How to retire early at 55

Early retirement is a dream for many people, but the road to get there can be pretty difficult for most families. The Social Security Administration defines full retirement age as 65, and about half of Americans retire between the ages of 61 and 65.  According to the LIMRA Secure Retirement Institute’s analysis of U.S. Census data, about 18% retire before 60, and 5% retire before the age of 55.  These tips are really designed for that last demographic.  Those who really want to push the boundaries and retire by the age of 55, which is a pretty daunting prospect for most debt-laden American families.

Amongst younger people, the FIRE (Financial Independence Retire Early) lifestyle movement has gained in popularity the last few years.  Those in that community are pushing the limits of extreme saving, with the goal to become part of the 1% that can generate enough fixed income under the age of 50 to retire comfortably.  This goal is probably out of reach for many people, but the overall principles can be useful if you’re willing to make large lifestyle changes and ultimately save far more than the 15% of your income suggested by most financial professionals.

At Arrow, we’re not proponents of the extreme form of FIRE (saving 75% of your income to live passively for the next 60 or 70 years!), but we do think early retirement by the age of 55 is a more realistic target for the average person.  Here are some of our tips:

1.)  Maximize your income

While it seems obvious, it is sometimes overlooked that your income is by far your greatest tool to reach early retirement.  15% of 150k is of course more than 15% of 50k.  That means the best “return” you can possibly get is by investing in yourself.  Additional education, certifications, a willingness to relocate or leave a comfortable job for a higher paying one are all part of the early retirement recipe.  Do you have to do this?  Of course not, and quality of life and job satisfaction should always be of paramount importance.  But if you want to retire early, you might need to make some sacrifices.

Another option is to get a “side hustle” — a part time job, consulting on the side, Uber/Lyft, any additional income streams that can be invested to build your long-term portfolio.

2.)  Contribute while you’re young

The earlier you start, the better.  Unless you have an extraordinarily high income, if you begin putting money into your IRA and 401k at age 40, it’s going to be nearly impossible to retire by 55, assuming you don’t own any other assets.  The power of compound interest is always going to benefit those with more time, and history has shown that time is the most valuable resource in building extreme wealth.  In addition, getting into the habit of investing early (and regularly) builds good money habits that can last for decades.  I often hear from people that they had an epiphany which forced them to view money and their spending habits in a different light.  This is often a driving force in changing their behavior.  If it happens at 25, then they are set.  If it happens at 60, things are going to be tough.

3.) Take advantage of free money (in and outside of retirement plans)

Another common mistake made by investors is to not take advantage of sources of free money.  Sounds crazy right?  The most obvious form of free money for most Americans is an employer match in their qualified retirement plan (401k, 403b etc.).  A 2015 study by financialengines.com found that 25% of people were not contributing enough in their 401k to maximize their employers match.  That is just free money left on the table.

Another source of free money is credit card rewards.  If you’re responsible with your credit cards, and never leave balances or pay any interest, reward points can be a good source of investable cash.  My wife and I put nearly all of our expenses on credit cards for this reason.  That free cash is then put into investments.  For example, if you put a large percentage of your expenses (say $50,000 per year) onto a 1% reward credit card, you’ll have an extra $500 each year.  Over 30 years, if that $500 is invested in the stock market (2x per year at $250) with an average return of 7%, you’ll have $54,787.79.  That’s free money, but only if you’re extremely responsible with those credit cards and never leave a monthly balance!

4.) Contribute where it makes the most impact

The order that you put money into your investments can really impact your long-term savings goals.  At Arrow we advocate the following order:

                1.) 401k until employer contribution is fully matched.

                2.) Traditional or Roth IRA (depending on your tax situation and income), for both spouses if married.

                3.) Back to the 401k until it’s maxed out ($19,000 contribution limit in 2019).

                4.) Brokerage account

Of course, many people are not going to be able to max out multiple 401k’s and IRA’s every year, but regardless of where you have to stop, this order maximizes growth in tax-deferred or tax-free accounts.

