If early retirement is a goal that appeals to you, it’s worth taking a closer look to see what it means in practice. This step-by-step guide to retiring early sets out the main things you’ll need to think about and some recommended ways to address them. We'll flag up the pitfalls to avoid and the opportunities to watch for, and also show you how you can estimate your final private pension income - no matter what age you are now.
What do you mean by early retirement?
The first question to consider is twofold: what exactly counts as ‘retirement’, and what is ‘early’? Retirement usually means finishing work, but that doesn’t necessarily mean you want to just play golf for the rest of your life. Perhaps you still want to work and earn in some way – just not in the way you have been.
So for this guide, we’ll assume that ‘retirement’ means ‘financial independence’. It means you don’t have to lie on a beach doing nothing – but that you could if you wanted to.
What about ‘early’? Well, traditionally retirement has been from the age of 60 to 65, as reflected by the state pension age (though this is now rising). You can consider ‘early retirement’ to be any retirement before the age of 65, but we’ll focus mainly on a retirement that happens at some point in your 50s.
What do I need to retire early?
Since we’ve said that retirement = financial independence, the question becomes: what do I need to become financially independent? (i.e. not having to do a job I no longer want to do).
Financial independence doesn’t necessarily mean being rich. All it means is that your outgoings over the rest of your life don’t exceed your income plus your savings. Once you put it in those stark terms, you can break your ambition down into goals.
What you need to achieve financial independence
Being financially independent usually requires:
- Paying off your debts
- Paying off your mortgage (or being close to doing so)
- Enough income for your daily needs (e.g. from your pension)
- Additional funds so you can enjoy life
- Sufficient savings for emergencies
This doesn’t necessarily demand a huge level of wealth – but it does require living within your means. The more modest your intended lifestyle, the less you’ll need in the way of assets.
Here’s our Unbiased step-by-step guide on how to retire early:
Prioritise paying off debts above building up savings, since the interest on debts will far outstrip any savings interest you might earn. If you have multiple debts, always pay at least the minimum payment on each one, to avoid the debt snowballing. After that, pay off the debt with the highest interest rate first.
You can also sometimes transfer the balance of one credit card to another. Clearly, it’s a good idea to move as much of your debt as possible to the card with the lowest interest rate.
Any outstanding debt from student loans can usually be left until last.
It’s usually good to make overpayments on your mortgage if you can afford them. The upshot is that you’ll pay off your mortgage sooner, but also pay less overall. Generally, this is a better use of money than building up savings (though an emergency fund is still useful).
Just beware of mortgage providers charging excessive penalties for early repayment of the loan. Ask your mortgage broker to check the terms of your mortgage in this area, if you’re not sure.
Now you need to work out the minimum you’ll need to spend each year to have an acceptable lifestyle. For the moment, forget things like luxuries and holidays – they will come later. First, get down your basic ‘survival budget’.
It’s sensible to suppose your basic needs won’t change much – you’re still going to be the same person in ten years’ time. However, you should be able to deduct regular expenses such as mortgage repayments and servicing debt (assuming you’ve dealt with those issues above).
You can also discount any necessary expenses that specifically related to your working life, such as daily travel costs to and from work. Similarly, if you have children they will (probably) be grown up by then. Though they may still need financial help from you, this will count as discretionary spending – so deduct child-related costs for now.
You should aim to arrive at a single monthly and/or yearly figure. Call this ‘Essentials’. Remember that costs will rise gradually with inflation year on year. Also consider that in your final years you may need to find money to pay for care.
This may be the hardest figure to estimate. You’ll need to think in detail about your plans for retirement: where you want to live, how many holidays you’ll take, what interests you’ll pursue, even what vehicles you want to own – do you crave your own boat, or is a bike enough for you?
Call this figure ‘Discretionary spending’. Again, assume that your costs will rise with inflation over time, but also that your lifestyle may modify in later life as you slow down.
Make a note of the two figures, Essentials and Discretionary spending. You now need to judge whether your assets can meet two different targets:
- Essentials only
- Essentials PLUS Discretionary spending
Now estimate the length of your retirement. If you’re retiring aged 55, then 30 years is a reasonable figure.
The next step is to find out whether your assets can cover those levels for spending for such a long time.
Make an inventory of all your assets, to see where your retirement income could come from. Assets may include:
- Private or workplace pension pots
- Income from final salary pensions, if you have any
- Savings and investments
- Your home (can you downsize or release equity?)
- Other property (to let or sell)
- Other sources of income post-retirement
Record these separately, as some will be lump sums while others may be regular income. Also, not all will be accessible in the same way.
As we’re talking about early retirement, state pension income is not included in this list. However, you can start to factor it in from your state pension age onwards.
Now you can work out whether your combined assets will be enough to generate sufficient income over the length of your retirement.
The most important element here will be your workplace or private pension(s). Estimate how much you can achieve via drawdown, an annuity, or a blend of both. You will probably need to consult a financial adviser about this, but our guides will help.
Savings and investments
You may want to consider transferring other savings and investments to your pension in advance of retirement, as they will benefit from a boost thanks to tax relief. If you have lot of savings, it’s best to do this before you start to access your pension, as this will reduce the amount you can pay in.
Your home can be a significant source of income, whether it’s just subletting a room to a lodger, downsizing (which is also an option for empty nesters) or releasing equity. Talk to a financial adviser or mortgage adviser if you’re considering equity release, as it can come with significant downsides.
Property can be a great source of regular income in retirement – but being a landlord in retirement comes with a lot of responsibilities too. Make sure you’re prepared for the work involved.
Other sources of income
If you choose to phase your retirement you can continue earning either from part-time work, a different lower-paying (but more satisfying) job, or even your own business. Anything you can do to increase the amount of money coming in – especially in the early years – will help your accumulated savings to last longer.
Is your pension on course to let you take early retirement?
No matter what age you are now, it's possible to predict roughly how much income you might be able to generate from your private pension pots. The Unbiased Pension Calculator lets you work out (based on certain assumptions) the size of pension income you could reasonably take from your pension pot over an average retirement, based on how much you're saving at the moment. Thought it can't make firm predictions, it will give you a good idea about whether you need to increase your pension contributions, or whether you can indeed retire sooner than expected.
Will your money last if you retire early?
As noted already, retirement can be a long time – and an early retirement will hopefully be even longer. Retiring early places a triple strain on your funds, because not only does your money have to last long, but you’ve also had less time to build it up. Every extra year of early retirement means:
- One year more spending
- One year less earning
- One year less compound interest
In short, every year of early retirement will cost you significantly more than an ordinary year of retirement. A financial adviser can help you work out exactly how much more, and whether you can really afford it. For more tips on this, check out our article on how to retire at 55.