For those who can’t face the prospect of decades of drudgery, is there a case to be made for early retirement? And how might that be achieved?
Reasons to retire early
In practical, financial terms, early retirement makes no sense in almost every situation. For even a basic standard of living in retirement, you need a pension pot worth hundreds of thousands of pounds. The earlier you start saving, and the longer you keep it up, the better your quality of life once you retire.
But there are cases where early retirement might make sense as a lifestyle choice. For one, just because average life expectancies are rising doesn’t mean you’ll necessarily make it that far yourself. If you do have the funds, there’s something to be said for limiting your working life.
Alternatively, you may have a health condition that means you either know you won’t have a long retirement if you stop working at 70, or there’s a strong chance of it. Equally it may become difficult to work. Although more people than ever are still healthy in their 60s and 70s, not everyone is.
Or perhaps you’re facing redundancy. Despite good intentions, it is more difficult for older workers to start afresh in the jobs market. Early retirement, even with a lower income, could be a lot more appealing than retraining.
Pitfalls of early retirement
But it’s important to be careful. Even if it seems appealing, there are plenty of pitfalls to early retirement.
Most obvious is stretching the same size of fund – or indeed, smaller – over a longer period of time. Unless you’ve managed to earn a substantial amount already, your disposable income, and therefore quality of life, will be much lower than if you continued to build your fund for a few years longer.
Be aware that you have to have enough ‘qualifying years’ of National Insurance contributions to draw a full state pension. If you retire too early, you may lose out. If you’re considering early retirement, you presumably have a sizeable private fund, but don’t underestimate how helpful the full state pension can be.
Planning for early retirement
If you’re set on retiring early, the key is building up a large enough, reliable income. It’s essential to start early. The earlier you start saving, the more you can build your fund. This is true for both compound interest and because it provides capital to put into higher yielding investments.
Whilst in your 20s you’re unlikely to have much disposable income. If you can put any aside, the aim should be to attract as high an interest rate as you can. Since they’re tax-free this usually means an Isa, but long-term savings bonds could be a good option.
As your disposable income increases, it might be worth exploring higher risk options such as mutual funds to grow your capital even further. But remember you’re investing for the long-term. Keep tabs on your funds and investments, but don’t panic at fluctuations in the market. Generally speaking, longer-term investment strategies are better protected against market movements than short-term. Consider how after plumbing new depths in the crash of 2008, the FTSE 100 is now performing at record levels.
Use your workplace pension scheme. Any contributions you make are matched by your employer, and to a lesser extent, the government. So it’s worth aiming to contribute the maximum percentage of your salary as early as you can, to receive the largest amount of free money anyone is likely to offer you (short of winning the lottery) and see it grow with compound interest.
A reliable income
As you get a little older, the next step is to put the money you’ve accumulated into something that will provide a reliable source of income when the time comes to retire.
SIPPs (Self-Invested Pension Plans) provide a tax-efficient wrapper through which to invest. Be careful about regulations on how you can draw from it though – as a pension it will be subject to the same rules. If you want to retire early, you need to make sure it’s possible to access the fund as early as you want.
Many advisers recommend not putting all your eggs in the pension basket, and for early retirement that goes doubly. Investigate other options, such as having investments large enough to pay reliable, sizeable dividends regularly. Buy-to-let is an excellent option for regular income, particularly if you can take on a number of properties.
The key to early retirement is to start saving early, build as large a fund as you can, and spread it among varying assets that will provide a reliable, regular income.