Who does not want to retire early?
No bosses to report to. No need to slog or worry about Monday blues.
Sounds interesting, doesn’t it?
By the way, an early retirement does not mean that you will simply sit around and do nothing. It is about the freedom to do what you want to do without affecting the lifestyle you desire. That may mean no work or engaging in something you like.
If you are planning to retire early, you must work towards it. It won’t happen overnight. Here are a few things you must keep in mind.
#1 Need to Invest more
This is a no brainer.
What you needed to achieve by the age of 60, you want to achieve in 15 or 20 years less. Even more in fact since you must provide for an additional 15-20 years of retirement.
Unless you have a lot of money or live frugally, this won’t happen overnight. You will have to plan and work towards it. No matter how you look at this problem, you will have to invest more.
If you want to accumulate Rs 1 crore in 35 years, you need to invest Rs 4,330 per month. If you want to accumulate the same amount in 15 years, you must invest Rs 28,700 per month (return of 8% per annum). Almost a 7-fold increase in investment requirement. Can you do that? You may have to make a few sacrifices.
#2 Plan for a longer retirement
You retire at 60 and want to plan till the age of 90. If you retire at the age of 40, you must plan for 50 years of expenses and inflation and 50 years of unplanned expenses. Makes the planning even more difficult.
#3 While planning, work with reasonable or even conservative assumptions
While planning for retirement, it is not wise to assume returns of 12-14% p.a. on your investments during retirement. You must keep in mind that a good portion of your portfolio during retirement will be in fixed income products, which would yield 6-8% p.a. Your risky investments say equity, will have to work doubly hard to achieve 12-14% returns at the portfolio level. Now, the long-term capital gains tax on equity investments makes it even more difficult.
I have not even considered the sequence of returns risk. A bad sequence of returns during the early part of retirement can spoil your entire planning.
A higher return assumption will lead to a lower required corpus. Let’s say you want Rs 50,000 per month (Rs 6 lacs per annum) for the next 40 years. Assume inflation is 0% (please play along). Therefore, you need Rs 6 lacs per annum (in nominal terms) for the next 40 years.
If you think you earn 12% p.a. during retirement, you need to save Rs 55 lacs. At 6%, you would need Rs 95 lacs. At 6% return, you need to target an 80% bigger corpus. Which is a safer option?
By the way, at 0% inflation, 6% nominal return is 6% real return. Not easy.
#4 Sticking to a withdrawal rate or a safe withdrawal rate may not be very smart
4% is an often talked about withdrawal rate. A small background. This exercise was done for US markets, for particular asset allocation, for a period between 1926 and 1994, for post-retirement life of 30 years. As per the study, irrespective of when you retired, if you had withdrawn inflation-adjusted 4% of your initial portfolio (and not 4% of your portfolio every year), you would never have run out of money during your retirement.
Will this same safe withdrawal rate hold for you and over the next 40-45 years? This can only be figured out in hindsight. You must be dynamic and adjust.
Why is this important? Many early retirement aspirants face this question whether they have enough to retire early.If they work with false assumptions or weak assumptions, they can reach wrong conclusions.
If you think 6% is the safe withdrawal rate, then you can retire with current expenses of Rs 6 lacs with a portfolio of Rs 1 crore. At 4% safe withdrawal rate, you will need Rs 1.5 crore. Which one is correct, or neither is correct? I don’t know. No one knows. But yes, it pays to be conservative. You will have greater buffer.
Moreover, how much you spend during retirement is important too.
#5 You are fine so long as you are surviving on capital gains or interest income
Many investors believe that you are fine so long as you are living off the interest/capital gains from your investments. Or you are fine so long as your portfolio value or net worth is intact. Not really.
Your retirement portfolio needs to provide for expenses for life. And your expenses will grow with inflation. In fact, for an infinitely long retirement and positive inflation, the portfolio must keep growing. Fortunately, we must plan only for a few decades.
During the initial part of your retirement, your portfolio should grow (not necessarily though). This is because the returns from your investment would exceed your expenses. Gradually, inflation will rear its head and your expenses will exceed returns from the corpus. At that time, your retirement corpus will start depleting.
#6 Plan for health-related expenses. Purchase health insurance.
During retirement, everything comes from your retirement corpus. Your retirement corpus takes a hit for any unplanned expenses. One of the trickiest expenses could be your hospital bill or any health care related expense.
You may have decided to retire at a young age. Till such time, your employer covered you. You never had any major hospitalization either. As you retire and grow older, the God may not be as kind on you. Therefore, it is important to purchase a health insurance plan before you retire. While a big medical emergency fund must be part of the retirement plan, it can fail you (deplete fast) if your health condition requires frequent hospitalization.
#7 Have a buffer
This is an extension of the previous point.
Not matter how hard you plan; something will go wrong somewhere. You may have to support a family member. Your daughter may need money to start a business. Unplanned expenses can take any form. Be prepared for it.
How do you it?
By having a bigger retirement corpus.
Plan for more. Be conservative with your assumptions while arriving at your retirement corpus. You can be conservative by assuming lower rate of return, by assuming a high rate of inflation or a higher level of expenses. If this is too much, simply aim for 120% of what you think is enough.
By the way, you need some luck too or else no amount of buffer will ever be enough.
#8 Do not make insipid investments or commitments
You make a commitment to invest Rs 2 lacs per annum for the next 10 years for an insurance policy when you want to retire in a couple of years. Such investments are not a good idea. If you have planned your finances well, you must not need life insurance once you retire. The same applies for an early retirement. In that case, what is the need to commit yourself to heavy premium payments for a long time? It will be an unnecessary burden on your pocket.
Some of your investments like NPS mature at the age of 60. If you are planning for an early retirement, then products like NPS must be avoided, especially if you are planning to retire at a much younger age of 40 or 45. If you exit NPS before the age of 60 (superannuation), you must use 80% of the accumulated corpus to purchase an annuity plan. Only 20% can be withdrawn lumpsum. Annuity rates increase with age. You wouldn’t get a good annuity rate at the age of 40 or 45.
Many of us invest in NPS for the extra tax benefit of Rs 50,000 under Section 80CCD(1B). Quite a few take tax advantage of employer contribution to your NPS account under Section 80CCD (2). If you are planning an early retirement and are contributing heavily to NPS, be prepared that this money will get stuck or you will have to purchase a low return annuity product. By the way, annuities are fine products, but you need to purchase them at the right time.
#9 Close all your loans before you retire
This is something most people aiming for Financial Independence and Retire Early (FIRE) do. You don’t want to burden yourself with loan EMIs after you retire.
An early retirement does not mean you stop working. You do what love to do. This new work may not bring much income or may bring only a small percentage of your pre-retirement income. Keeping yourself engaged after retirement does not only help you financially but may also be good for your health and emotional well-being. In fact, many of my clients have early retirement as one of their goals. The first thing I ask them (out of curiosity) is that what they will do once they retire.
A good thing about early retirement is that you retain some flexibility. It may be easy to get back to work if you have been away from work for only a few years. If you have taken early retirement. Keep track of your portfolio and your expenses. If required, get back to work and get your finances in order.