Deciding on Early Retirement: Lining Up the Moving Parts

Retiring early has become much more popular over the last several years, as people reassess the value of continuing to work and weigh the benefits of exiting their careers. While the first question is about the size of your retirement savings fund and whether it’s possible – or advisable – to give up a few more years of income, there are other factors to keep in mind.

An effective retirement plan has a lot of moving parts to it, so it’s a good idea to think through the various decisions you need to make and be sure you are tracking on everything before you stop work.

Making the Decision – the Psychological Impact

Retirement is less a transition and more of a dramatic shift, because once you stop work everything else changes and you need to have a plan in place. Separating the decision into two parts can be a useful exercise. First: Do you really want to? Think through:

1. Will you miss work?
2. What will your social life look like?
3. How will you create meaning for yourself?
4. Will you launch a new career or undertake part-time work?

The psychological impact of one of the biggest life changes shouldn’t be overlooked, not only because it safeguards your mental health but also because it puts you in a better position to budget effectively and make the right financial decisions.

The Financial Impact of Early Retirement

You’ll be sacrificing additional years of wealth accumulation – but you may also be sacrificing social security benefits you may need. Social security counts your highest paid years, so the longer you work the more you replace lower paid years earlier in your career, and the more your benefit goes up. If you don’t know what your social security benefits will be or if you’ve paid enough in to maximize them – check it out here: https://www.ssa.gov/myaccount/

Your next decision is whether to claim social security as soon as you are eligible or wait for a few more years to take advantage of the late retirement boost. The difference in the monthly benefit for waiting until you hit or exceed full retirement can be very significant. Early retirement begins when you become eligible at 62 years old; Full retirement is somewhere between age 66 and 67 for most people depending on your birthdate, and Late retirement ends at 70.

Full retirement is the benefit you are entitled to based on your work history. Retiring early subtracts from your full benefit, and retiring late adds to your benefit amount.

The amounts aren’t absolutes – they increase by a 8% for every year you delay, so you don’t have to make it all the way to age 70 to see some benefit.

Maximum Monthly Retirement Benefits for 2022

Can You Bridge the Gap with Retirement Savings?

Deciding when to claim social security may come down to whether you’ve created enough 401(k) or IRA savings to see you through. Accessing these savings (assuming you are over age 59 ½ and will not have to pay the 10% penalty for early withdrawal) can have tax implications both now and later.

The more you draw down now, the lower these balances will be when you have to start taking required minimum distributions (RMDs) at age 72.  This will give you more control over your taxable income which is important as up to 85% of social security benefits are taxable.

Health Insurance

Are you getting the idea that there are a lot of moving parts here? And we haven’t enough talked about health care yet!

Medicare eligibility begins at age 65. There are several ways to bridge the gap if you’re not eligible yet. These include part-time work that includes coverage, spousal coverage, or purchasing a policy through an exchange.  For many people, depending on their overall health situation, the availability of affordable healthcare can be the determining factor in deciding to retire early.

If you do decide to retire before Medicare kicks in and purchasing insurance through the exchanges is the best option – think carefully about what level of care you need.  The different tiers of plans allow you to control how much you pay for insurance, with the trade-off being how much the insurance pays towards your care.  If you are generally healthy and don’t need to visit the doctor often, a lower tier of coverage may be the right choice for you. However, if you have existing health conditions or would just feel more comfortable with the ability to have more flexibility with your health plan, you may want to purchase a more comprehensive – and expensive – level of coverage.

Percentage Breakdown of Coverage by Insurance Tier¹

Setting a Realistic Budget

You’ve thought through the decision, you’ve made a plan for social security and you’ve got healthcare figured out. What’s next? Budgeting. It’s the only way to get to a realistic number for what you can afford to take out of your savings every year – for the next 30 years.

1. Make a list of all your expenses. These should be the things you have to pay every month – housing, heat, utilities, automobile, insurance, food, etc.
2. Make a list of the top five things you want your life in retirement to reflect. Travel, philanthropy, indulging an avocation.

Making Your Income Meet Your Needs

Once you have that number, the next step is to make sure that your income in retirement can meet your needs. You can take two approaches here:

1. Pick a static amount that will leave you with enough principal. A generally accepted rule of thumb is 4% per year.  If 4% of your investment accounts, plus pension and social security isn’t enough to meet your budget – you‘ll need to pare back.
2. Take an end-goal approach. You can set up a plan yourself, or work with a financial advisor to create an investment allocation that will throw off the income you need.  This is a function of your risk tolerance and your timeline for spending money in retirement.

The Bottom Line

Whenever you decide to retire, there are a lot of decisions to make.  Thinking things through in advance and having a realistic plan in place will not only help you make a good decision – you’ll be able to move into the next phase of your life with assurance.

1. Healthcare.gov.

The information contained herein is intended to be used for educational purposes only and is not exhaustive.  Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return.  If applicable, historical discussions and/or opinions are not predictive of future events.  The content is presented in good faith and has been drawn from sources believed to be reliable.  The content is not intended to be legal, tax or financial advice.  Please consult a legal, tax or financial professional for information specific to your individual situation.

This content not reviewed by FINRA