the dog every day (or just do nothing), but you could if you wanted to.
And this is what appeals to me – I do not see myself as ever retiring in the traditional sense. There is plenty of drive in me to achieve more, I have no intention of hanging up my boots. But I would also like to get on with those other achievements right now, not when I am 65, which means doing it early. Which means not being dependent on working 40-60 hours a week for somebody else in return for a salary, because I want my time back.
So what will I need to do if I want to retire early? How do I achieve that “financial independence”?
“Financial independence” isn’t about being rich. In simplest terms it means your outgoings don’t exceed your income.
This means being able to:
– Pay off your debts
– Pay off your mortgage (or being close to doing so)
– Have enough income for your daily needs
– Have additional money so you can enjoy life
– Have sufficient savings for unexpected events or emergencies
Remember this doesn’t necessarily demand a huge level of wealth – it’s not about being rich. But it is about living within your means. So the modest your future lifestyle, the less you’ll income and assets you will need.
Conversely, if you want your future lifestyle to include fast cars and luxury trips around the world, then you will need an income to cover it. There is a trade-off here; if you want a more luxurious life, then you will need to accumulate more assets to give you the income you will need. We will come onto this later.
So let’s go through the key steps in a little more detail. It will require working on the numbers and if you are not good with numbers you will either need to bite the bullet and start learning or maybe enlist the help of a numerate friend that you can trust. But the number crunching cannot be avoided.
- Pay off your debts
Generally speaking, you need to prioritise paying off debts above building up savings, because the interest on debts will far outstrip any savings interest you might earn.
Getting to know your debts is really important, and ironically most people are afraid to do so. But it is important to do this, because how you treat each one might save you a lot of money. For each debt, understand the interest rate you are paying, how long the debt is for, how much interest you will end up paying over the life of the debt, if there are any penalties for paying off early.
Once you have done this, prioritise paying them off, but remember that you will probably need to pay at least the minimum payment on each one to avoid additional charges or the debt snowballing.
You can also sometimes transfer the balance of one credit card to another, or consolidate them into a single lower interest rate. Clearly, it’s a good idea to move as much of your debt as possible to the card with the lowest interest rate.
Any outstanding debt from student loans is an interesting exception and can usually be left until last.
- Pay off your mortgage
It’s usually good to make overpayments on your mortgage if you can afford them. The upshot is that you’ll pay off your mortgage sooner, but also pay less overall. Generally, this is a better use of money than building up savings (though an emergency fund is still useful).
Again, be very aware of mortgage providers charging excessive penalties for early repayment of the loan. Speak to a good mortgage broker to check the terms of your mortgage in this area, if you’re not sure. It may even be worth re-mortgaging to a deal that gives you this flexibility, but you have to do your homework and work out the sums first.
- Work out your basic income needs in retirement
Next need to work out the minimum you’ll need to spend each year.
For now just focus on the essentials and forget luxuries and holidays – they will come later. You need to work out your basic ‘survival budget’.
It’s sensible to suppose your basic needs won’t change much – you’re still going to be the same person in ten years’ time. However, you should be able to deduct regular expenses such as mortgage repayments and servicing debt (assuming you’ve dealt with those issues above).
You can also exclude any necessary expenses that related to your working life, such as daily travel costs to and from work, and the cost of any lunches from the local sandwich shop.
If you have children they will (probably) be grown up by then. Though they may still need financial help from you, this will count as discretionary spending, so exclude child-related costs for now.
Do this calculation for a whole year, because this will allow you to build in quarterly or annual one-off costs. This will give you a single yearly essential costs figure. Call this ‘Essentials’.
You will then need to take into account inflation year on year, and also that in your final years you may need to find money to pay for care.
In this exercise, you are trying to work out an estimate – not an exact number. Because in reality things will end up being different, so keep the numbers simple.
- Work out your discretionary spending in retirement
You’ll need to think in detail about your plans for retirement: where you want to live, how many holidays you’ll take, what interests you’ll pursue, even what car you want to drive. Do you want a little sailing boat or a classic car?
