Throughout America, millions of Baby Boomers are in or nearly in their 60s, and many are finding themselves ill-prepared to handle the financial realities of retirement. Research from the Employee Benefit Research Institute and other organizations shows that many of those approaching traditional retirement age are set to work until age 70 or even longer to make ends meet, shattering past early retirement dreams.
For those who have time on their side, though, the situation isn't as dire. By making smart moves with your money early on in your career, you'll put yourself in the best position possible not only to avoid having to work the rest of your life but also to improve your odds of retiring sooner than you had ever expected. Three simple yet powerful tactics that have stood the test of time can help you the same way they've helped countless early retirees before you.
1. Invest early -- no matter how little you can save
Too many people never bother to start investing because they think investing is reserved for the rich. Coming up with even a few dollars a day to set aside for retirement is beyond some people's financial means, and even those who can manage it may believe that scraping up $100 or less in a typical month won't add up to much.
But investing early gives you two big benefits. First, compound interest has a much more dramatic impact for every year you allow it to work. As a simple example, if you invest $100 in a stock that returns 10% annually over the long run, you'll have $2,800 after 35 years. Invest the same amount five years earlier, and it will turn into $4,500 -- more than half again as much. Put another way, starting five years earlier potentially means you can stop working five years earlier if you're diligent about saving consistently throughout your career.
2. Use the full power of tax-advantaged retirement accounts
To help you build a consistent retirement savings strategy, tax-favored accounts like IRAs and 401(k) plans play a vital role. Early in your career, when your tax rates are low because of your limited income, Roth IRAs and Roth 401(k)s are especially valuable. By allowing you to withdraw your funds free of tax in retirement, Roths have an edge over traditional IRAs and 401(k)s when you're in a low tax bracket. The up-front tax deductions offered by traditional retirement accounts don't have much value if you're in a lower bracket now than you expect to be in when you retire.
Later in your working life, as your pay increases and you move into higher tax brackets, traditional retirement accounts regain an edge over Roth accounts. Tax deductions let you put more toward your retirement, and employer-provided incentives like matching contributions and profit-sharing can make participating in a company-sponsored plan even more lucrative. Even if you only have limited funds to invest, taking full advantage of those incentives can essentially add free money to your retirement nest egg, letting you retire that much sooner.
3. Focus on a sustainable income stream from your retirement portfolio
The hardest decision with early retirement is when to pull the trigger and quit your job for good. Even those who have amassed substantial savings get nervous when the time comes to retire, as it's impossible to be certain whether the money you've saved will be enough to last a lifetime.
But gauging your expenses in the last few years of your career and predicting what your retirement pursuits will cost should give you a sense of how much income you'll need to replace after you retire. Once you've taken sources like Social Security into account, taking your anticipated annual income and multiplying it by 25 can give you a sense of whether you've saved enough to cover your living expenses.
Multiple studies have shown that starting with an initial withdrawal of 4% of your portfolio and then adjusting that higher to account for inflation has been sufficient in the past to cover 30 years or more of retirement expenses, and targeting 25 times your anticipated needs will match up exactly with the requirements of what most experts call the "4% rule."
The earlier you want to retire, the more you'll want to pad that figure in order to provide for a longer period of retirement. Nevertheless, following the 4% rule provides a good starting point for assessing whether what you've saved will be enough.
Obviously, retiring early takes a lot of work and dedication, with most people cutting their budgets to the bone in order to maximize their savings. But for those who dream of an early retirement, those sacrifices are worth the payoff, and following these time-tested tips will give you the best likelihood of making your dreams of retiring early come true.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.