Crafting an Early Retirement

Question of the week:I'm 30 years old and am absolutely determined to not wait 35 more years until I retire. I'm maxing out my retirement accounts, but what else should I be doing to be able to retire early? --Thomas C.

Dear Thomas,

Given that you may end up living more years in retirement than you do actually working, early retirement calls for some serious preparation and commitment.

When we asked Armchair Millionaire community members how they are planning to retire early, we heard from many who, like you, have had an early retirement in their sights for many years. Here are some typical comments:

Million Dollars or Bust. "I'm confident that I will retire at 50 years old with at least a million dollars. I am 31 now, and I started maxing my 401(k) at age 18." --Dion

Lucky 13. "I would like to retire by the time I am 55 with two million dollars. I am 34 right now. I started saving when I was in grade school with my babysitting money. I currently save 13 percent of my paycheck, which goes into my 401(k), my son's college savings plan and paying off my mortgage early." --Whitney

Retirement Power Tools. "I'll retire hopefully at 55. My wife and I focus on putting at least 10 percent into each of our 401(k) accounts, max out a Roth IRA, contribute monthly to a mutual fund account, purchase government protected I-bonds, and also stash away another seven percent of our gross pay each month into a money market account -- all of which is in addition to pension accounts we have through our employers." --Brent

Committing to early retirement is a big step, and you want to be sure to go into it eyes wide open. My checklist will help.

The Armchair Millionaire's Checklist for an Early Retirement

• Be sure it's really for you. Ask yourself a few key questions. Do you like going to work in the morning, or would you rather do just about anything else? Do you have compelling interests or hobbies outside of work that you know you want to pursue full-time, or would you find yourself with time on your hands without a job? Do you derive a large part of your identity from your occupation, or do you see other things as being more important about who you are?
• Find out what you need. Decide the age you want to retire and then make a guess at your life expectancy (your own family members will be a good guide). Once you know how many years you'll need your retirement income to last, figure out the total amount you'll need to derive that income. You'll need to factor in investment returns, Social Security and pension benefits, inflation and your rate of withdrawal. If it sounds complicated, you're right. Fortunately, there is an array of retirement planning calculators available on the Web. Check out at least a couple and compare the results.
• Know the rules on tapping your retirement accounts early. Many people who retire early may want access to funds in their 401(k) and IRA. While these are generally off limits until you reach the age of 59 1/2, there are some special circumstances in which you can access them early. Because the rules on early withdrawal of these funds are complex, you'll probably want to seek professional advice.
• Plan carefully. Advance planning is crucial because the odds are high. If you begin withdrawing retirement funds and it turns out that you're pulling out too much too soon, for example, you may do irreparable damage to your chances of making your money last as long as you need it to. As you approach the age at which you wish to retire, I strongly recommend that you engage a financial planner to help you run the numbers and figure a safe level of withdrawal, as well as to help you structure an appropriate portfolio.

THE BOTTOM LINE: We all want an abundant and secure retirement. If you want it earlier than usual, then you'll have to work even harder to get there. But with commitment and the right plan, it can certainly be done.

To 401(k) or to Roth

Question of the week:Citing a need to cut expenses, my employer just suspended its match on employees' 401(k) contributions. With the match gone, I'm wondering if it's better to just set up a Roth IRA and drop the 401(k). What do you think? --Martin S.

Dear Martin,

This is one of those classic dilemmas in which you're forced to compare apples to oranges, which takes a bit of mental juggling. And it's one that more and more people are facing, given that many employers are cutting and even removing their 401(k) matches. The Profit Sharing/401k Council of America says that company contributions in 2001 were an average of 2.5 percent of pay, down from 3.3 percent in 1999.

We recently posed your question to members of the Armchair Millionaire community. Since contributions to 401(k)s are usually tax-deductible and contributions to Roth IRAs are not, much of what we heard was about taxes. Here are comments from both sides:

Go for the Roth. "I have never seen taxes go down over time, so I prefer the Roth IRA. Also I don't want to have to guess what I'll really have left over after taxes when I retire." --Brad

Go for the 401(k). "I fund my 401(k) over a Roth to get the tax deduction now. The current law says that withdrawals on Roth IRAs are not taxable, but who knows what will happen in the future? I don't have enough faith in Congress to trust that they won't someday repeal the Roth IRA, so for now, give me the current deduction." --Bryan J.

In my opinion, if your employer does offer a match on your 401(k), you should go for it. The free money in the form of that match makes the decision a slam dunk.

