If you have your sights set on retiring early, you probably know it's key to start investing as soon as possible. Compounding is what builds wealth, and the earlier you retire, the less time your money has to grow.
But even if you start investing a large chunk of your income at the beginning of your career, there are a few common mistakes that could delay your dreams of retirement. Here's what not to do if you want to retire early.
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1. Not building an emergency fund
When you're focused on retiring early, you may be tempted to invest every last cent to maximize the power of compounding. But you typically want at least a three- to six-month emergency fund before you start investing.
When you don't have money set aside for the unexpected, you risk having to raid retirement savings when something goes wrong. You could get hit with taxes and a 10% penalty, depending on the type of retirement account. If you need money after the market has tanked, you could be forced to sell investments at a loss, which could easily push back your retirement date.
2. Using your retirement money to buy a home
Even though rising interest rates have cooled off the housing market, homeownership remains stubbornly out of reach for first-time buyers in many pockets of the U.S. So it's understandable why you may look to your retirement money to make a purchase. But doing so comes at a steep cost.
You can withdraw your Roth IRA contributions at any time without owing taxes or penalties. It's possible to withdraw up to $10,000 of Roth IRA earnings penalty-free (but not tax-free) if you're a first-time homebuyer who hasn't yet reached age 59 1/2. (The IRS will consider you a first-timer if you haven't owned a home in the past two years.) You can also withdraw money from your 401(k) early for a home purchase, though you'll owe taxes and a 10% penalty.
But the biggest drawback is that you're missing time in the market. Because there are limits on how much you can contribute to retirement accounts each year, you can't just automatically reimburse your IRA or 401(k) when you have more money.
3. Prioritizing your kids' college fund over your retirement savings
If you're a parent, you obviously don't want your children to start their careers bogged down in student loan debt. But retiring early requires you to invest more for your own future so you can stretch your money for as long as possible. So unless you're awash in cash, you may not be able to fund 100% of your kids' educations and retire early.
Keep in mind that your children have options for shouldering some of the costs of college, like financial aid, scholarships, working part time, and yes, taking out a reasonable amount of student loans. If your retirement goals mean you'll have limited funds for college, talk to your kids about your financial situation and try to set expectations as early as possible. Don't wait until they've been accepted to their dream school to tell them you can't afford to pay for it.
4. Forgetting about healthcare costs
Fidelity estimates that an average 65-year-old couple will spend about $315,000 in healthcare costs during retirement -- even when you account for Medicare. But if you're retiring early, you could have a significant window where you aren't yet eligible for Medicare and have to pay out of pocket for health insurance.
If you're retiring early, it's essential to have a plan for obtaining health coverage, whether that means buying private insurance or a plan through the Health Insurance Marketplace, or choosing COBRA. While you're still working, stashing away money in a health savings account (HSA) to help you shoulder those future costs is a smart move.
5. Thinking retirement means never working again
Think carefully about what you really want out of early retirement: Are you looking to never work another day for the rest of your life? Or are you hoping to enjoy life more without being tied to a 40-plus-hour workweek or reporting to a boss?
Your early retirement goal will be a lot more attainable if you're open to working some. In fact, many proponents of the FIRE movement (financial independence, retire early) focus more on the goal of not being dependent on an employer than they do on giving up work altogether. Many early retirees still work in some form, such as freelancing, a side hustle, or a part-time job.
Early retirement requires a lot of sacrifices during your working years. Pinpointing what you want your retirement to look like can help you set realistic goals and determine how much you're willing to sacrifice.
