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3 Ways to Make Early Retirement a Reality

Rita Williams, The Motley Fool

There's a burgeoning movement spearheaded by millennials called FIRE, which stands for Financial Independence, Retire Early. In numerous blogs, FIRE proponents share stories about retiring in their 30s and the ways to achieve it. Country living, simplicity, leisure, freedom -- here we come.

Actually, the FIRE movement does not always involve complete retirement at a young age. Some FIRE proponents work, but work less or in occupations they only dreamed about in the 9-to-5 world. What the philosophy focuses on is the freedom to do as you wish.

Man and woman in beach chairs.

Image source: Getty Images.

Does this all sound good? Just keep in mind that no one in the FIRE movement just pulls up stakes and quits on the spur of the moment. You need to follow some steps to achieve early retirement.

1. Have a clear sense of how much you'll need

You'll need a firm idea of how much you'll need as a nest egg if you want to retire early.

In standard retirement planning, the 4% rule guides many projections. It says that you can withdraw 4% of a portfolio invested 60% in stocks and 40% in bonds, and your money will last 30 years. The 4% rule was devised in the 1990s to guide retirees who were worried about running out of money. At that point, 30 years was a generous retirement span. FIRE proponents will want to plan smaller withdrawals in order to adjust for a longer retirement.

A corollary to the 4% rule is the amount of retirement savings you need. If you multiply 25 by the annual income you want at retirement, that's how much you need. Thinking of living on $40,000 a year? Then you'll need $1 million in early retirement funds.

Many FIRE proponents think in terms of saving big and planning in terms of years. One year's expenses saved equals one year of early retirement freedom. Under this line of thinking, if you currently earn $80,000, and can bank $40,000 while living on the other $40,000, you've just bought yourself one year of early retirement.

Draw up a budget of your fixed expenses (housing costs, utilities), variable expenses (debt payment, energy costs), and one-time expenses (vacations). You need to have actual figures and estimates for future spending.

It's prudent to have a budget both of your current expenses (to ascertain how much you current lifestyle costs) and a projected budget for early retirement. A change in lifestyle goes hand in hand, for many people, with the dream of early retirement. Many people want to travel. Many others want to live in a place renowned for scenic beauty, but off the beaten track. The former might be more expensive than your current costs. The latter might be less.

2. Save as much as you can

Then you save, and save, and save. FIRE often entails living frugally to achieve the goal. You use your budget to pare down as many expenses as you can. Then you save every penny of disposable income and freed-up cash you can get your hands on.

Do you save in tax-advantaged retirement funds, such as 401(k)s and individual retirement accounts (IRAs)? You need to make some decisions here. There's no question that these are the best way to go for folks who plan to retire in their 60s or later. But in exchange for their tax advantages, there are taxes and penalties for withdrawing them before the age of 59 1/2.

Let's explain the retirement savings vehicles and penalties a bit more.

A 401(k) is a defined benefit plan offered through workplaces. You make a decision about how much of your salary to save. It's taken out pre-tax, which can save you on taxes. Your money's growth is not subject to tax until it is withdrawn.

A huge potential benefit in 401(k) retirement plans is the employer match, which usually equals 50% to 100% of your own contribution up to a certain limit. Save 3% of your salary on your own dime, and a company with a 100% match will often give you an additional 3% in the 401(k) account.

In 2019, folks can save up to $19,000 per year in a 401(k), or up to $25,000 if they're 50 or older.

IRAs, on the other hand, are self-directed accounts that come in two flavors. The first is a traditional IRA. It saves on taxes as well, because contributions up to $6,000 in 2019 are deductible from your income. (The limit rises to $7,000 for those 50 or over.) Any gains throughout the years are tax-free as well. But the withdrawals will be taxed.

Both 401(k) and traditional IRA money will not only be taxed at withdrawal but also are often subject to a 10% penalty for early withdrawal if you take the money out before you're 59 1/2. In other words, the enviable $400,000 that you've saved in a 401(k) may have $40,000 shaved off the top. There are a couple of more complicated ways to get at your retirement money earlier than age 59 1/2, but they're tough enough to follow that it makes traditional IRAs and 401(k)s a little iffy for those planning early retirement.

Contributions to a Roth IRA, however, aren't subject to penalties for early withdrawal. Note that you can only withdraw your contributions without penalty, though. That's because in a Roth IRA, you contribute from after-tax money and receive no deduction. In a Roth IRA, your investment gains accrue tax-free, but any accrual taken out before 59 1/2 is subject to a 10% penalty and taxes. Withdrawals taken out after that age are not subject to tax.


Because of the penalties, some FIRE proponents think it's better to just stick to regular stock funds and stocks. They return more than bonds or other fixed-income instruments based upon a historical average of 7% annually over the years, and can be liquidated for cash at any time. If you sell stocks as part of your FIRE income strategy, though, be prepared for the taxes on capital gains.

3. Generate cash with a part-time or seasonal job

FIRE has a porous take on the word "retirement." While it can mean the kind of leisure we usually associate with the word, it often means doing work you love or couldn't do in the regular business world. As a result, FIRE is entirely consistent with holding a part-time or seasonal job, as long as it's about the rewards of financial freedom. You can supplement your retirement nest egg with this cash.

Have you long wanted to start a part-time business? Now's your chance. Develop the plan and put it into action without financial pressure. Or love to ski, and think you'd be a great ski instructor? FIRE gives you the opportunity to move close to a resort and put that vision into action. Once the snow melts every year, then you can be well and truly retired.

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