Are You Ready for Early Retirement?

If you are considering early retirement, what planning needs to be done to make sure you are prepared to support yourself for the rest of your life?

If you want to ensure you don’t have to go back to work, you need to be confident in knowing your expenses, income sources in the short- and long-term, and your health insurance coverage.

Expenses

Well before your last paycheck is deposited, you need to determine how much you need to maintain your lifestyle. Review your expenses over the previous 12 months to get an idea of what your annual spending needs are. Your financial institution may provide an annual summary to make this process easier.

Next, you’ll want to consider what additional expenses you may incur in retirement. Now that you aren’t working, you’ll have more time available to you, and people typically find ways to spend money in their newfound free time, including additional travel, hobbies, or home projects. These extras can get expensive quickly! Some of these won’t be lifelong expenses, but could be relevant for the first phase of retirement when you are checking items off your bucket list.

Income

Now that you know your expenses, you need to identify your sources of income. If retiring early, you may not be eligible for Social Security or a pension right away (if you are one of the few who still have access to a pension).

Your savings are likely a combination of cash, brokerage accounts, and retirement accounts. Cash and brokerage accounts can be accessed at any point without penalty. If investments are sold from the brokerage account at a gain, capital gains tax will apply.

Retirement accounts such as your 401k, 403b, or pre-tax IRA accounts generally have a 10% penalty that applies if making distributions prior to age 59 ½. If retiring before age 59 ½, you’ll want to make sure that your cash and brokerage accounts can support your income needs.

There are a few exceptions to the penalty if you need to access the retirement funds before age 59 ½. One exception to the penalty is a 72(t) distribution. This strategy allows you to draw substantially equal payments from a pre-tax retirement account for the longer of five years or until you reach age 59 ½.

The IRS has a few methods for calculating the payment amount required to comply with the regulations. If you plan to pursue this strategy, work with a professional experienced with 72(t) distributions.

Another option to avoid the early withdrawal penalty is called the Rule of 55. In this scenario, you can take distributions from an employer plan if you separate from service in the year you turn 55 or later. You can’t retire at 50 and plan to start taking distributions after age 55. You must be working until the same calendar year you turn age 55.

Unlike the 72(t) distributions, you have flexibility with the distribution amount and frequency. You will want to talk to the employer plan administrator to ensure that the Rule of 55 applies to your plan and to verify that you can take partial distributions. It’s important to note that the distributions must occur from the retirement plan of the employer you just left. Older 401(k)s, 403(b)s, or IRA accounts are not eligible.

Social Security eligibility begins at age 62. Depending on the year you were born, full retirement age is between age 66 and age 67. If you plan to draw between age 62 and your full retirement age, your Social Security payment will be permanently reduced by about 30%. You can review the payment amounts on your Social Security statement. Just because you retire early, you may not want to draw Social Security early.

Pensions are another source of income in retirement. Every pension is different, but like Social Security, there is often an increase in the payment amount if you delay. Most employers have specific criteria that must be met to be eligible for the pension. If you are retiring early, you want to make sure that you are not impacting your pension.

Health Insurance

Retirees are not eligible for Medicare until age 65. To avoid a gap in health insurance coverage, you’ll need to secure your own policy. If your employer has more than 20 employees, you should be eligible for 18 months of COBRA. This allows you to maintain the same policy that you had in place through your employer. Still, you are responsible for 100% of the total premiums (both the employer and employee portions) plus a 2% administrative fee. If you retire between age 63 ½ and 65, COBRA can bridge the gap between retirement and Medicare eligibility.

If COBRA is not an option, you will need to purchase your own insurance. Most individuals obtain coverage through the Health Insurance Marketplace®. The premiums for these plans have increased substantially in the last few years. The plans with the lowest premiums are generally high deductible plans. When considering insurance costs, factor in both monthly premiums and the deductible to understand what your out-of-pocket expenses could be if you have a major health issue.

Final Thoughts

Early retirement is a major financial decision. Take time to review your situation with your financial advisors to ensure you can retire with the peace of mind that comes with financial security.

About Us | Get the Bedel Blog | More Retirement Articles