The earlier you retire, the longer your retirement will be -- which means more fun and less work over the course of your life. The problem, of course, is that many workers struggle to come up with enough savings to finance any retirement, let alone an early one. You can buck the trend and enjoy a well-funded early retirement by adopting the following approach.
Add up retirement expenses
The first thing you need to do when drawing up any retirement plan is to figure out what exactly you want to do during your retirement. After all, some retirement dreams are far more expensive than others. If your idea of an ideal retirement is to lounge around the house reading and watching TV, with perhaps the occasional leisurely walk through the park, your retirement expenses will be a whole lot lower than someone who wants to pursue more expensive endeavors, such as lots of travel or a glamorous nightlife.
Once you've decided what you want to do with your life after you retire, you can start adding up your retirement expenses to figure out just how much money you'll need to finance those retirement dreams. You can start by looking at your current expenses, then remove anything that will no longer apply and add in the expenses for your retirement plans. For example, if you're positive that your house will be paid off by the time you retire, you can remove your monthly mortgage payment from your retirement expenses (but remember that you'll still have to budget for homeowner's insurance and property taxes).
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Set your income goal
Let's say that you've added up all your retirement expenses and come up with a figure of $3,000 per month. That number is your absolute minimum expenses, so you'll need to add a little "wiggle room" to this figure to account for any expenses you may have forgotten or any unexpected one-time charges that could blow your budget out of the water. So add 10% to this estimated monthly expense to bring the new total to $3,300 per month, or $39,600 per year. That's the minimum amount of income you'll need after you retire.
Next, decide just when you're going to retire. After all, "early" covers a lot of ground. Retiring before age 59 1/2 is extremely difficult because you'd have to pay early withdrawal penalties on any money you took from your retirement savings accounts, so you should probably plan to retire no earlier than that. 62 is when you'll first become eligible to get Social Security benefits, so that's another good target for early retirement.
Let's say that you decide to pick your 62nd birthday as your planned retirement date. In that case, you can work your Social Security benefits check into your income plans – but there is a catch. Claiming Social Security before your full retirement age means that your benefits will be reduced, so you'll need to generate somewhat more income from your retirement savings to make up for the difference. Your Social Security statement will tell you your estimated retirement benefit based on whether you retire at age 62, at full retirement age, or at age 70.
For purposes of this example, assume that claiming Social Security benefits at age 62 will give you a monthly benefits check of $1,000. That's an extra $12,000 per year in income that you can subtract from your $39,600 goal, meaning that you'll need to generate just $27,600 from your retirement savings each year.
Figure out your savings goal
Once you know how much income you'll need to get from your retirement savings accounts, you can figure out how much you'll need to have saved in total by the time you retire. To be safe, assume that you'll be able to withdraw 3.5% of your total retirement balances each year (in many years you'll be able to take more, but setting this to a conservative percentage insurers you'll have enough income even during years that your investments perform poorly). Divide your $27,600 annual income goal by 3.5%, and you'll get a total savings goal of $788,571.42.
Now that you have a total savings goal, you can use that number to figure out how much you need to contribute in order to hit your goal by age 62. A savings calculator can make doing the math on this a whole lot easier. For example, if you're 40 years old and have $25,000 in your retirement savings accounts today, assuming an average annual return of 7%, the calculator will tell you that you need to save $12,926 per year in order to retire at age 62.
How to hit your savings goals
If the contribution goal that pops out of the calculator looks way too ambitious to you, you have a few different options. First, you can dial back your retirement plans. Cutting down on your retirement expenses means you'll be able to get by on less income, which in turn means you won't need to save so much. Second, you can come up with some other sources of retirement income. For example, you might decide that you'll get a part-time job for your first few years of retirement, providing some much-needed extra income that you won't need to generate from savings. And third, you can work on your current income and expenses to make room in your budget for a much bigger retirement contribution. You might find a way to get rid of some current monthly expenses, such as that Hulu subscription that you rarely use, or you could take on more hours at work or even pick up a side gig to generate some more income.
Whatever approach you choose to make your contribution goals manageable, it's critical that you put it in place immediately. If you wait to start making retirement contributions, you'll end up having to contribute far more then your initial target, making it even harder to save enough. In fact, you're better off starting contributions immediately even if you can't save enough to hit your target -- each additional contribution will get you that much closer to your savings goals. When it comes to saving money, the early bird really does get the worm.
