How To Save For Early Retirement On A Low Income?

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More and more Americans want to retire early, following the movement started by Covid-19. Known as the FIRE ( Financial Independence Retire Early) movement, the idea is to retire long before the full retirement age of about 66.

However, saving for early retirement may seem impossible after paying your monthly responsibilities if you have a low income. Here is how you can work toward that dream:

Make Adjustments to Your Priorities

Living on a low income means you must budget and spend carefully because money can only go so far. So try and live off as little of your income as possible and save the rest. Think of all the ways you can save money, like taking public transportation instead of using a car, cooking at home instead of ordering out, etc.

Besides cutting out small expenses, you should reduce your debt as much as possible, particularly costly credit card debt.

Finally, you can also look for ways to increase your income to add more savings to your retirement coffers. Gigs like driving for Lyft, food deliveries, and even extra office work can help you steadily grow your retirement fund.

Annual Retirement Spending

Working out how much money you will need for retirement can be tricky because you must consider several factors here. The longer your retirement, the more money you need to budget. However, don’t forget that early retirement will incur penalties if you draw cash earlier from retirement accounts like IRAs and 401ks.

Other things to consider when working out your retirement budget include taxes and healthcare, especially if you lose existing coverage to retire earlier. Furthermore, when working out your final expenses required to retire, times your monthly total by 12 to get your annual living costs. It is also good to add anything between 10 and 20% to that amount to give yourself leeway.

Total Savings Needed

Retirees widely use several rules to calculate the total savings needed for withdrawing from the labor force.

Rule of 25

The first rule is that you need 25 times your planned yearly spending saved before retiring. Therefore, if you plan to spend $30,000 during your first year in retirement, you need to have $750,000 invested before retiring, and if you plan to spend $50,000, you need $1.250.000 in savings.

Additionally, the rule only applies if you have your retirement money invested so that it continues to grow to help prevent inflation from eating into your capital.

The 4% Rule

The second rule is the 4% rule, which says that you can withdraw 4% of your invested savings in the first year of retirement. Then, each year after, the amount you draw is adjusted for inflation.

Financial planner, William Bengen, developed the rule in the 1990s to help retirees increase their income in a way that will keep up with inflation. But, of course, you can choose to do it a bit differently with a more or less conservative approach.

Both strategies are reasonable but not foolproof, proving that a sound financial plan is critical to any retirement.

Investing for Growth

Retiring early means less time to save, and you will need money coming in over a more extended period to support your expenses. Therefore, you will need wise investments in a balanced portfolio that will continue to grow.

Roth IRA

A Roth account gives you a good return because of its compound interest. You cannot touch the growth until you turn age 59 without incurring a penalty, but you can withdraw contributions early. All retirement plans should start with a Roth IRA.

Taxable Brokerage Account

Anyone planning to retire at least five or more years before age 59 will want to use some of their money early without penalty. The contributions and growth of a taxable brokerage account are not tax-free, but the funds will offer better returns than most savings and is available immediately.

IRA and 401(k)

IRAs and 401(k)s  have a 10% penalty for withdrawing before age 59, so use them only if you know you won’t need that money before then. There are some ways to draw earlier but carefully read the rules before attempting it.

Stocks

Investing in individual stocks is another option; you won’t owe capital gains taxes on these until you sell. Long-term capital gains on stocks held for at least a year have a 15% cap.

Health Savings Account

Contributions to a health saving account have tax deductions, and this is a great plan to save for healthcare expenses. In addition, after a certain age, you can invest your HSA contributions, and you don’t pay tax on earnings or the interest on this money. When using the money for health expenses at any age, the money is tax-free, and after the age of 65, you can use the funds for any payments at a minimal tax rate.

Real Estate

Investing in investment properties can give you a passive income stream, and a large portion of that is tax-deductible under the current tax code. Additionally, if you sell your primary residence, you won’t pay capital gains tax. There are several ways to invest in property, including crowdfunding.

Bonds, CDs, and High-Yield Accounts

Treasury and municipal bonds allow you to invest money not needed immediately, and they have some tax perks. They pay you an income from their bi-annual interest and get full payment on their expiry.

Over the short term, enhance your money needs with CDs and high-yield savings accounts that pay higher interest than regular savings accounts.

Last Word

Working towards early retirement is exciting if you keep to the rules. However, if you have a low income, you must remain particularly dedicated to your cause. Keep your expenses in check, and save wherever possible to ensure that when you retire, you don’t need to run back to work after you run out of money.

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