Do you aspire to retire at the age of 50? If so, you’ll need a fool-proof plan. In no special order, we have listed below the essentials to an early retirement.
1. Use Conservative Assumptions
Every retirement plan must use various assumptions in the planning process, such as life expectancy, market returns, and inflation. When drafting a plan for an aspiring early retiree, it’s best to use conservative assumptions. Because an early retiree has to plan for more years of living expenses than that of a traditional retiree, it’s important to err on the side of caution. The worst thing that could happen in retirement is that you outlive your assets. Knowing that your plan works using conservative assumptions will help you sleep during periods of market volatility.
2. Determine Your Ideal Pot of Money
Retirement spending often consists of Social Security income and portfolio withdrawals. If you’re lucky, it also includes a pension. The future of Social Security is unknown and the earliest you can access benefits is at age 62, so it’s important to have a plentiful amount of investable assets. Determine the amount of investments that you need to last you a lifetime.
Remember that retirement is the change of behavior. You transition from decades of saving as much as possible to spending down your previous assets. Once you’ve retired, you’re unlikely to add to your portfolio, so you’ll want to retire with a sustainable amount.
3. Create a Spending Plan
Before you flip the switch, be sure to nail down your current spending as well as what you expect to spend during retirement.
Gather the past year’s worth of credit card and bank statements. Separate the fixed expenses from the variable ones and decide whether each will continue throughout retirement.
- Will your mortgage be paid off?
- Are you planning to downsize?
- Will you take more trips and vacations?
- Do you want to join a gym or start a hobby during retirement?
Once you have a clear vision for what your retirement might look like, be sure to build in the appropriate expense so that you can make the most of your golden years.
4. Solve the Health Insurance Gap
Medicare coverage begins at age 65. Retiring by the age of 50 means you’ll have to find private care for 15 years. With the rise in health care costs and the uncertain future of the American health care landscape, this can be considered one of the major unknowns to early retirement.
Don’t forget about dental and vision insurance. If you currently have coverage through work, you’ll have to find a replacement for that, too! Determine how you will fund the 15-year gap.
- Will your covered spouse continue to work?
- Does your former employer offer health insurance to retirees?
- Do you qualify for Affordable Care Act subsidies?
These are all important questions to ask yourself when managing the health insurance gap.
5. Shoot for Asset Diversification and Plan for Taxes
Every aspiring early retiree knows that maxing out your retirement accounts (401(k) and IRA) will not be enough. In order to retire early, you’ll need to invest in a taxable account, also known as a brokerage.
When sold, brokerage assets are taxed at capital gains rates which can be more favorable than the ordinary income rates levied on 401k and IRA money. Assets held in a brokerage can also kick off dividends and interest, which are taxed at ordinary income rates. You’ll need to understand how to be a tax-efficient and tax-diverse investor.
6. Avoid Penalties
Another reason all early retirees must have a brokerage account is because retirement account withdrawals are subject to a 10% penalty if taken before the owner reaches age 59 ½. Remember, the withdrawals are also taxed at ordinary income rates so tacking an additional 10% penalty could really hurt.
What does this mean for your portfolio?
Let’s say you’re 55 and need $30,000 to cover your annual expenses. Assuming you’re in the 22% federal tax bracket, you would need to sell $39,600 of your IRA or 401(k) assets to net $30,000. This calculation doesn’t take state and local taxes into account, either! Withholding for taxes already takes out a large chuck.
Why add fuel to the fire with the early withdrawal penalty if you don’t have to?
Don’t Underestimate Retirement Planning
Retiring is not something you wake up one day and decide you want to do. It takes years, even decades, of planning to accomplish. Retiring early takes extra time and effort. Time is of the essence, so jump right in and don’t hesitate to enlist the help of a financial advisor.
Prior to implementing any investment strategy referenced in this article, either directly or indirectly, please discuss with your investment advisor to determine its applicability. Any corresponding discussion with a Bedel Financial Consulting, Inc. associate pertaining to this article does not serve as personalized investment advice and should not be considered as such.