One retirement rule of thumb is that retirees spend about 80 percent of their after-tax income in retirement. Generally, this doesn't work for early retirees because they save more aggressively. If you save 30 to 50 percent of your income, it makes more sense to use your expenses rather than your income to extrapolate your after-retirement spending.
If you saved aggressively and accumulated 25 times your annual expenses, then you are very close to financial independence, which means early retirement is an option. If you use the 4 percent withdrawal rule your retirement portfolio is likely to last the rest of your life. Most early retirees think their expenses will stay the same after they quit working, but that's not a safe assumption. Here's why you'll probably spend more after taking an early retirement:
Travel. Many of us want to travel more when we retire. With more time, it's possible to visit a country for two months instead of two weeks. That amount of time allows you to explore a destination in depth rather than the quick gloss vacationers usually do. Most of us have a bucket list of countries to visit, but traveling can be an expensive hobby. Travel will most likely increase your expenses after retirement unless you're committed to traveling cheaply.
It's possible to travel frugally, but you have to be more creative. In our working years, we value time more, so we don't mind paying extra for convenience. With more time, you can optimize travel financially instead. For example, airline tickets with more stopovers are usually cheaper. In retirement, direct flights don't need to be a huge priority. You can even use creative options like booking a repositioning cruise instead of flying.
Hobbies and projects. When we're working full time, a lot of things are put on the back burner. In retirement you will have time to remodel the kitchen, take a photography class, learn to play an instrument and buy the Harley you've always wanted. Yet, all these activities that you've been waiting to do will cost money. Sure, do-it-yourself projects around the house will increase the property value, but home improvements will cost plenty of money in the short term. Your retirement budget should account for a variety of potential hobby activities.
Health care. It's essential for early retirees to budget for health insurance coverage after leaving their employment. Medicare is available at 65, but if you retire early health care is your responsibility. COBRA is one option, but it only lasts up to 18 months and the price can be very expensive. Another option for early retirees is the health insurance marketplace created by the Affordable Care Act. Some early retirees might even qualify for tax credits with their lower level of income. It's extremely likely that you will use more health care services and have to pay more for health care as you get older, so you need to factor likely health care costs into your retirement budget.
Too much free time. Many retirees choose to keep busy, but it can take a few years to figure out what to do with your time. When we're working, we usually spend money in our idle time. This habit can carry into retirement when there is a lot more idle time available. If you spend your weekends shopping, eating out and going to shows, then you probably need to learn how to entertain yourself with cheap or free events.
Most early retirees are good with their finances and that's why they can retire early. However, they should realize that spending will probably increase after retirement and take that into account. But this uptick in spending isn't an insurmountable barrier for early retirees. They can work part time to cover recreational expenses or explore a hobby that doubles as an income stream. Early retirees are often resourceful and can adjust their course accordingly.
While the level of spending often increases initially upon retirement, it will usually decrease as people get older and do fewer activities. Health care expenses may increase in the later years, but travel and recreation expenses will usually go down. At some point, Medicare and Social Security benefits will kick in, and it will give you a little more breathing room to have that extra cash and benefits coming in later on in retirement.
Joe Udo blogs at Retire By 40 where he writes about passive income, frugal living, retirement investing and the challenges of early retirement. He recently left his corporate job to be a stay at home dad and blogger and is having the time of his life.
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