5.)  Avoid financial “vampires”

I define a financial vampire as an asset whose value rapidly depreciates shortly after purchase.  Common examples are vehicles, boats, expensive jewelry, and other “status” items.  Every heard the joke that a boat is a hole in the water that you throw money into?  It’s a perfect example of a financial vampire.  The moment you walk away from the dealership or store, you’ve lost a huge amount of money that you can’t recover.  In addition, expensive cars and trucks cost more to insure and repair, which compounds the financial losses even farther. 

Here’s an example:

Bob buys a used Hyundai Elantra for $12,000 in Oklahoma on a 60 month loan with $1,000 down with a 4.5% interest rate.  His total cost after fee’s and loan interest is $14,444.39.

Allen buys a brand new Ford F-250 for $33,150 with the same loan details, and his total cost is $39,582.88

The problem is that both of these assets will reach a value of $0 over time.  Since vehicles don’t retain their value, Allen ends up spending $25,000 extra on something that was always going to be worthless in the long run.  And that doesn’t count gas, upkeep and other hidden costs of vehicle ownership.  Throw in a few more cars and a few more decades of poor vehicle buying habits and Allen’s family is down $100,000 or more towards their retirement goals.

6.)  Use a fiduciary to maximize your draw-down/fixed income scenarios and to monitor investments

At the risk of being biased, there is a lot of evidence that suggests people who use fiduciary financial advisers (not insurance agents or brokers!) outperform in their investments compared to those who don’t.  See here and here for some good articles on the subject.  One of the primary reasons is that people often put themselves into investments that are not balanced to the amount of risk they are willing to take.  So they “panic sell” when the market is in decline, and end up with extremely subpar returns.  A good fiduciary is a coach and educator that can guide you with good decision making during those market declines.

Secondly, generating a good fixed income portfolio in retirement, and appropriately coming up with a plan to draw down your accounts or live off interest requires extensive financial planning.  Many people try to do this themselves without any statistical modeling or understanding of the tax implications, and they end up losing thousands of dollars that would have been avoidable.  Others get convinced by salesmen into extremely subpar annuities or whole life insurance packages that are far more expensive than the type of fixed income portfolio that would be produced by a good fiduciary.

7.)  Don’t deprive yourself of fun vacations or entertainment

You work hard and you should be able to do fun things.  Any financial plan (like the extreme form of FIRE) that makes it nearly impossible to really enjoy life with your family is not something we would advocate for.  Why not?  Well, because it’s going to be much harder to stick and follow that plan if you’re miserable for 20 years trying to save 75% of your income.  Your financial plan should be something you can stick to for a long period of time.

8.)  Buy a house that corresponds to your income level

A good rule of thumb is that your monthly housing costs (mortgage payment) should be less than 30% of your monthly gross pay.  This is just a ballpark estimate and everyone has different amounts of debt and different circumstances.  However, if your housing cost/gross pay ratio is significantly higher than 30% you might be putting a real squeeze on your plans to retire by 55.  Particularly because the money being lost to interest could be gaining interest in an investment account.

9.)  Create income streams in retirement

This could be a pension plan, it could be a fixed income portfolio produced with your financial adviser (hopefully not an insurance company product like a fixed annuity!), or could be rental income.  Regardless a stable income stream from a variety of sources leads to the kind of dependable financial situation that is necessary to retire early.

10.)  Have a plan to “bridge the gap”.

You won’t be able to withdraw your traditional IRA or 401k contributions until 59.5 without a 10% penalty.  Full social security benefits don’t trigger until 66 (we tend to not advocate for early social security benefits at 62, but it depends on the situation).  So if you retire at 55, there is going to be a multi-year gap that will need to be funded before taking advantage of some of your other income streams.  Taxable accounts should almost always be drawn down first, so it makes sense to have a brokerage account that acts as a bridge between early retirement and full retirement age.  Additionally, rental income could be a great source of funds to bridge the early retirement gap.  Either way, these are complicated issues that should be worked out with your fiduciary.