Do You Want to Retire Early? by Nate Eads, CFP®

Many people have aspirations of retiring while still in their 50’s. The idea of being able to relax and do what you want at a relatively early age after decades of working can be heartening. However wonderful retiring early may sound, there are several things that must be considered.

Health Care

How to cover your health care needs can be one of the biggest factors in deciding to retire before age 65, which is when eligibility for Medicare begins. While some companies offer health care insurance to employees even after they retire, it is not very common. Often individuals are left to figure out on their own how to bridge the gap when they leave their employer provided group insurance until they are eligible for Medicare. Fortunately the portability feature of Affordable Care Act has helped address this issue. Prior to the Affordable Care Act, if an individual were to leave their group insurance and seek coverage on their own they could be denied health insurance due to pre-existing conditions. Fortunately that is no longer the case. The ability to at least attain insurance, assuming you had prior coverage, has opened the possibility of leaving group coverage for many who want to retire early. Of course the potential cost increase of premiums needs to be considered, especially if your employer was covering premium payments.

How to cover your living expenses?

If you are considering retiring before age 59 ½, funding your early retirement may be another hurdle. Often pensions, if available, do not kick in until a retiree reaches age 60. Withdrawals from IRAs before age 59 ½ may be subject to an additional 10% penalty on top of taxes. Finally, most people are not eligible for Social Security until at least age 62.

Assuming you don’t have significant enough assets outside of your retirement accounts (if you do, then this obviously isn’t a concern), what are your options?
 

1. Rule of 72(t) – The basic premise of the rule allows withdrawals to be taken from retirement plans as at least five substantially equal periodic payments, continuing for a minimum of five years or until the retirement account owner reaches age 59½, whichever is longer. The allowable amount will vary for each individual owner, based on their age, account value, and which IRS approved calculation method they choose. One of the shortcomings of this option is once elected the distributions cannot be changed, so you need to be relatively certain that the amount is adequate enough to cover your needs and that you will want to continue with the distributions as required.
2. Keeping your 401(k) –Financial advisors will often recommend you immediately roll your old 401(k) into an IRA once you leave your company. Unfortunately doing so in the case of an early retirement may be more in the advisors best interest than yours (is the advisor only making the recommendation so they can get control of the money?). If you are employed by a company and are participating in the company’s 401(k) plan and you leave employment at any time during or after the year in which you reach age 55, there will be no penalty for taking distributions from the plan. Normally, any distribution (other than specifically-qualified distributions) prior to age 59½ would result in a 10% early-distribution penalty being applied. It is important to note that these distributions only qualify when received from a company-established defined contribution plan – NOT an IRA account.
3. Roth IRAs – One of the major benefits of a Roth IRA is five years after the initial contribution, all contributions can be withdrawn without tax or penalty, even before age 59 ½. Fortunately when making distributions from a Roth IRA the IRS considers the contributions to be withdrawn first. For example, if over the years you had contributed $30,000 to a Roth IRA and the account value is now $65,000, you can withdraw up to $30,000 without having to pay any income tax or penalty before age 59 ½.
4. Home Equity – While this most likely should be a last resort and needs to be THOUROUGHLY thought out, tapping into the equity in your home to bridge a minor gap in retirement funding may be an option as well. Considering today’s low interest rates, taking a home equity line of credit to help cover some expenses may be an option for those set on retiring before they can access their retirement investments penalty free.

Overall impact on your financial plan

Many people do not understand the consequence retiring early has on their long-term financial picture. The impact is two-fold: “X” number of years with less saving and well as “X” number of years with additional withdrawals. This can result in a significantly different lifestyle for retirees. Recently we worked with clients who were considering retirement at age 57 instead of 60 as originally planned. After seeing that they may need to reduce their spending by several thousand dollars per month for the rest of their lives, they decided that the few extra years of working was worth it in order to really have their “dream retirement” later on. Before making the decision to retire early you should make sure you understand the impact it may have on your lifestyle for decades to come.

If retiring early is something you are considering, the best approach is to start planning now. Like most financial issues, time is often one of your strongest allies. Running down the beach, while you are still capable of running, can be a lofty goal and one that needs to planned out before making the first step.