A few years ago, my wife and I discovered that we were financially able to retire in our mid-30s. With reasonable assumptions on investment returns and a modest lifestyle, we had a strong likelihood of sustaining ourselves financially without ever working again.
We never set out to be ultra-early retirees. I still work to cover the costs above the bare necessities of life, strive for a bit of a buffer above that baseline, and to be able to support our other life priorities, like our children's educations. Still, whether you're looking to retire in your 30s, your 60s, or somewhere in between, there are three important lessons we learned in that process that may help you in your journey to retirement success.
No. 1: Keep your costs down
First and foremost, what made that milestone possible for us is a low-cost lifestyle. Were we to pay off the mortgage and cut all other expenses to the core, we could keep our expected costs for our family of six well below the equivalent of two full-time minimum wage jobs. A low-cost lifestyle helps in three key ways:
- It takes that much less of a nest egg to cover your costs. One key retirement planning guideline is known as the "4% rule." Under that rule, you can spend 4% of a well invested nest egg in your first year of retirement, and adjust for inflation annually. Under that guideline, you need $300 saved up for every $1 of monthly expenses your nest egg needs to cover. The lower your monthly costs, the less that nest egg needs to be -- by $300 for every $1 of monthly spending.
- It frees up more money to invest to let you build that nest egg. All else equal, the less you spend, the more you have available to invest. If you start by living on less than what you earn, and you consistently add a large portion of any raises to your investments, you'll soon surprise yourself by how much you're able to sock away.
- It gives you more wiggle room to cover the unexpected. Cars, furnaces, air conditioners, water heaters, and many other core parts of modern living all break down from time to time. All else equal, the less you spend every day, the more of your money stays available to cover the costs of those emergencies when they happen.
No. 2: Take advantage of free money
Money you invest in a traditional 401(k) style plan through your work is contributed pre-tax, effectively adding your marginal tax rate to the money you invest. If your employer offers a decent match program, that match plus the tax deduction could effectively instantly double your money. I'm not aware of any way to get a legal and guaranteed instant 100% return on your investment other than that simple act of contributing to your traditional 401(k) and getting a decent employer match to go along with it.
Even if you don't get an employer match, investing in any 401(k) and/or IRA plan offers you tax-deferred compounding and the potential for either tax free withdrawals or tax deductible contributions. Money you're not spending on taxes is money you can keep working for you.
No. 3: It makes sense, even if you don't plan to retire early
In our case, an ultra-early retirement wasn't our primary goal, but along the way, it quickly became apparent that saving aggressively as if for retirement still made incredible sense. Aside from the previously mentioned free money, here are five key reasons why:
- Retirement accounts are protected from most creditors. 401(k) plans have protection from most creditors under federal rules, and IRAs up to $1 million are protected from bankruptcy. Some states offer even more protection. That protection means money in your retirement account is more likely to stay yours, even if something happens to otherwise drain your assets.
- It is possible to tap retirement plans early, even for other priorities. The IRS offers several exceptions to the early distribution penalty rules for retirement accounts, even for reasons other than retirement. And with a Roth IRA and at least a five-year head start on your other financial goals, you can get some serious flexibility in tapping those accounts early.
- Retirement investing can be done automatically. Once you fill out your paperwork indicating your contribution level and investment choices, investing in your 401(k) continues automatically, straight from your paycheck. You don't miss the money you never see, and once it really gets compounding, the money already in your account will do most of the work for you.
- Unparalleled work flexibility comes from being "retirement-ready" early. Imagine not having to worry about destitution from losing your job, having to accept a job you don't really like just to make ends meet, or having to stay in a job you can't stand. Imagine having a significant chunk of money available to you to start your own business should you have a goal of being your own boss. All that is possible with an adequately funded retirement plan.
- Investing early in life for retirement makes your money more productive. Say you expect to earn 8% per year on your investments and would like a $1 million nest egg. If you start investing 40 years before retirement, it'll take $287 per month and require a total of $137,760 invested over the course of your career to get there. If you wait until you only have 20 years left, it'll take $1,698 per month, and you'll have to invest a total of $407,520.
Your future self will thank you for it
Once you make funding your retirement a top financial priority, it brings with it substantial benefits that can have an incredibly positive impact on your life, even well before you're ready to retire. The sooner you start on that path, the sooner you'll see those benefits. So get started now, and it won't be long before you look back on that decision to start funding your retirement as one of the best financial decisions you ever made.