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How to Retire Early

Unbiased Financial Information Provided by Financial Finesse

Millions of employees dream of leaving the working world before their hair turns gray -- while they can still do things like travel, golf and generally kick up their heels. Others need to quit the workforce early for health or family reasons. If you're in either group, it's time to design an early-retirement plan.

How Much Will You Need?

Your retirement "bottom line" will depend on your income and expenses:

  • Are you dropping out of the business world completely, or will you be doing some part-time or freelance work?
  • Will you be sticking close to home to care for a family member, or do you plan to travel to exotic locales?
  • Will you be occupying your time with low-cost activities, or do you intend to indulge in some expensive hobbies?
  • Will your mortgage be paid off by the time you retire?

Obviously, the more income you have in retirement and the lower your expenses, the greater the possibility of making ends meet. Whatever your plans might be,make sure you're realistic about the amount of money you're going to need.

"[Retirees] should expect to spend 80 percent to 100 percent of their current income in retirement," says Mari B. Adam, CFP®, MBA, CRPC. "Thanks to improvements in healthcare, people are living longer, more productive lives. That means your years in retirement could equal your working years."

So, how do you calculate how big your nest egg needs to be for you to live the retirement lifestyle you want? According to Anne Chernish, CFP®, an easy rule of thumb is to estimate how much money you'll need in the first year of retirement and then figure out what level of assets it would take to generate that income each year.

For example, if you need $45,000 per year and nothing is coming from other sources (such as pensions, Social Security, or part-time employment income), it would take $1 million invested in a balanced portfolio producing an after-tax rate of 4.5 percent to "earn" the annual income you need to live.

Use the chart below to get an idea of how big a portfolio it would take to generate a specified annual income at a particular rate of return.

The Size of Portfolio Required to Produce a Specified Annual Income at a Particular Rate of Return

Rounded to the nearest 1,000

How Do You Generate the Income to Fund Your Dream?

Hopefully, the news that you need a million bucks to fund a $45,000-a-year lifestyle doesn't come as a huge shock. Even if it does, don't abandon your retirement dreams yet. You might be just as surprised to find out that your nest egg is in better shape than you thought.

Take an inventory of all your retirement resources. Pore over your IRAs and 401(k), 403(b), or 457 accounts. Check your Social Security benefits. Tally up all your other assets. Take one last look under the mattress. Are things looking up?

One word of warning: While you may have a tidy sum stashed away in retirement accounts, those funds aren't typically accessible before age 59 1/2. Early withdrawals usually carry pretty hefty penalties. And you won't qualify for Social Security benefits until age 62, the earliest you can receive a reduced benefit. All that makes a large liquid portfolio the key to an early retirement.

"To finance the first years of your early retirement, make sure you have money outside your retirement accounts," says Ellen Hoffman, author of the book Retirement Catch-Up Guide: 54 Real-Life Lessons to Boost Your Retirement Resources Now. "It's important to be able to tap into these funds until you are able to withdraw from your retirement accounts."

What if you've checked every possible place and still find yourself short? If early retirement is still your goal, be flexible. Work part-time for the first few years in retirement, move to a less expensive area, forgo the major trips until you can tap your IRA and retirement plan accounts, or are eligible for Social Security. Do whatever it takes for you to achieve your dream before your hair turns gray.

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