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3 Steps to Prepare for Early Retirement

Most of us have an age in mind at which we’d like to stop working. But what if circumstances change and you need to retire early?

According to a 2020 survey conducted by the Employee Benefit Research Institute, nearly half of retirees said they left the workforce earlier than planned

Early retirement is often brought about by unexpected events such as an illness or a layoff—both of which were especially prevalent in the wake of the coronavirus pandemic. “It may not be part of your plan, but that doesn’t mean it isn’t doable,” says Rob Williams, vice president financial planning at the Schwab Center for Financial Research. “The challenge is figuring out whether your savings can last.”

With that in mind, here are three steps you can take to determine if you’re prepared for early retirement.

 

Step 1: Review your current financial picture

To begin, ask yourself three questions:

  • What are my expenses now? Start adding up your current expenses, which will help determine your target annual income. It can be helpful to split your expenses into two columns: one for need-to-haves (such as groceries and housing) and one for nice-to-haves (such as eating out, hobbies, and travel)—which will make it easier to identify cuts should you need to trim back.
  • What could my expenses look like in retirement? Consider what expenses may look like in retirement. You might need to replace your car in 5 years or the roof in 15 years. Maybe you want to help pay for your child’s wedding or prepare for long term care needs in late retirement. To imagine what life may look like, it may be easier to think in increments like 5, 10, 15 or 30 years from now.
  • What’s my potential income? Tally up any earnings you expect to receive from pensions, Social Security, and any other sources of nonportfolio income. Subtract that number from your target annual income to determine how much of your income you’ll need to generate from your portfolio. For example, if you need $90,000 in total income and expect to receive $40,000 in nonportfolio income, you’ll need to withdraw $50,000 a year from your portfolio to meet your spending needs.

    That said, keep in mind the so-called “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 of retirement, you’ll need a portfolio balance of at least $1.25 million ($50,000 / 0.04). Keep in mind, this is a place to start. You can review and adjust spending over time, based on investment performance and other factors.
  • What about health care? If you lose your employer-sponsored health insurance, you’ll need coverage until you become eligible for Medicare at age 65. Make sure to consider and compare all available options, including COBRA, private insurance, and joining your spouse’s plan, if available. You may also be eligible for discounted coverage through organizations such as AARP. “Health care can take a big bite out of your income, so leave no stone unturned when looking for the best option,” Rob says.

 

Step 2: Assess your portfolio

Now that you have a clear picture of your income needs, you should dig into your portfolio’s health to determine if it’s equipped to support an extended retirement. Ask yourself:

  • Do I have enough set aside in short-term reserves to weather a downturn? We suggest having enough cash on hand to cover a year’s worth of retirement expenses. Then, allocating another two to four years’ worth of spending needs in short-term investments such as certificates of deposit and Treasury bills. Having an adequate short-term reserve can help you avoid having to make a portfolio withdrawal during a downturn.
  • Is my asset allocation in line with my risk tolerance? After setting aside money needed soon, your mix of assets plays the largest role in controlling the amount of risk and potential return in your portfolio. For example, a large allocation to stocks will give you the most growth potential, but also exposes you to potential for larger losses—especially in the short term. However, with enough in short-term reserves, we suggest investing the remainder of your portfolio that is in line with your goals, time horizon and risk tolerance. “When you’re facing a retirement that could last a decade longer than planned, you may need to hold more stocks in the early years to capture as much growth potential as possible, after you set aside your short-term reserve” Rob says.

 

Step 3:  Run a financial plan and rebalance your portfolio

Lastly, you need the confidence to know if you can retire. Use a retirement calculator, or if you’re a Schwab client, run a complimentary financial plan on schwab.com, to look at your investments, growth potential, and likelihood, without future changes in spending, that your savings can last. If you would like help, consider working with a qualified financial planner.

Maintaining a diversified, balanced portfolio becomes all the more important in retirement because it helps ensure your portfolio isn’t taking on too much—or too little—risk. A plan will help determine an appropriate target allocation – in other words, your investment mix.

Anytime your portfolio drifts from its target allocation by more than a few percentage points, use it as an opportunity to bring your holdings back in balance. For example, if your target stock allocation is 60% but your holdings have drifted to 65%, you may want to sell part of your stock holdings and invest the proceeds in areas, such as fixed income, that have become underweight.

 

The bottom line

“Life doesn’t always go according to plan, but reevaluating your finances and portfolio allocation is an important first step toward keeping your retirement on track—no matter when it hits,” Rob says.

What You Can Do Next

  • Read more about tax-smart approaches to investing or talk to a Schwab Financial Consultant at your local branch.

  • Want to talk about your portfolio? Call us at 800-355-2162.

Important Disclosures:

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risk including loss of principal.

Diversification, asset allocation, and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets. Rebalancing may cause investors to incur transaction costs and, when rebalancing a nonretirement account, taxable events can be created that may affect your tax liability.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, Financial Planner or Investment Manager.

While Schwab Plan is available to clients at no cost, any investments you ultimately make may incur costs such as fund operating expenses and advisory fees.

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