The Truth About Retiring Early

The end of summer always makes me nostalgic. Kids are going back to school, and we all go back to our regularly scheduled lives, but what if the summer ending doesn't mean you return to the daily grind? What if, when it seems like the world is going back to early mornings, commutes, and packed lunches… What if you retire and your short summers, turn into endless free time? What happens if you retire?

Thousands of Americans ponder this question every day. At what age should I retire? For many, the answer to that question is based on Social Security and Medicare eligibility. However, for some, the idea of retiring even younger than 65 is extremely attractive. We’ve compiled a short list of things one should consider when deciding to retire early.

Where are my different savings/investment buckets and how much will I be taxed or penalized for accessing them early? For example, a traditional IRA or traditional retirement plan (401(K), 403(B), etc) should not be used until an individual is 59.5. So, if you retire early and plan to use traditional assets, be prepared to discuss a 10% penalty for premature distributions or utilizing a 72(T)-distribution method to avoid the penalty.

Conversely, it may be easier to retire prior to age 59.5 if one has a Roth IRA/retirement plan OR non-qualified (non-IRA) assets. With a Roth, a person could access the funds before age 59.5 if the account has been open for at least 5 years and they are only using the principal. Growth is still subject to the 59.5 age limit.

A Non-qualified account may be the key to a happy early retirement. While non-qualified accounts such as joint accounts and TODs may not be as tax-advantaged, the flexibility may be worth it. For example, one could retire at 55, use non-qualified assets until they are 59.5, and then use IRA assets to fund most of their retirement cash flow until they turn on social security later. Important to note that turning on social security will likely not pay for all of someone’s retirement expenses, but it would lighten the burden felt by the rest of the portfolio.

How will I pay for healthcare? Many individuals still access great healthcare before reaching Medicare eligibility by maintaining coverage through a spouse, utilizing COBRA for 18 months, or participating in a medical cost-sharing program. Either way, when considering retiring early, it’s important to note that healthcare costs will represent a substantial amount of funds needed monthly.

What does your debt situation look like? Retiring early for health reasons, or really any reason is certainly attractive, but make sure you have a plan for paying off any remaining debt items you have such as credit cards, auto loans, mortgages, student loans, or personal loans. With rising costs of goods and services and taxes, be sure to factor in yearly increases to your escrow account based on property valuations as well.

What is my risk tolerance? When retiring early, or at any age, it’s important to know how much income is needed each month to pay for not only bills but travel, entertainment, rainy days, etc.

Consider how much of those assets you want to have in a relatively low-risk investment, and how much you want to continue to leave at a moderate (or higher) risk level to strive for more growth and keeping up with inflation and other long-term expenses down the road.

The million-dollar (or should it be a billion?) question: How much should I have saved for retirement when I am ready to retire? While this answer will vary greatly from person to person, we’ll leave you with this nugget to process. Know how much monthly income is needed in today’s dollars. Take that monthly number and use it to determine the rough amount of funds you think you’ll need for one year of retirement. Make sure to factor in taxes. Needing $5,000 per month could really mean needing $7,000 per month to satisfy the income taxes as well. Most individuals should plan to have 10-12 times the amount of annual funds needed before considering retiring. At 10-12 times the annual amount needed, plus Social Security, Medicare, and any other income such as pensions, part-time work, and rental income, an individual could reasonably expect a smooth transition into retirement.