Many people dream of retiring early at 55, 50, or even 45. But it's not just a dream. With enough financial discipline and a little luck, an early retirement can be achieved if you can overcome these obstacles first.
Less time to earn more money. There's no getting around it. To retire early, you will have to make the most of the limited number of earning years you have. This means you will have to earn more money and save a larger percentage of those earnings. How much will it take? Some early retirees report saving over 50 percent of their income at times. Could you live on half of your income?
Limitations on the power of compounding interest. Compound interest occurs when the interest earned on your savings is added to the original savings amount and the now higher balance continues to accrue interest. Over time, compound interest acts like a big snowball of savings. For the special power of compounding to work, you need to give it time. The sooner you tap into your savings, the less time compounding interest has to work its magic on your money. The difference in those last 5 to 10 years of saving can be huge. Think of the amount of snow that's added to a snowball on the last few rolls.
Age-related retirement benefit restrictions. In order to tap into certain tax-sheltered retirement accounts without penalty, you need be a certain age. These age limits typically aren't in your 40s. For example, you need to be 59 1/2 to withdraw money from a traditional IRA plan without penalty. Take note that the Roth IRA withdrawal rules are a bit more forgiving to early retirees because you have already paid income tax on the contributions. In addition to retirement plan withdrawals, you'll have to wait until you are at least age 62 for Social Security benefits.
College expenses usually hit at the same time. If you have kids, odds are they will be entering college right around the time you might be considering an early retirement. If you didn't save enough money for them in a 529 college savings plan already, you may need to fork over a lot of cash to help them get through college. This can strain your ability to retire when you want to. Most financial advisers recommend prioritizing your own retirement savings over college costs for your children. The kids can fend for themselves and take out a loan if needed. You can't get a loan for retirement.
Your savings will have to last as long as you do. If you retire early, you will have to make your savings last longer than someone who retires at an older age. This means you'll need more money or to withdraw less of it each year. Retiring at 50 means your money might need to last over 30 years. Most retirement planners will suggest a 4 percent withdrawal rate to ensure you can count on your savings lasting for 3 decades.
Philip Taylor is the author of 104 Ways to Save Extra Money. Read his popular blog, PT Money: Personal Finance for more insightful money tips, like his recent suggestions for the best online checking accounts.