There are many factors that will help you determine whether you’ll be able to retire early. Here’s how to figure it out.
Question: I’m 50 years old, my wife is 44 and we would like to retire by the time I’m 55, if not sooner. We have a little over $600,000 in 401(k)s, IRAs and other retirement accounts and another $250,000 or so in stocks, mutual funds and cash that we can draw on once we retire. Our mortgage will be paid off shortly and we have no other debt. Do you think we can pull off early retirement? —Anonymous
Answer: The fact that you’ve saved a considerable sum and aren’t going into retirement saddled with debt, certainly increases your chances of being able to retire early.
Still, I can’t give you a definitive answer to your question. I would have to know a whole lot more about your finances to even begin to take a reasonable stab at it.
But I can tell you how to assess your situation so that you can figure out on your own or with help from an adviser whether it’s realistic for you to call it a career within the next five years.
As I see it, you’ve got to size up your shot at an early retirement from two different perspectives – a financial and a lifestyle point of view. The two are related, of course, but we’ll tackle them separately, starting with the financial side.
Whether you’re evaluating your prospects for retiring early or at a normal retirement age (whatever that may be), the fundamental financial question you face is this: Can the retirement savings you’ve accumulated in 401(k)s and other accounts generate enough sustainable income combined with Social Security and any pensions to support you for the rest of your life?
You’ve provided a rough sketch of one aspect of your finances – namely, the assets that you can draw on during retirement. But in order to tell whether that nest egg is sufficient, you’ve also got to consider the other side of the ledger, which you haven’t mentioned – i.e., expenses. You need to know how much money you will need on an annual or monthly basis to live comfortably once you’ve left your job.
I’m not talking about a guesstimate here. I’m talking about putting together a detailed retirement budget that lays out the actual expenses you’ll face at the time you retire and projects your likely spending even into the later years of retirement. Only after you do that can you judge whether the size of your savings stash will be large enough to support you throughout a retirement that, in the case of you and your wife, could last upwards of 40 years.
Unless you’re some sort of a math wiz, this isn’t an assessment you can do with a pencil and paper. There are too many variables and uncertainties. So you have two options: go to an adviser who can crunch the numbers for you, or run the numbers yourself using an online calculator, such as Fidelity’s Retirement Income Planner. One of the features I like about this tool is its interactive budget worksheet that allows you to break down your spending into nearly 50 different categories. You can even assign different rates of inflation to different expenses if you think, say, your health care costs will rise faster than what you spend on travel. What’s more, you can even budget for expenses that you know will disappear at some point in the future, such as a car loan or home equity loan that you’ll pay off.
By plugging in this information along with details on your retirement investments and other resources plus an estimate of how long you’ll live (I generally recommend planning at least until your early ’90s), you will come away with a forecast of how many years your savings and other income sources will likely support you.
Pitfalls of retiring young
It’s important to remember, though, that early retirement presents some special challenges. If you retire at 55, you’ll have at least seven years until you can begin collecting Social Security. That means you’ll be relying more heavily on your savings in those early years, which increases the possibility of going through your nest egg too soon.
You also can’t qualify for coverage under Medicare until you’re 65. That may not be a problem if you can count on retiree health coverage from your former employer. But less than a third of companies offer this benefit. So although you may qualify for coverage under COBRA for a while, chances are you will eventually have to buy your own health insurance policy. You’ll definitely want to price private policies so you know ahead of time how much of your budget you’ll have to devote to this expense.
Then there’s the issue of whether you can access the money in your tax-deferred retirement accounts without paying a 10% penalty in addition to the regular income tax you must pay. If you’ve retired from your job and you’re 55, you can tap your 401(k) money without being hit with a penalty, but there’s still the practical issue of what options your ex-employer offers to retirees for getting to those funds. (Can you pull out money whenever you like as often as you like, or are there restrictions?)
As for your IRA, a 10% penalty generally applies to withdrawals you make before turning 59 1/2. You can sidestep the penalty by taking “72(t)” withdrawals – essentially, substantially equal periodic payments based on your life expectancy. But the rules governing these payments can be complex and a bit of a hassle. Be aware too that there are unscrupulous advisers out there using the bait of penalty-free 72(t) withdrawals to lure people into high-priced investments and even fraudulent investing schemes.
So to the extent you can, you’ll probably want to tap taxable accounts early in retirement and let those tax-deferred babies continue to compound without the drag of taxes.
Now to the lifestyle issue. Regardless of your retirement age, it’s always a good idea to do a little “lifestyle planning” before leaving your job. What sorts of activities will fill your days once work isn’t there to provide structure? Where will you live? Will you work part-time? Maybe move in and out of the workforce? Do volunteer work?
But these sorts of issues are especially important for anyone contemplating early retirement. After all, someone who’s 55 still has plenty of life to live, things to accomplish and lots to contribute. (At least that’s what this 55-year-old thinks.) So I’d be surprised if you’re going to devote yourself solely to leisure activities for the next several decades. More likely, you’ll want to engage in some sort of work – maybe try a new occupation or start your own business or just pick up jobs occasionally to keep yourself engaged.
And this is where the financial and lifestyle aspects of retirement intersect. If, after doing the sort of analysis I described above, you find that early retirement looks a bit iffy, a few lifestyle adjustments might increase the odds of it panning out. The extra bucks you earn from taking a part-time job early in retirement, for example, could allow you to cut back on drawing from your savings enough to significantly boost the number of years your money will last.
And although finding a retirement job that offers health benefits is no cinch, you might be able to find one that at least allows you to pick up coverage at a group rate that’s lower than what you’ll pay for a private policy.
Bottom line: Determining whether you can pull off early retirement is a financial issue, but your willingness to be flexible in terms of your retirement lifestyle also plays a key role. So start taking a hard look at both those areas now. The sooner you do, the sooner you’ll see whether an early exit is a real possibility, and the more time you’ll have to make any adjustments you might need to make to turn your early retirement dream into reality.
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