Retiring ahead of schedule may seem like a dream, but it is doable – with the proper planning. Some 9% of workers say they plan to leave their jobs behind before age 60, according to the Employee Benefits Research Institute. That’s some years shy of the normal retirement age – currently 66 or 67, depending on when you were born.
If you’re planning to start your retirement five, 10 or even 15 years early, one of the most important things to consider is how to make your savings last for the long haul. There are several things in particular you need to look at to make sure retiring early won’t leave you shortchanged in your later years. (For more, see 6 Signs You’re Ready to Retire Early.)
Streamline Your Budget
The first step in managing your savings in early retirement is being realistic about your budget. The money you’ve stashed away has to last beyond the typical 20 to 30 years that it would if you were retiring in your mid-60s. Figuring out how much you can reasonably afford to spend each year depends on what you’ve saved, your life expectancy and what you anticipate your expenses will be.
“How much annual income will you need in retirement? If you aren’t able to answer this question, you’re not ready to make a decision about retiring. And, if it’s been more than a year since you’ve thought about it, it’s time to revisit your calculations. Your whole retirement income plan starts with your target annual income, and there are a significant number of factors to consider; so it is important to actually take the time to create a good retirement budget,” says Scott A. Bishop, CPA, PFS, CFP®, partner and executive vice president of financial planning, STA Wealth Management, Houston, Texas.
The 4% rule has long been the baseline for determining your withdrawal rate. This rule dictates that you withdraw 4% of your savings the first year in retirement, then withdraw that same amount, adjusted for inflation, going forward. Theoretically, drawing down your nest egg at that rate should allow it to last for 30 years. (For caveats, see Why the 4% Rule No Longer Works for Retirees.)
When you need your savings to last an extra decade or longer, however, the 4% rule may not be realistic. Instead, you may need to consider dropping your withdrawal rate to 3.5% or 3%. For example, let’s say you retire at 50 with $1.5 million saved, and you choose a moderate asset allocation. If you live another 40 years, your initial withdrawal rate would be 3.2%, allowing for an initial monthly distribution of $4,000. If you waited until 55 to retire, those numbers would adjust to 3.4% and $4,250, respectively.
Knowing how much you have to work with on a monthly and yearly basis can help you tweak your budget. If you run the numbers and your estimated withdrawals aren’t going to be enough to cover your expenses, you’ll either need to find a way to lower your cost of living or push back your early retirement date so that your income aligns with your spending.
Plan Ahead for Medical Costs
Seniors are eligible to sign up for Medicare coverage beginning in the three months before they reach age 65. If you retire before that, you’re responsible for maintaining your health insurance until Medicare kicks in. The costs may be low if you’re relatively healthy and all you’re paying is the monthly premium, but out-of-pocket costs can skyrocket if you develop a serious health problem. (For related reading, see "Top 3 Health Insurance Options If You Retire Early")
According to HealthView Services (HVS), a 65-year-old couple who has Medicare, as well as a supplemental insurance policy, can expect to spend $404,253 on healthcare (including out-of-pocket costs like deductibles and copays) over their remaining lifetime. Costs continue to rise: A 55-year-old couple today can expect to spend $498,962, or nearly 25% more when they retire in 10 years.
Putting money in a health savings account (HSA) while you’re still working is one way to prepare for future medical expenses if you’re planning to retire early. “Working people should, if possible, make tax-deductible contributions to their HSAs and let the money grow tax free. Invest the money in the stock market,” says Louis Kokernak CFA, CFP, owner of Haven Financial Advisors, Austin, Texas. Withdrawals are tax-free if they’re used for healthcare expenses, and once you turn 65, you can pull money out of an HSA for any reason without a penalty. You will, however, still pay taxes on the distribution.
You may also want to think about investing in long-term care insurance, which would keep you from having to spend down your assets to qualify for Medicaid if you need nursing home care later on. (For more, read Medicaid vs. Long-Term Care Insurance.)
Time Your Social Security Payments
As mentioned earlier, full retirement age is 66 or 67 if you were born in 1943 or later, but you can begin taking Social Security benefits as early as 62. That may be tempting if you’re worried that your savings may run thin in early retirement, but there’s a catch. Taking Social Security early diminishes the amount of benefits you receive. Conversely, waiting longer to apply increases your benefit amount.
If your full retirement age is 67, for example, but you start taking Social Security at 62, you would receive 70% of the benefits you’re entitled to. If you wait until age 70, however, you’d get 124% of the benefit amount. If you’re retiring early, taking benefits at 62 might help your savings go further, but you will get more money if you can afford to put it off. Doing the math on applying earlier or later makes it easier to decide when the best time to take benefits would be. Tips on When to Claim Social Security gives you more details on strategies to investigate.
The Bottom Line
Making early retirement a success means looking at the financial aspects of it from a slightly different perspective. The longer your retirement outlook is, the more important it is to have a roadmap for how you’ll spend what you have saved.
“A pre-retirement checklist requires a detailed spending plan or you will most likely outlive your savings,” says Eric Flaten, founder and senior advisor, ePersonal Financial, Bellevue, Wash. “Track your expenses online using an expense tracking tool. This places your daily spending literally at your fingertips with any smartphone or tablet.”
Paring down your budget, factoring in medical care and accounting for Social Security can all help keep you from going broke.