The biggest problem early retirees face is failure to change spending habits when they retire early. I worked with a couple who provides an example. I set up their portfolio to provide a retirement income of $40,000 annually which combined with social security and pensions gave them an income of $80,000 annually. The brother of the wife became ill and she made three trips cross country. I told her that she could not afford to take such trips because their early retirement budget did not allow for such discretionary expenses. Next thing I knew, she paid $8,000 for elective dental work. I resigned as their advisor because she refused to change her spending habits. This couple was fortunate enough to retire early but the wife's unchanged spending habits was leading them to a life of poverty.
When you retire early, many estimate that you can probably live on about 75% of your pre-retirement income comfortably. This assumes that some 25% of your pre-retirement income went to work and its associated taxes, transportation and clothes - and savings toward retirement. In fact, you can select any reasonable percentage of pre-retirement income as your goal and they key is to stick to a budget. If you don't keep to your budget, you permanently erode the nest egg that is designed to support you for the rest of your life.
The three early retirement income sources are social security (if you have attained age 62), pension, and your savings. With so many people under funded for retirement, you may want to do some part time work to supplement your early retirement finances. Again, remember that any overspending will PERMANENTLY erode you nest egg and cause future financial pain. The fact that you were able to retire early will be offset by poverty in old age.
The maximum possible social security income for 2008 and 2009 is $2,185/mo. and $2,323/mo. respectively if you start receiving it at your full retirement age. However, whatever your full retirement benefit is, it'll be reduced by about 25% if you retire early. It'll also be reduced if you earn above a threshold income while you're under your full retirement age (for 2008, you lose $1 of social security income for every two dollars you earn from working above $13,560/yr. $14,160/yr for 2009.
Your savings are composed of your savings accounts and your defined contribution plans – 401(k), IRAs, etc. You'll want to choose the best way to convert these to income. When you retire very early, before age 59 1/2, you can employ rule 72t to access these retirement accounts without penalty. Possibilities include converting them to an annuity (use the fixed annuity calculators for an estimate), another form such as an IRA, or Roth IRA, and devising your own withdrawal procedure that ensures that your retirement income will last as long as you.
Controlling your expenses helps prevent them from robbing needed early retirement income. You can categorize your expenses under essentials, debts, taxes, and enjoyment. Essentials cover your food, housing, and transportation. Housing and transportation may have more inexpensive alternatives you can choose from. If you are attracted to an area with lower housing expenses, the sooner you make the move, the better.
Debts such as mortgage, car, and credit card payments should be reduced as much as possible when you retire early. Paying off these loans is often the best way to handle them. Downsizing your material possessions is important in these first two expense categories. While your pre-retirement ego may have had you buy a new BMW every three years, a used Chevy will get you to your destinations just as fast.
When you retire early, income taxes are pretty much dependent on how you choose to handle your distributions from savings and what tax category your savings are in – tax deferred, taxable or tax free (such as a Roth IRA). See a retirement advisor because the order in which you spend your different post of money can affect your tax bill by thousands of dollars each year. Part-time work can produce a very high penalty on your efforts if they diminish your social security benefits if under your full retirement age.
With your expenses minimized, you can better plan on the travel and enjoyments that you've set aside for your early retirement years. Be a smart shopper. You may have enjoyed staying at the Ritz while working but when you retire early, you need to get accustomed to clean three star hotels in the off season.