SUMMARY: Early retirement might sound like a way to win extra time in one's personal life, but the financial realities can be challenging. We look at the facts surrounding retiring early, and at some strategies to live better on post-career resources.
If retirement is already a complicated step to take in life, then leaving your working days behind before you're in your 60s is even more complex. Some choose it proactively, with all the money in place to live well outside of a career - but others can end up in a scenario of early retirementbecause of illness, or because the recession took their job, and their career, and neither are coming back.
For those retiring on the early end of the spectrum, take heed. Managing the process without causing undue damage to your lifestyle takes know-how and careful planning.
Let's turn to the realities of early retirement, and some strategies to make the most of the years it entails.
- Frugal living. For the early retiree, unless you're talking significant independent wealth, investment windfalls, pensions, and/or an inheritance, the post-work scenario means a dramatic shift in one's standard of living - and it's usually a shift toward a more frugal lifestyle. Start with the idea that conventional retirement advice, on the most basic level (and there are many variables) pegs the amount you need to save to retire at 15% of your annual take-home for about 45-50 years. Say you take home $100,000 annually, then we're talking about accruing some $675,000-$750,000 - if you started saving at 25. And that's a modest nest egg. You'd then live, under typical models, on about 4% of what you tucked away - so, in our example, that's $27,000-$30,000 per year, plus income from any assets. Early retirees need to approach the equation even more aggressively. Assuming one could live frugally before retirement and save 30% for 30 years, you could sock away about $900,000 by the time you're 55. And then your annual budget would be closer to $36,000, plus asset-based income.
- Early retirees and Medicare. One benefit of retiring early is that considerations of health are often farther off than is typically the case for those who leave work in their 60s, or later. In any case, for individuals seeking coverage away from the workplace, buying health insurance under the ACA may be a more flexible environment than before Obamacare- especially given the removal of obstacles surrounding pre-existing conditions - but remember that you still won't qualify for Medicare until you're 62. And even when that program kicks in, you'll have spent resources for up to (or exceeding) a decade already. Bottom line, if you retire early, you'll likely need additional monies to cover health expenses given the longer span of exposure to personally covered events.
- The Social Security hit. If you were born after 1960, full retirement age is 67. While you can collect Social Security as an early retiree, you probably won't get the full benefit of the program. That's because the government calculates your payments based on a full 35 years of your highest earnings as a worker. Retirees who haven't racked up those 35 years are penalized, in a sense, because the non-working years amount to zeros in the Social Security calculation.
- Penalties for early account withdrawals. If your early retirement depends upon withdrawing funds from a 401(k) or an IRA, the government is going to take a penalty share of that money when you draw it down before age 59-1/2. Unless you can show hardship or a medical emergency, expect to pay 10% for withdrawing from these kinds of instruments before you reach the minimum age.
If all of this amounts to early retirement sounding like a challenging step, remember that it's not impossible. People do retire early, and they do so successfully, but they need strategies in place to absorb some of the long-term costs that come with a non-salaried lifestyle. By taking into consideration housing, taxes and the budget on which you'll buy food, entertainment, travel, and the like, early retirees can maximize the money they have to spend.
- Downsize your home. Housing can consume more than 1/4th of the average household's budget. Downsizing one's home, renting part of it, refinancing to a shorter-term mortgage to save on interest, even selling one's house and creating a savings instrument with the net can significantly change your early-retirement equation for the better.
- Consider location in light of taxes. States that do not levy income tax can create savings for early retirees facing what is probably an extra decade or more of making their nest egg last. But even a less-than-total reduction of taxes can help keep more money in place for longer, and this includes sales tax and property tax. Part of the care that goes into a successful early retirement is the concept of location. Where you choose to live is deeply intertwined with how you're able to live after work.
- Identify and minimize go-forward expenses. Controlling expenses for early retirees means re-approaching even basic concepts, such as transportation. For example, owning and maintaining a car can run into the five-digit realm during the life of the vehicle - particularly when said life spans more years for the early retiree. Public transportation options and rentals can create significant savings. If you travel abroad, which is an oft-cited desire of many retirees, pick places where your dollar is worth more because of exchange rates. Countries such as Chile, Argentina, and India are often advantageous destinations, in this regard.
Finally, remember that many retirees - early and otherwise - return to part-time work to augment their available resources.
"Retiring today doesn't necessarily mean not working," says Don Tebbe, a consultant to retiring executives for the past 20 years, in an e-mail interview. "For many it means post-career work, paid or unpaid - maybe even an encore career - that is more engaging, offers more freedom, and provides greater contribution and satisfaction."
And this can be key to balancing all the frugality we've just examined.
Say you love driving, but you've given up your car to save money. Explore driving shifts in a cab, part time. Another example: if you want to be near the water, but have relocated away from the beach to cut expenses, pitch off-season care-taking services to homeowners in waterfront locales.
These kinds of moves pair helpful revenue with upticks in quality of life that can go a long way for the early retiree - not only providing additional purpose to one's days, but also increasing the longevity of the plan they've put in place.