Most of us have an age at which we’d like to stop working—but what if circumstances change and retirement comes early? According to a 2020 survey conducted by the Employee Benefit Research Institute, nearly half of retirees reported leaving the workforce earlier than anticipated.
That said, just because early retirement isn’t part of your plan doesn’t mean it isn’t doable. So, how do you know if you’re adequately prepared for early retirement? Follow these steps to find out.
Step 1: Review your finances
To begin, ask yourself four questions:
- What are my expenses now? It can be helpful to split your current expenses into two categories: must-haves like groceries and housing, and nice-to-haves like eating out and travel.
- How will my expenses change in retirement? While some costs, such as payroll taxes and retirement contributions, will go away, others, particularly health care, are likely to increase. Also factor in the potential for major one-time expenses, such as a child’s wedding, a new car, or a roof replacement. And don’t overlook the cost of long-term care—which roughly 70% of retirees will require at some point in their lives, according to longtermcare.gov.
- What’s my potential income? Tally up income from pensions, Social Security, and any other nonportfolio sources. Subtract that number from your target annual income to determine how much money you’ll need to generate from your portfolio. For example, if you need $90,000 a year in income and expect to receive $40,000 from nonportfolio sources, you’ll need $50,000 from your portfolio to meet your spending needs.
- What about health care? If you’re no longer covered by your employer-sponsored health insurance, you’ll need coverage until you become eligible for Medicare at age 65. Health care can take a big bite out of your income, so make sure to compare all available options, including COBRA, private insurance, and your spouse’s plan, if available. You may also be eligible for discounted coverage through organizations such as AARP.
Step 2: Assess your portfolio
Now that you have a clear picture of your income needs, ask yourself three questions to help determine the overall strength of your portfolio:
- Am I prepared to weather a downturn? Having adequate short-term reserves can help you avoid having to make a portfolio withdrawal during a bear market. We suggest having enough cash on hand to cover a year’s worth of retirement expenses, plus another two to four years’ worth of spending needs in short-term investments such as certificates of deposit and Treasury bills.
- Is my withdrawal rate sustainable? Keep in mind the 4% rule, which says that withdrawing 4% of your portfolio in your first year of retirement—and adjusting that number annually for inflation—will give your portfolio a high probability of lasting 30 years. Thus, if you want to withdraw $50,000 in your first year, a $1.25 million portfolio ($50,000/0.04) has a good chance of seeing you through retirement. Be aware, however, that this rule is conservative and doesn’t account for fluctuations in spending or market performance. A financial planner can help you develop a retirement plan, including a personalized spending rate based on your needs and time frame.
- Is my asset allocation in line with my time horizon, risk capacity, and risk tolerance? Maintaining a diversified, balanced portfolio becomes even more important in retirement to help prevent taking on too much—or too little—risk. For example, if you’re facing a retirement that could last a decade longer than planned, holding more stocks in the early years will help guard against the risk of outliving your savings. Just be sure you take a more conservative approach with the money you’ll need to tap in the next few years. Striking a balance between short-term income needs and longer-term growth is critical in retirement.
Step 3: Dig into the details
Making the shift from saving to spending can be challenging under the best of circumstances. The key is to plan your retirement with as much detail as possible—as well as with the understanding that you can’t predict everything and will likely need to make changes as your needs come into focus. A planner can help you take a hard look at your finances and make the necessary adjustments to keep your retirement on track—no matter when it hits.