Tom Fridrich, JD, CLU, ChFC®, Senior Wealth Planner
We’ve all asked ourselves whether it’s too early to retire (usually after a particularly challenging commute or dealing with a difficult client). You may have even gone so far as to take a sneak peek at your account statements and thought, surely you have enough to live comfortably if you retire early.
But even if you feel confident today, would it be reasonable to retire early? Let’s look into the factors you should examine as you conclude whether you can retire early.
How Early Is Early?
While the FIRE (Financial Independence, Retire Early) movement has been spreading like, well, wildfire on social media, that’s not what we’re talking about here. FIRE aficionados are a small subset of consumers who are saving aggressively with the goal of retiring extremely early.
For our purposes, we’re referring to “early retirees” as those in their late 50s or early 60s. Often, they have built exceptionally successful careers and saved substantial amounts in various asset classes.
While the ultra-high-net-worth population might indeed be able to live off their investments and the resulting interest without ever earning another dime, they also are likely to have a certain echelon of lifestyle that can still put them at risk if they don’t make good financial decisions. That’s why no matter what your financial situation, we recommend the following guidelines.
1. Run Your Numbers
You need to get a handle on your various sources of income and where they are housed — as in, how easily you can access them when you need them. Having a good-sized pool of liquid assets is important so you can preserve your capital rather than making withdrawals during an ongoing market downturn, which can have a damaging impact. When a portfolio is down significantly, you’ll need to cash out more shares to arrive at the same amount of income, and it can be tough to recover from the loss of those assets.
First, analyze your guaranteed sources of income such as a pension and/or Social Security. It’s important to note that Social Security was not designed to replace all of your income and the age at which you begin to take it can have a long-lasting effect on your monthly income. In most scenarios, waiting until full retirement age is best. Also, identify other potential streams of income such as rental income from real estate holdings. A source of income that some people overlook is their home. A reverse mortgage can be a way to turn the equity in your home into income when you need it.
Then, establish how much you can and should expect to withdraw from your investment accounts each month. Most economic research recommends a safe withdrawal rate to be no more than 2% to 4% — which could be less than you are imagining. You have to have realistic expectations for your investment returns and remember that inflation can outpace the cost of living.
Finally, look at your debt picture. Cleaning up your balance sheet and erasing high-interest debt is essential to avoid putting excess strain on your portfolio. In some cases, a small mortgage can work in your favor if you itemize and take the mortgage deduction.
After you’ve done this math, you might be wondering if you have “enough,” and certainly that’s hard to assess when there are so many unknowns. Different people have different theories regarding income and capital preservation so consulting a financial advisor whose perspective aligns with yours is imperative.
2. Understand Your Tax Situation
It’s easy to forget about managing taxes in retirement, but the old adage applies: It’s not what you make, it’s what you keep. Some people don’t realize that withdrawals from their IRA and 401(k) accounts are taxable (unless they are in a Roth account) or that portions of your Social Security may be taxable and your Medicare premiums could increase if your income is too high. Property taxes can take a further bite out of your budget.
Be knowledgeable about your tax position and aim to diversify your accounts so you can manage your taxes judiciously through tax-free income from municipal bonds or Roth accounts in years when that would be advantageous. Research any and all pertinent tax breaks, which can vary by state. Leverage your financial advisor to help you take advantage of tax opportunties pre- and post-retirement.
3. Consider the Lifestyle You Want
Study after study has shown that a successful retirement depends on having purpose and connection. Now is the time to figure out how you will structure your time, whether it’s joining a club, volunteering, reinvigorating old friendships, learning a new hobby or some combination of those. The more you can diversify your activities, the more likely you are to feel content and fulfilled. Start a list before you retire and try them out as some things might not work out as you had hoped.
Another important factor of lifestyle is where you live – if there are plentiful activities and people your age; if the weather is agreeable; if you’re near your family (or not, as the case may be).
Having a plan in place before you retire can be key to a successful experience.
4. Make a Realistic Budget
Many people assume their spending will decrease in retirement without work-related expenses, but that’s not always the case. For example, think about what you do on the weekends. Do you spend money because there’s nothing you have to do? If that pattern continues throughout retirement, your budget can quickly get out of whack.
