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How do I know if I can retire early?
Some people go to great lengths to set their spending, saving and investment goals in order to retire early.
Justin McCurry retired more than 30 years early at age 33 with $1.3 million so he could spend more time traveling with his wife and three children. This is no accident.
While the main goal is to calculate how much you need and hit that magic number, there are other considerations.
Reaching that number can be so exciting that you want to launch right away, McCurry said. But he says not paying attention to the details of life after get off work can undermine or even undo some of your efforts.
Check your math and risk
First, you need to tally up your expenses, consider the lifestyle you want to live, and come up with a figure for how much annual income you think you’ll need. But the tricky part is figuring out how much money you need to save to provide that income.
The classic retirement rule of thumb is the “4% rule.” This means that if you save 25 times your annual expenses, you can expect to withdraw 4% per year and not outlast the life of your portfolio.
But the formula is based on a person retiring in their 60s and still living about another 30 years. Retiring early means you’ll be dipping into your savings for longer than a typical retirement.
“We looked at our spending and added and subtracted budget line items,” McCurry said. Work clothes and commuting clothes are out and travel is in. “We decided to use a 3.5% withdrawal rate because we are in our 30s and to be more conservative.”
His family of five now lives on $40,000 a year.
Arrange cash flow
Because early withdrawals from traditional retirement vehicles like IRAs and 401(k)s incur penalties, early retirees need to figure out how to access funds regularly with the least amount of adversity.
The Basic Equal Periodic Payment (SEPP) plan allows you to withdraw approximately 3-4% of your funds each year until age 59.5 without incurring taxes or early withdrawal penalties. Although subject to a strict IRS formula, there are three methods to determine the payout. Once these payments begin, they will continue for five years or until you reach age 59.5, whichever is later.
While this might work well if you’re trying to bridge the short gap between retirement and age 60, McCurry doesn’t think it will work for him.
“I was 33 when I quit,” he said. “I didn’t want to lock myself into a fixed salary for the next 27 years.”
Instead, he set up a Roth IRA conversion ladder.
The Internal Revenue Service (IRS) allows penalty-free and tax-free withdrawals of funds converted from a traditional IRA to a Roth IRA. The problem is you need to wait five years. If you converted $30,000 in 2018 (and paid any taxes owed), you can withdraw $30,000 in 2023. You can build an income ladder by redeeming an amount for withdrawal each year for five years.
Get ready for healthcare
Not only is healthcare a major expense, it’s also unpredictable: both your health and the system.
With Medicare still a few years away, you’ll need to buy your own health insurance. That can be expensive. But retirement also reduces your income, which may make you eligible for some kind of help.
McCurry and his family received coverage through the Affordable Care Act, and even received a subsidy of nearly $10,000 given their income and family size.
Set up your home
McCurry says a change in where you live can cause your expenses to change dramatically.
“People generally live where they live because their jobs take them there,” he said. “But they say ‘I can’t afford to retire here.'”
Consider downsizing, or moving to a location with lower housing costs.
McCurry recommends settling into your new home before you retire. Even if you plan to travel for a while immediately after retirement, it’s worth organizing your future home before you go, and you can even earn passive income by renting it out.
“Maybe you want to pay cash, but if not, it’s easier to get a lease or mortgage while you’re working,” McCurry said. “Sure, you can show a mortgage broker a $2 million balance sheet, but they can still say they need to see your income.”
Stress test your plan
Don’t forget to consider other unknown factors such as inflation and market returns.
“We often run multiple scenarios using different assumptions, such as inflation or growth rates,” says Jennifer B. Harper, certified financial planner and director of Bridge Financial Planning. She then said she applied “Monte Carlo” analysis, a model that looks at multiple outcomes to provide a probability distribution or risk assessment for an investment to show the range of potential predictions.
“It’s not perfect,” she said, “but it’s much better than modeling everything as straight-line growth.”
CNN Business (New York) First published September 27, 2018: 2:12pm ET