A financial goal dreamed of by many individuals is to retire early. After all, who doesn’t love the idea of having as much free time as possible to pursue hobbies, holidays, passion projects, or entrepreneurial ideas?

The average retirement age in the United Kingdom is still 65. However, since the 2020 pandemic, many people are choosing to retire earlier. In fact, the Financial Independence/Retire Early (FIRE) movement has even enabled some individuals as young as 30 to retire from work through an aggressive savings rate.

However, stepping away from work isn’t a straightforward process. And it requires substantial financial planning to ensure savings don’t run out. This is especially true for those who wish to retire before the age of 60. Why? Because most private and state pension investment vehicles (such as a pension fund) don’t allow withdrawals before the state pension age.

With that in mind, here are six critical steps investors need to consider when aiming for early retirement.

1. Estimate living expenses

Throughout retirement, there will always be a combination of staple and discretionary spending. And it’s essential to plan for both. Individuals should try to estimate how much they’re likely to spend on a monthly or annual basis to maintain their desired lifestyle.

Some of the most common staple expenses include:

• Utilities
• Housing
• Food
• Transportation
• Clothes
• Insurance
• Healthcare

Some of the most common discretionary expenses include:

• Holidays
• Travelling
• Entertainment
• Hobbies

According to the British Department for Work & Pensions, the average annual retirement income in the United Kingdom is £18,772 – or £1,564 a month.

2. Calculate the required pension pot size

With an estimate of annual spending in place, individuals can now approximate the savings they’ll need. Most financial advisers recommend using the 4% rule. This principle is simple and states that a retiree should only withdraw a maximum of 4% of their pension portfolio per year to meet annual expenses.

Therefore, a retiree with £18,772 of annual expenses would need a pension pot of approximately £469,300. Needless to say, that’s not exactly pocket change. But through prudent pension saving and investing, reaching this milestone may not be as impossible as it seems.

For example, investing £500 each month into an S&P 500 index fund that has historically yielded a 10% annualised return would build a half-million portfolio within roughly 22 years. For a 23-year-old who just graduated from university, this could be sufficient to retire early at the age of 45. And by embracing the principles of FIRE, reaching this investment goal could be even faster.

3. Prioritise saving money

To fuel an early retirement investment portfolio, investors need capital. And the more that can be spared, the faster a pension pot can become established. The general rule of thumb for retirement planning is to set aside 10% to 15% of gross annual income for pension savings. However, if following the principles of FIRE, these proportions can vary anywhere up to 75%.

So how can individuals raise the necessary capital for their pension pot? There are generally three most effective methods.

• Spend Less – Cutting spending today and funnelling these savings into a retirement plan can help investors cut years off the normal retirement age. Even small contributions, such as cancelling unused subscriptions or skipping a morning coffee, can have a tangible impact. Under FIRE, individuals may live even more frugally, missing out on takeaways, holidays, and travelling to cut spending wherever possible.
• Cut Debts – Reducing or outright eliminating any outstanding debts frees up more capital for investments and potentially reduces expenses during retirement. For example, repaying a mortgage before retiring will likely wipe out a massive chunk of housing expenses. Meanwhile, interest payments on a credit card can become far more manageable, reducing stress and pressure on household budgets.
• Earn More – Suppose that even after cutting spending and eliminating debts, there is still insufficient capital to hit desired retirement goals. In that case, earning more money is the best course of action. This could entail asking for a raise, promotion, or looking for a higher-paid job.

4. Use a tax-efficient retirement account 

A commonly forgotten expense that investors need to take into consideration is tax. Interest, capital gains, and dividends received from savings and investments are taxable. And this can have a profound impact on the amount of time required to reach desired retirement goals.

Fortunately, tax expenses can be mitigated using tax-efficient savings and investment vehicles. In the United Kingdom, investors have several options, each with advantages and disadvantages.

• Stocks and Shares ISA – This is a special type of tax-efficient investment account for British investors only. All capital gains and dividends from investments within a Stocks and Shares ISA are tax-free. However, investors are limited to depositing a maximum of £20,000 per year.
• Lifetime ISA – This special type of account enables individuals to deposit up to £4,000 a year and receive a 25% bonus from the government on any deposits. In other words, individuals can receive up to £1,000 a year by depositing money into this account. However, funds can only be withdrawn to either buy a property within the UK or as a pension after the age of 60.
• Self-Invested Personal Pension (SIPP) Account – This is a special type of tax-deferred investment account for British investors only. Capital gains and dividends received from investments are protected from tax. Furthermore, any deposits made are tax-deductible, with tax relief issued into the SIPP shortly after each deposit. However, investors cannot withdraw any money until reaching the age of 55 (57 from 2028). And when funds are taken out, only 25% of the portfolio can be withdrawn tax-free. The rest is taxed as regular income.

5. Prioritise growth investments

Younger investors seeking to retire early may find greater success by focusing on growthier investments such as stocks. While this approach comes with additional risk, it also opens the door to higher returns that can accelerate the compounding process. After all, early retirement means a short time horizon to establish a required pension pot.

Does this mean all investors should focus on aggressive growth? Of course not. Regardless of the investment objectives, investors must stay within their risk tolerance limits. But suppose it’s impossible to meet required retirement goals by doing this? In that case, investors need to either extend their time horizon by retiring later or find additional capital to fuel their retirement savings.

6. Speak to a financial adviser

Retirement planning can be a complicated process and is highly personalised. Speaking to a professional independent financial adviser can help quickly establish a plan and strategy that meets specified retirement goals while keeping risk in check.

They can also help with the initial preparations, spending calculations, monthly investment targets, and figuring out an appropriate retirement age. The relationship also doesn’t necessarily end once retirement is at hand. Financial advisers can also help to manage income streams, keep track of spending to ensure individuals don’t go beyond budget, and generally help ensure that retirement savings last.

While financial advisers can be expensive, the cost of not having one may be higher in the long run.

What is a good monthly retirement income?

As previously stated, a “good” retirement income ultimately depends on the individual and their desired retirement lifestyle. Factors such as outstanding debts, the number of dependent children, and the state of health can also have a significant impact.

A commonly used target is to generate sufficient income from a pension pot that covers 80% of pre-tax income while still employed. This proportion can be lower for investors embracing FIRE, provided they are willing to live more frugally during retirement.

For uncertain individuals who need help, reaching out to a financial planner or retirement adviser is likely a wise decision.

The bottom line

It’s not difficult to understand why many people want to retire early, ahead of the normal pension age. However, it’s far easier said than done. Individuals need to take a planned, disciplined approach and may need to be willing to make sacrifices for current and future lifestyles.

This article contains general educational information only. It does not take into account the personal financial situation of the reader. Tax treatment is dependent on individual circumstances that may change in the future, and this article does not constitute any form of tax advice. Before committing to any investment decision, an investor must consider their individual financial circumstances and reach out to an independent financial advisor if necessary.