Early Retirement Planning

By Cathy DeWitt Dunn

Retiring early, before social security and Medicare benefits are available, requires careful planing. A significant portion of your pre-retirement income should be maintained by some means that is likely to continue for the rest of your life. Planning for early retirement is complicated by two factors:

You will have less time to save for retirement
You will live longer in retirement than if you retire later in life.

A successful early retirement requires first that you save as much as possible during your working years, and second that you find ways to minimize your monthly living expenses when you are retired.

Your Friends – Time and Compound Interest

When it comes to retirement savings, time is your best friend and compound interest is your next best friend. Many financial planners suggest you adhere to a strict plan. to invest a portion, say 20%, of each paycheck in an index like the S&P500 and let it accumulate without taking any withdrawals until you retire. The money you withdraw then will be taxed at the lower long-term capital gains rate. You can also complement those savings with tax-deferred plans like a 401(k)s or long term deferred annuities. Keep in mind that these investments may not be used for income before you are 59 ½ because of IRS penalties. As a result, the portion money you need prior to turning 59 ½ should be invested with tax efficiency in mind.

Your Enemy – Inflation

If compound interest is your friend, inflation is your enemy. The long term average annual inflation rate is 3%. At that rate, over the next 40 years, the purchasing value of a dollar shrinks by 70%. For example, $1 million of savings will only purchase about $300,000 worth of goods in 40 years. How does this affect retirement?

Let’s say that you are able to save $1 million of today’s dollars towards retirement. Your plan is to start using that money in 40 years and spend $50,000 per year. Because of inflation, the $1 million dollars you saved would only last about 6 years.

Investing with Inflation in Mind

For the long haul, you need to invest with inflation in mind. Investments such as real estate, commodities, gold, silver, and collectables generally increase in value along with inflation. While safety is important, keep in mind that, over the long term, stocks have bettered inflation whereas bonds have not. This is because Inflation allows companies to pass on cost increases, so in general profits increase and their shareholders benefit. Annuities that allow participation in stock market gains, like fixed index annuities, may provide a long term hedge against inflation while also protecting against losses and providing guaranteed lifetime income.

While research on aging shows that as we get older our annual living expenses decrease, that is not always the case. Many retirees own their homes outright, which does decrease their monthly bills substantially, but even when there is no mortgage to pay, retirees find that their annual property tax bill continues to climb. Healthcare and long term care expenses are also increasing year by year.

When planning for retirement, it is important to factor in these costs as well. A person has one opportunity to effectively plan for early retirement, and if that opportunity passes, it is too late. Unfortunately youth and wisdom do not often go hand-in-hand, so it is very important that anyone desiring to retire early seek professional advice early in the planning stage. One excellent source of financial advice can be obtained by calling the retirement planning experts at Annuity Watch USA at (972) 473-4700.