Retiring ahead of schedule may seem like a dream, but it is doable with the proper planning. Depending on when you were born, the normal retirement age is currently 66 or 67. If you’re planning to retire five, 10, or even 15 years earlier than that, one of the most important things to consider is how to make your savings last for the really long haul.
It will take some strategic planning to get out of the full-time workforce ahead of schedule.
Key Takeaways
- Create a realistic budget to determine if you have enough saved to retire early. If not, consider how you can lower your cost of living.
- Decide how you’ll pay for healthcare until you’re eligible for Medicare as well as how you’ll handle non-covered costs once Medicare kicks in.
- Delay taking Social Security until age 70 to get the maximum benefit.
Create a Realistic 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 well beyond the 20 to 30 years that conventional retirement planning is based on.
Figuring out how much you can reasonably afford to spend each year depends on what you’ve saved, your life expectancy, and your anticipated expenses.
Scott A. Bishop, executive director of wealth solutions at Avidian in Houston, puts it this way:
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.
How Early Retirement Alters the 4% Rule
The 4% rule has long been the baseline for determining your withdrawal rate from retirement savings. This rule dictates that you withdraw 4% the first year in retirement, then withdraw the same dollar amount, adjusted for inflation, every year going forward. Drawing down your nest egg at that rate should make it last for 30 years.
If you need your savings to last an extra decade or longer, the 4% rule may not be realistic. You may need to consider dropping your withdrawal rate to 3.5% or 3%.
For example, let’s say you retire at age 50 with $1.5 million saved, and you choose a moderate asset allocation. If you expect to 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 reset your early retirement date so that your income aligns with your spending.
Plan Ahead for Medical Costs
People are eligible to sign up for Medicare coverage anytime during 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 monthly premiums may be manageable while you’re relatively healthy, but out-of-pocket costs can skyrocket if you develop a serious health problem.
A 65-year-old couple retiring in 2021 will need to save $300,000 to cover healthcare costs over their remaining lifetime, according to Fidelity Investments. Costs continue to rise, which means a 55-year-old couple retiring in 2021 can expect to spend more.
Putting money in a health savings account (HSA) while you’re still working is one way to prepare for future medical expenses if you plan 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, of Haven Financial Advisors in 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 owe income 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.
Delay Collecting Social Security Payments
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 age 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 lowers the amount of your benefit permanently. Waiting longer to apply increases your benefit amount. Waiting until age 70 gets you the absolute maximum you can get.
63 and 65
U.S. Census Bureau data indicates that retirement age in the United States averages 63 for women and 65 for men.
If your full retirement age is 67, for example, but you start taking Social Security at 62, you would receive a permanently reduced benefit. If you wait until age 70, however, your benefit will increase 8% for every year you wait.
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.
How Can I Retire Early?
Conventional retirement planning assumes you’ll retire at age 65 or thereabouts. If you want to retire earlier, adjust the plan to fit the goal. You’ll need to ratchet up your savings now or trim your retirement spending later. Consider how you’ll cover medical costs after retiring, both before and after you’re eligible for Medicare. Plan on delaying signing up for Social Security until you reach age 70. That’s when you’ll be eligible for biggest payout.
Does the 4% Rule Work for Early Retirees?
The 4% rule turns into a 3% or 3.5% rule if you’re planning on retiring early.
The 4% rule recommends withdrawing 4% of the balance in your retirement account in your first year after retiring, then withdrawing the same dollar amount, adjusted for inflation, every year thereafter. If you retire early, you have a lot of years thereafter. Plan accordingly.
Can I Retire Early and Get Social Security?
You can collect Social Security as early as age 62, but your payments will be reduced permanently. Every year you wait will get you a higher payment up to age 70. That’s when you want to sign up in order to get the highest benefit.
The Social Security Administration’s Calculator can give you a quick estimate of how much you’ll receive at any given retirement date.
The Bottom Line
The longer your retirement outlook is, the more important it is to prepare 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 at ePersonal Financial in 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 costs, and delaying Social Security benefits can all help keep you from going broke.