Wondering how to retire early? Lots of people would like an early escape from the rat race, whether it is to travel, pursue a passion project, start a business, volunteer, or just stop working.

However, retirement planning is tricky enough when you plan to work until your full retirement age. It is even more so if you want to stop working years—or even decades—sooner.

Can it be done? Absolutely. But unless you are independently wealthy—and few people are—it will take work and discipline. Here are five key steps to take.

Key Takeaways

  • It takes planning and discipline to retire early.
  • Start by estimating your monthly expenses and calculating how much you will need to retire.
  • Cut expenses out of your current budget, so you have more money to save and invest.
  • Work with a qualified financial advisor who can help you manage your finances before and during retirement.

Step 1: Estimate Your Retirement Expenses

If you want to retire early, the first step is to estimate how much money you will spend each month once you retire. Start by adding up expenses for things you cannot avoid, such as housing, food, clothing, utilities, transportation, insurance, and healthcare.

Ideally, you will enter retirement debt-free. That means no mortgage, no credit card balance, no outstanding medical bills, and no student loans or other debt. However, if you are still paying off any debts, be sure those payments are included in your budget.

Next, add in any discretionary expenses you will have, including those for entertainment, travel, and hobbies. Add everything together to ascertain how much you will need each month to maintain the retirement lifestyle you envision.

Of course, keep in mind that your budget will change as you reach different phases of retirement—you may decide to drop your life insurance policy, for example. This preliminary budget will be a good starting point, so it is worth taking the time to make it as accurate and realistic as possible.

Step 2: Calculate How Much You Need to Retire

Now that you have an estimate for your monthly spending, the next step is to calculate how much money you need to save. There are several ways to estimate this. One approach is to have between 25 and 30 times your expected yearly expenses plus the cash to cover one year's worth of expenses.

Start with your monthly expenses and multiply by 12 to obtain an annual estimate. Next, find your "target" range. Here's an example. Assume your monthly expenses will be $5,000—or $60,000 per year. Using this approach, you will need between $1.5 million and $1.8 million to retire plus $60,000 in cash.

Another approach is to take your estimated annual expenses and divide them by 4% to see how big your nest egg should be. If you're likely to spend $60,000 per year, you will need $1.5 million ($60,000 ÷ 0.04).

If you want more wiggle room in retirement, try dividing by 3% (or somewhere between 3% and 4%). With the same $60,000 per year budget, you will need $2 million ($60,000 ÷ 0.03). It's always better to have a cushion.

To see how close you are to your retirement goal, subtract your current nest egg from your target number. For example, if you need $1.5 million and you already have $500,000, you'll need $1 million more before you can retire.

Step 3: Adjust Your Current Budget

Here's where the discipline comes in. You will have to work hard to make up that $1 million shortfall—particularly if you want to do it quickly. Many people who want to retire early live on 50% (or less) of their income. The remainder is used to pay down debt and invest in that nest egg.

You have three options here:

  • Spend less
  • Earn more
  • Do both

It is essential that you create a budget so you know where your money goes—and where you can cut back. There are lots of budgeting apps that can make this tedious process a little easier.

Remember, the more you earn, and the less you spend, the sooner you can quit your 9-to-5 and start enjoying retirement.

Step 4: Max Out Your Retirement Accounts

Regardless of when you plan to retire, it's wise to start early and save frequently. Retirement accounts like individual retirement accounts (IRAs) and 401(k)s are a great way to do this.

While you are still working, do everything you can to max out your retirement accounts. A traditional IRA allows you to contribute to your retirement, the earnings grow tax-free, and you get a tax deduction in the tax year you make a contribution. However, when the money is withdrawn in retirement, it's taxed at your income tax rate in the year of the withdrawal. Conversely, a Roth IRA allows certain distributions or withdrawals to be made on a tax-free basis, and your earnings grow tax-free. However, Roth IRAs do not offer a tax deduction in the years they're funded.

For 2020 and 2021, an individual can contribute up to $6,000 each year to a traditional or Roth IRA. If you are age 50 or older, you can add a $1,000 catch-up contribution each year. 

If you have a 401(k) at work, you can contribute up to $19,500 per year for 2020 and 2021, or $26,000 if you're age 50 or older. Be sure to invest enough to take advantage of any match your employer offers—it's free money.

Step 5: Work With a Financial Advisor

If you want to retire early, you have two big challenges:

  1. You have less time to save for retirement.
  2. You have more time to spend in retirement.

Unless you're a rock star investor, it's a good idea to work regularly with a financial advisor. An advisor can help you develop an investment strategy to make it easier to reach your retirement goals. They can also show you exactly how much you need to invest each month to reach your goal within a certain number of years.

Once you retire, your advisor can help you manage your income streams to make sure the money lasts. Income streams might include income from dividends, required minimum distributions, Social Security, defined-benefit plans, and real estate investments.

Take the time to find an advisor you are compatible with—you could end up working with them for decades, after all. If you are concerned about the cost of a financial advisor, remember that you are not just paying for their time; you are paying for their expertise. If you find the right advisor, that expertise will more than make up for the expense.

The Bottom Line

Many people would like to retire early, but few have the financial resources, planning skills, and discipline to do so. To get started, estimate your retirement expenses, determine your target nest egg, and then save and invest to make it happen.