Call this figure ‘Discretionary spending’. Again, assume that your costs will rise with inflation over time, but also that your lifestyle may modify in later life as you get older and inevitable slow down a little.
Again, work out an average annual cost.
- Estimate your total costs over retirement
You should now have your Essentials and Discretionary Spending numbers. You now need to consider what the total cost will be over your retirement “life”.
You now need to assess whether your retirement income and assets can meet two different targets:
– Essential Spending only
– Essential and Discretionary Spending
Estimate the length of your retirement. A reasonable target is 85. So if you intend on retiring at 58, then 27 years is a reasonable figure.
The next step is to find out whether your assets can cover those levels for spending for such a long time.
- Calculate what income you can achieve in retirement
Make an inventory of all your assets, to see where your retirement income could come from.
Assets may include:
– Private or workplace Pensions and
– Final Salary pensions
– Savings and investments
– Your home
– Other property you own (that you could let out or sell)
– Other sources of post-retirement income
You will also get your state pension, but since you are retiring early you will need to think about when you can start to factor this in.
Now you can start working out whether your combined assets will be enough to generate sufficient income over the length of your retirement. Let’s look at each separately.
Pensions
The most important element here will be your workplace or private pension(s). Estimate how much you can achieve via drawdown, an annuity, or a blend of both.
You will probably need to consult a financial adviser about this, but there are some good guides available on the web, just do a quick search for pension annuities.
Savings and investments
You may want to consider transferring other savings and investments to your pension in advance of retirement, as they will benefit from a boost thanks to tax relief. If you have lot of savings, it’s best to do this before you start to access your pension, as this will reduce the amount you can pay in.
Your home
Your home can be a significant source of income, whether it’s just subletting a room to a lodger, downsizing (which is also an option for empty nesters) or releasing equity. Talk to a financial adviser or mortgage adviser if you’re considering equity release, as it can come with significant downsides.
Other property
Property can be a great source of regular income in retirement – but being a landlord in retirement comes with a lot of responsibilities too. Make sure you’re prepared for the work involved. There are plenty of nightmare stories out there.
Other sources of income
If you choose to phase your retirement you can continue earning either from part-time work, a different lower-paying (but more satisfying) job, or even your own business.
Remember, you are considering this for a reason, like not being dependent on bringing a salary just to sustain your current lifestyle. As I mentioned earlier, I do not see myself as ever retiring in the traditional sense, I still want to achieve more and don’t want the ties of a full time job to get in the way.
Anything you can do to increase the amount of money coming in – especially in the early years – will help your accumulated savings to last longer.
Personally I have achieved great satisfaction from generating an additional semi-passive income through digital marketing, not just about earning a new income stream but learning new skills – take a look at my pages on earning and income from digital marketing.
Is your pension on course to let you take early retirement?
No matter what age you are now, it’s possible to predict roughly how much income you might be able to generate from your private pension pots. The Unbiased Pension Calculator lets you work out (based on certain assumptions) the size of pension income you could reasonably take from your pension pot over an average retirement, based on how much you’re saving at the moment. Thought it can’t make firm predictions, it will give you a good idea about whether you need to increase your pension contributions, or whether you can indeed retire sooner than expected.
Will your money last if you retire early?
As noted already, retirement can be a long time – and an early retirement will hopefully be even longer.
But the real challenge is that every year that you retire early puts a double-strain on your funds, because not only does your money have to last long one year longer, but you’ve also had one less year to build it up. Every extra year of early retirement means:
– One year more spending
– One year less earning
And don’t forget you will have one less year of growth in your pot of assets.
In short, every year of early retirement will cost you significantly more than an ordinary year of retirement.
Speak to a financial adviser.
If you are serious about retiring early, it is worth investing a little money in a financial adviser to help you work out exactly how much more you will need, and whether you can really afford it.