Aside from determining what you’ll spend on housing, food, entertainment, utilities, travel and the like, there are bound to be additional unexpected costs. Now’s the time to conduct research so you’re not blindsided. One cost that surprises many early retirees is healthcare – you don’t want to find out too late that it’s far more expensive than you anticipated. If you retire before you qualify for Medicare, determine how you’ll obtain and pay for health insurance. While the Affordable Care Act means there are more options than in the past, there will still be an out-of-pocket cost.
Long-term care is another significant potential expense. Fortunately, there are many more alternatives today that are far more palatable than the “nursing homes” of past generations. But they all come with a cost. Research various insurance options to find a solution that can help subsidize the care you want.
5. Recognize that You Might Have More Years than You Think
Obviously, none of us has a crystal ball to project life span, but people tend to underestimate their longevity. And while it’s great news that you may be enjoying a longer life, you want to ensure your wants and needs are adequately covered throughout your retirement years. Unless you have a health condition that will reduce life expectancy, you should estimate living into your early- to mid-90s to be safe.
6. Stress Test Your Portfolio
While it’s vital to have a holistic view of your accounts, you also want to know how they might react under different economic scenarios, such as inflation, interest rate spikes, recessions and more — all of which could mean your assets have to stretch farther.
Financial advisors today have a wide array of tools that can help dynamically predict the effects of various risk factors and “what if” scenarios on your portfolio. While there’s no guarantee the advisor can provide a 100% accurate answer, they can give you a better idea of where you sit and help you identify any gaps.
7. Think Through Options Other than Full Retirement
After you do this exercise, you may come to the conclusion that it’s in your best financial interest to keep working for a while. It’s a wise choice for many. However, it doesn’t have to look like the full-time job that’s causing you drudgery. If you’re relatively secure but you want to enhance your safety net, look into part-time work. Turn your hobby into an income. Take on project work. Or investigate one of the many flexible remote work options available today.
The latter years of your career can be some of the most important financially, and it’s not just because you are continuing to save. Every year you hold off depleting your accounts is time that they can continue to accrue interest. Money can’t grow if you’re spending it, so earning income to finance your lifestyle rather than dipping into the nest egg you’ve amassed is critical. A study from the National Bureau of Economic Research finds that working just a few months longer boosts retirement income the same amount as if you’d added one percentage point to your retirement savings rate over 10 years.1
Another study identified the value of connecting with your future self to picture the choices they wish you were making. The great news is you can start today making the kind of financial and health decisions that will benefit Future You.
8. Realize No One Can Really Make a Fool-Proof Prediction
Remember, even the best predictive calculations and comprehensive planning can’t cover every scenario, and if we know anything, it’s that life is unpredictable. Your partner and/or you might have a health issue that requires round-the-clock care and expensive therapeutics. Your adult children might require more assistance than you had expected. The economy could face another unforeseen downturn. You might set a new record for longevity.
This isn’t meant to be a scare tactic, but rather to remind you that none of us has a crystal ball. Accumulating as much as you can before you retire is usually the best option for the majority of people. And some may confidently decide they are equipped to retire early, which is delightful. You just need to take the proper steps to be educated before you take the plunge.
Are you ready to talk to a financial advisor about your retirement planning needs? Contact us today.
1 National Bureau of Economic Research, “Working Longer Can Sharply Raise Retirement Income,” May 5, 2018. https://www.nber.org/digest/may18/working-longer-can-sharply-raise-retirement-income
Tom Fridrich is not affiliated with Cetera Advisor Networks, LLC.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.
Distributions from traditional IRAs and employer sponsored retirement plans are taxed as ordinary income and, if taken prior to reaching age 59½, may be subject to an additional 10% IRS tax penalty. A Roth IRA offers tax free withdrawals on taxable contributions. To qualify for the tax-free and penalty-free withdrawal of earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 59½ or due to death, disability, or a first time home purchase (up to a $10,000 lifetime maximum). Depending on state law, Roth IRA distributions may be subject to state taxes.
All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful.
