When thinking about retirement, many people anchor their planned retirement age to traditional timelines dictated by Medicare, Social Security, or required minimum distributions from retirement accounts. However, a growing movement known as Financially Independent, Retire Early (FIRE) redefines this paradigm. The FIRE philosophy is about retiring younger than convention suggests, leveraging your assets wisely to sustain financial freedom.
Retiring early offers the allure of enjoying your hobbies and interests in younger and often healthier years. Yet, without thoughtful preparation and a plan to ensure you’ll have sufficient assets to maintain your lifestyle during an extended retirement, this ambition can quickly turn into stress and anxiety. In a worst-case scenario, it may require unexpectedly having to return to work at a later age. Before setting off into the sunset, it’s essential to consider the factors necessary to fund an early retirement, and avoid common pitfalls that can put financial independence in jeopardy.
Establishing a sustainable budget and savings goals
The cornerstone of achieving a FIRE lifestyle begins with drafting a budget that reflects your spending habits, now and in your anticipated retirement.
- Current vs. desired spending. Analyzing your present spending patterns alongside your desired retirement budget will help you calculate the savings goals required to achieve your targeted level of spending. Reflect on categories like housing, travel, and hobbies, while considering that unexpected expenses will almost always arise. For example, healthcare costs prior to Medicare age (65) should be factored in. Coverage can be costly, and this expense can go overlooked if your employer provided healthcare coverage for you in the past.
- Save early and often. Once you’ve established your desired budget, determine the extent of assets and income sources you’ll need to sustain it as well as the rate of return needed to preserve and grow your portfolio over time. Starting to save at a young age provides the advantage of compounding growth, which is a huge benefit for those eyeing early retirement.
- Tax-advantaged savings vehicles. Traditional IRAs and 401(k) plans allow for tax-deferred growth while Roth IRAs and 401(k) plans allow for tax-free growth. Unlike 401(k) plans, Traditional IRAs and Roth IRAs have income limits associated with contributions so be sure to utilize these accounts while you’re eligible to do so.
- Consider other cash flows. Don’t forget to include estimates for inflation and taxes in your plan to ensure you maintain your spending power over time. This includes changes in tax rates if you plan to move to a state with different income tax rates or no income tax altogether.
Avoid succumbing to one-size-fits-all benchmarks — what works for one early retiree may not align with your aspirations. If you attempt to hit arbitrary goals (such as a certain portfolio size or net worth), you may end up working longer than necessary to achieve financial independence.
Identifying and diversifying cash flow sources
Mapping your cash flow sources is key to ensuring your spending can remain consistent year over year. Below are common resources to consider for your plan.
- Taxable brokerage accounts. Especially advantageous for those retiring younger than age 59.5, these accounts (including individual, joint, and trust accounts) allow you to make withdrawals without penalties, as would be the case with a traditional IRA. However, be wary of capital gains taxes when liquidating investments.
- Pretax retirement accounts. After crossing the age 59.5 threshold, tax-deferred accounts, such as traditional 401(k) plans and IRAs, become accessible without penalties. Although there are exceptions for processing withdrawals from these accounts before age 59.5 without penalty, they may not be tax advantageous over the long run. Additionally, remember that distributions from these accounts are taxable. Consider spreading out withdrawals from these accounts when you’re in your 60s to stay in lower income tax brackets and reduce future required minimum distributions.
- After-tax retirement accounts. Roth IRAs and Roth 401(k) plans allow for tax-free growth and withdrawals after age 59.5, so delaying withdrawals and extending the growth period in these accounts is often advantageous.
- Social Security. There are pros and cons to collecting Social Security retirement benefits at different ages. Claiming early (starting as young as 62) reduces benefits but extends your income period and could allow you to delay or reduce distributions from tax-deferred accounts, such as a traditional 401(k) plan or IRA. Delaying, on the other hand, can increase benefits up until age 70. In fact, delaying Social Security until age 70 increases your monthly benefit by about 77% compared to claiming at 62. Other considerations include your current health and family longevity. If you’re a married couple, you’ll want to determine the best time to start collecting if you anticipate one spouse will be collecting a spousal benefit. Also, consider if your plan is sustainable with only one Social Security benefit if a spouse were to pass away early.
- Embrace part-time opportunities to earn. Consider post-retirement ventures that align with your passions. A part-time role can enhance satisfaction, supplement income, and, for some, provide coveted healthcare benefits prior to reaching Medicare age (65). This could include consulting in a field of expertise or taking a job in the same industry but reducing hours to be less than full-time to provide schedule and workload flexibility.
Crafting a sustainable cash flow strategy in retirement requires thoughtful planning and a clear understanding of your available resources. Each option carries unique tax implications, timing considerations, and strategic advantages. Mapping these out in advance empowers you to maintain consistent spending, minimize tax burdens, and enjoy greater financial confidence throughout retirement.
Mitigating risks with contingency plans
Creating a tailored financial roadmap can lessen perils, but it’s important to think through the “what-if’s” to determine if the plan will still be successful if life doesn’t go according to plan.
- Planning for contingencies. An inability to consider unforeseen events can derail your retirement. For instance, if you’re a couple relying on a pension, confirm whether there’s a survivor benefit or if the pension only distributes income for the current beneficiary’s lifetime. Also, what will you do if life brings unexpected caregiving responsibilities or long-term care needs? Plan preemptively to hedge against uncertainty.
- Passive income pitfalls. Whether real estate or portfolio income, overdependence on passive income can jeopardize financial stability if assets underperform expectations. Think through how spending would have to change if you had rental properties and the properties went unrented for a period of time.
- Longevity planning. Run projections beyond your anticipated lifespan to prevent financial insolvency should you outlive your original plan. Don’t plan to spend every last dollar during your lifetime and build some cushion into the plan.
With the proper foresight, these common pitfalls can become manageable elements within a well-rounded financial plan.
Your financial advisor: An essential partner in your FIRE success
Your financial advisor plays a key role in achieving financial independence — the “FI” in FIRE. Key areas of support include:
- Clarifying your retirement goals. A good advisor can help you define what early retirement will look like for you — whether it involves a full exit from work, part-time work, or a phased transition — and work with you to create a financial strategy to support that vision.
- Optimizing your personal balance sheet. Your personal balance sheet is key to establishing a clear baseline from which to craft a retirement strategy that reflects your lifestyle and risk tolerance. By mapping out your assets and anticipated liabilities, your advisor can help you structure your finances to maximize cash flow and long-term stability.
- Mitigating risk. Will your money outlast you if you retire early? Your advisor can help develop contingency strategies that protect your retirement timeline from market volatility, rising healthcare costs, and unanticipated life events.
- Integrating tax and estate planning. Early retirement involves more than just investment management. Your advisor should be able to leverage a full suite of services that incorporate tax-efficient strategies, estate planning, and ongoing financial monitoring and advice to ensure your plan remains adaptive and resilient as your life evolves.
Ready to retire early? Start with a solid plan
Early retirement isn’t just a dream — it’s a goal that can be achieved with the right strategy. A tailored, comprehensive plan gives you the confidence that your aspirations are built on solid ground. From clarifying your retirement vision to optimizing your financial plan and mitigating risk, your financial advisor can guide you every step of the way. If you’re ready to take the first step toward financial independence and early retirement, you should start working with a financial advisor to start building your personalized plan.
