Key Considerations for Early Retirement

One of the main financial objectives people have is to prepare themselves for life after work, otherwise known as Retirement. The idea of retirement has changed a lot over the years. In past generations, retirement often meant leaving a job to never work again, and for many people, that definition still fits. However, some people now look at that phase of life as a time to exercise more control over their own time, whether that means traveling, relaxing, volunteering, or even working in some capacity. Regardless of how you see that phase of your life playing out, if most of your adult years have been spent engaging in work for pay, when you decide to leave that world, there are likely to be some significant changes to your financial situation. A trend among Americans today is that many people are looking to retire at earlier ages than in generations past. While there is no standard retirement age, previous generations tended to target around the age of 65 since many years ago, that was the age of Social Security Full Retirement benefits. Now, it is not uncommon for people to plan on retiring at age 60 or even well before that, and typically the goal is to retire at a young enough age that you can be in good enough health that you can enjoy doing all of the things you envisioned doing at that point in life. With those benefits of retiring at an earlier age, however, come issues that past generations retiring later may not have had to deal with. For this issue of the newsletter, we will look at three important considerations for people who plan to retire at an earlier age.

Covering Your Health Care Needs
Regardless of whether you are in good health or not, you might be subject to interactions with the health care system, and that can get expensive, especially if you don’t have adequate health insurance to cover some of the cost. Many people who are employed receive health insurance from their employer, and in doing so, are only responsible for a small portion of the cost of the insurance premium, not to mention the cost of the care itself. If you retire and have hit the age of 65, you will be able to (and should) apply for Medicare in one of its many forms to help pay for the cost of health care, and you often pay a standardized premium for the base insurance. However, if you retire prior to age 65 and no longer have employer-based health insurance, your coverage options are mainly private health insurance coverage or coverage through the government’s Health Insurance Marketplace (Affordable Care Act plans). In the case of private health insurance, you are responsible for the full premium cost, which can be fairly expensive. If you utilize a Health Insurance Marketplace plan, depending on your income level, you may be able to reduce your premium cost via the Federal subsidy, to make the plan more affordable. When choosing a plan, you also need to look at what the plan covers and what you can expect your out-of-pocket costs to be. Whatever option you choose, it is important to recognize the impact of the cost of health care, especially considering a higher likelihood of medical needs as you get older.

Replacing the Income from Your Working Years
Perhaps the biggest contributor to the decision to retire is what your prospects for income look like once you stop working. If you have had a lengthy career, you may have access to Social Security benefits and/or a Pension benefit to provide you with consistent lifetime income in retirement. If you have been able to put money away during your working career, you may have Savings and Investments you can draw from. Contrary to past generations, many people today will do some type of work in retirement, whether that is because they need additional income or because they still have a desire to do something productive, but maybe on their own schedule. Each of these sources of income have their own characteristics, and you want to factor that into your decision of when to retire and when to tap into those income sources. For example, Social Security provides lifetime income that generally will grow with Cost-of-Living Adjustments (COLAs), so that can help your income keep up with inflation. For the early retiree, you need to understand that in general the earliest you can start benefits is age 62 and taking it at that time will cut your benefit amount considerably from waiting until your Full Retirement Age (FRA). In addition, if you start Social Security between age 62 and your FRA, you may see your benefit amount further reduced if you have earned income that exceeds annual limits (The Earnings Test). On the other hand, your Savings and Investments, while they have the opportunity to grow, unless you’ve put your money into a vehicle that can provide guarantees, that pool of money is not necessarily going to last a lifetime, so you have to be judicious about your withdrawal strategy. Also included in that calculation is that the younger you begin withdrawing funds, the more time those funds may need to last. There are strategies you can put in place to strengthen your ability to navigate replacing your income, but it requires a well thought out approach and plan.

Navigating Changes to Your Tax Situation
People who work as employees typically have payroll taxes withheld from their paycheck, making it easier at tax time to have met the required tax liability. Even self-employed people can pay estimated taxes throughout the year to lessen the burden at tax time. Depending on where your income is coming from, in retirement you may also be able to withhold income taxes to help you out when it is time to file your tax return, but you may have to do your own calculation or figure it out by trial and error. As you make those determinations, you also want to take into account how your sources of income are taxed, which tend to be different in retirement than earned income. For instance, your Social Security benefits may be subject to tax, but that income does receive preferential treatment, such that the amount of your benefits that are included in your income tax calculation could be as low as 0% or as high as 85%. The percentage that is subject to tax is based on your other income outside of Social Security, so you may be able to improve your overall tax situation with proper planning. If you are withdrawing money from Investments, if the money is coming from a non-retirement plan investment, you may be able to benefit from only paying tax on Capital Gains, which are taxed at a lower rate than ordinary income. If your distributions are coming from a retirement plan investment, the taxability is going to be determined by whether the funds are coming from a Traditional or Roth investment. For early retirees with retirement plan investments, you also have to make sure you are abiding by the IRS rules with respect to early distributions and the associated tax penalty. Generally, employer plan distributions are exempt from the tax penalty between age 50 and 55, whereas distributions from Individual Retirement Accounts (IRAs) are subject to the tax penalty until age 59-1/2, unless certain provisions are made. You should also do your due diligence to take advantage of tax breaks where you live. Many states provide retirement income exemptions for people above a certain age, and there are often county tax exemptions for homeowners that have reached certain ages. While impact of taxes may be a remote thought in your mind, the better you can manage your tax situation, the more money you can put in your pocket.

Stewardship Emphasis

It may seem counterintuitive that freedom costs, but those who are willing to pay the cost of research and planning can find more enjoyment from their freedom.

The Empowerment Channel |Volume CCXIII | Dedicated to Promoting Financial Education through Stewardship