But if you don't have the match, then you need to have to have a clear understanding of the ups and downs of both kinds of plans. Both offer advantages and disadvantages that, depending on your personal situation, can make a big difference to your retirement. My guide breaks down the major differences between the two.

The Armchair Millionaire Guide to the 401(k)-Roth IRA Debate

• Taxes. A 401(k) contribution is deducted from your income before you pay taxes. Since it reduces your taxable income, it lowers your taxes. However, later--in retirement--you will have to pay tax on the money you withdraw, just like it was ordinary income. For the Roth, you get no tax break now--but you'll never have to pay tax on any of your withdrawals. So it's a matter of choosing whether you pay taxes now, or pay later.
• Contributions. The 401(k) wins here. In 2003, most employees can contribute up to $12,000 per year, and people over the age of 50 can contribute $14,000. The Roth? Just a paltry $3,000 in 2003 (or $3,500 if you're over 50).
• Investment choices. Typically, you'll have a dozen or so choices of mutual funds to invest in with a 401(k) plan. For a Roth IRA, though, the sky's the limit--stocks, bonds, and mutual funds can all be purchased through IRA accounts.
• Convenience. For making investing painless, the 401(k) is hard to beat--the money is taken out of your paycheck before you even see it and invested for you by your employer. For the Roth, you need to save the money, set up your account, and then make the investment. Most IRAs do allow automatic investments, though, so once your IRA is set up you can have regular monthly amounts taken from your checking account and invested in your IRA.
• Withdrawals. Uncle Sam says that you have to start withdrawing your money from your 401(k) by the time you hit age 701/2, and that you have to take out a minimum specified amount each year after that. On the other hand, you don't ever have to make withdrawals from your Roth IRA if you don't want to, making it a valuable estate planning tool.

THE BOTTOM LINE: Like every other investing decision, choosing a 401(k) or a Roth IRA requires you to look at a range of issues, most of them not black and white. Weigh each issue carefully to arrive at the best option. And if you're still not sure, then get the best of both worlds--fund both your 401(k) and a Roth IRA!

Social Security? Don’t Bet On It

Question of the Week: I’m 27 years old, and I think the outlook for Social Security is pretty bleak. What should I be doing to save for retirement? -Chris L.

Dear Chris,

You’re absolutely right to not plan on a Social Security check alone to fund your golden years. According to the Social Security Administration, the average monthly benefit for a retired person these days is just $845.

Fortunately, you’ve got two very important things on your side: plenty of time and a nice choice of plans that will help you save for your retirement. Here’s how two members of the Armchair Millionaire community are using these to pave the way to a secure retirement:

Starting young. "I began investing as much as I could as soon as I graduated from college. I have a Roth IRA and a regular investment account and contribute to both every month. Whenever there’s extra I invest in individual stocks. Since I’m only 23 years old, I have at least 45 years of investing ahead of me. I plan on using those years to the fullest!"—JoJo S.

Keeping it simple. "My goal is to have a portfolio that will run itself and not take too much time to tweak. I contribute the maximum allowed of my income to my 401(k) and my employer matches another three percent of my salary. The beauty of the 401(k) is that it’s completely automatic. My 401(k) is 100 percent invested in an S&P 500 index fund. Because most funds can’t beat this benchmark, it seemed like a no brainer."—Chris M.

401(k)s are offered by most employers, and are an excellent choice for retirement savings. Besides letting you defer taxes on your investment, a 401(k) will automatically deduct your contribution from your earnings, which puts your savings on autopilot. My checklist will help you get your money’s worth from your 401(k) plan.

The Armchair Millionaire’s Checklist for Getting the Most From Your 401(k)

• Get going! If you haven’t started contributing yet, talk to your Human Resources department. It will have everything you need to get started.
• Max it out. The most you can contribute this year is $15,000, or 25 percent of your gross income (whichever is less).
• Get the match. If you can’t afford the maximum contribution right now, at least make sure that you’re contributing enough to qualify for your company’s matching program.
• Be diversified. Consider mutual funds that invest in different parts of the market--large cap stocks, small cap stocks and international stocks.
• Keep a good thing going. If you leave your employer for greener pastures, do not cash out your 401(k)! You can roll it over into an IRA, move it to your next employer’s 401(k) or, sometimes, leave it in your old employer’s plan.

THE BOTTOM LINE: Saving for retirement may be the biggest financial task of your life. Take full advantage of the time you have and savings options available to you so you can decide when and how you retire instead of leaving that up to the government.