Retire early knowing you've got it made

There are three financial factors to consider:

• How much do you expect to have in monthly retirement income? This would include any money from a traditional pension plan, Social Security or other sources. Many people don't realize that even if they retire at 55 or 60, the earliest they can start receiving Social Security is at 62. And if you start then, the benefits are no more than 80% of what they would be if you waited until "normal" retirement age (currently age 65 or older). Many people choose to defer their Social Security benefits for as long as possible to increase the monthly benefits. Before you make this decision, ask your accountant or financial planner to help you calculate whether to start taking benefits at age 62 or to defer. Usually you're better off starting at age 62 even though the benefits are less. Why? You get extra payments that you can invest in the interim.

• How much in assets will you have accumulated by retirement? These include retirement plans that don't have the fixed-income payout of pension plans (such as 401(k) plans, profit-sharing plans, Individual Retirement Accounts, etc.). You also may have other sources, such as an inheritance or the profits from selling your house for a less expensive one.

• How much will you spend? Planners recommend that you estimate your retirement expenses to be about 80% of those you incurred before retirement, but many people want to keep the same standard of living and replace work-related expenses with travel, entertainment and other new costs.

The dreaded inflation factor

Don't forget about the effect of inflation as you consider your days in the RV rolling down Highway 1 in south Florida. What looks like a hefty retirement income at age 55 or 60 may be near the poverty line by the time you're 70 or 75. For example, let's assume that inflation increases at 3% a year. If you retire today at age 55 on a yearly income of $40,000, you'd need $72,000 by the time you're 75 to maintain your standard of living. At age 80, or 25 years after you retire, you'll need $83,800. And look at the difference a mere 1 percentage point change in average inflation makes: If that 3% inflation rate actually averages 4%, you'll need $87,600 at age 75 and $106,000 at age 80.If you are still seriously considering early retirement, there are some courses of action to start taking today:

First, when you estimate your expenses, put in a 5% fudge-factor. In other words, assume that your expenses will be 5% more than you anticipate.

Assume an inflation rate of at least 4%. Long-term, it has averaged about 3% but over the last 20 years it has been closer to 6%.

Start planning now, which usually means slashing your budget so that you can sock away every dollar you can. (This is good advice anyway, whether you plan to retire early or not).

Remember that the earlier you retire, the longer your retirement portfolio is going to have to work for you. So just because you're planning to retire doesn't mean you need to move more money into conservative, lower-yielding, fixed-income investments. (Remember that all of your income doesn't need to be from dividends and interest; it is perfectly acceptable to take some capital gains, too.)

If you retire at 55 or 60, you will probably (hopefully!) need a substantial part of that money in 20 to 30 years, so a good portion of your funds should be invested in the stock market.

Finally, and this is critical, see a competent, experienced financial planner every couple of years to run the numbers for you or to double-check your own numbers. The planner can serve as a sounding board to give you a second opinion about your retirement strategy and investment allocations.

Now what do you do?

If, after doing this "number crunching," you find that you can retire early, the burning issue becomes what will you do with your time. When you're exhausted from work, the possibility of day after day stretching by with no required attendance anywhere sounds delightful, but this can get old very quickly. When you start making a financial plan to retire early, start planning what you're going to do with your time when that day comes. Even the best made plans can change; many an early retiree has returned to work because she cannot stand the thought of not working for the rest of her life.

At a time when most people can't afford to retire and maintain their standards of living, taking the chance of retiring early is a big risk. However, if you start planning early in life, do your homework and understand that you're likely to be around for the next 20 to 40 years and your money needs to be, too, early retirement may be for you. The only downside from a social perspective is the envy of everyone else you know who would give anything to be in your early retirement shoes.

Updated Aug. 13, 2008

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