Real Conversations: Retiring “Early”

More workers are thinking about the feasibility of retiring early.  Most financial planners use 65 as a normal retirement date simply because it is the Medicare eligibility age.  But retiring “early” is multi-dimensional, with considerations for income sources, tax implications, types of investment accounts owned, longevity of assets and social security strategies, in addition to securing quality healthcare.

This month’s real client conversation stems directly from that burning question, “No way I want to work to 65 - tell me when I don’t have to work anymore!” 

Here are some key takeaways from our client planning discussions around “early” retirement:

1.)   Have a clear income strategy

Creating income in early retirement often involves drawing from investment accounts, retirement plans, or part–time work.  Understanding where your cash flow will come from and the tax implications of each source is key to maintaining long–term financial stability.  We frankly talk a lot about part-time work, especially the “earlier” you want to retire from that magic 65 number.  More workers are transitioning into retirement by gradually reducing their hours, rather than stopping work completely, or finding consulting or project work.  This approach helps provide greater flexibility in how and when you draw from investments and take social security, likely extending the permanency of your retirement income.  Many clients are focusing on finding any part-time work that simply offers health care. 

2.)   Healthcare is expensive – plan for it

This is easily the number one most overlooked (and underestimated) expense in retiring early.  Currently, the national average for a Silver Plan on the Health Insurance Marketplace is about $700 per month per individual.  That does not include deductibles, copays, prescription costs, etc.  I recently did a healthcare cost assumption for a married couple in their early 60s and it was over $30,000 per year until retirement.  When you are covered under a plan through work, often those group plans offer better pricing, lower deductibles and bigger networks than the Marketplace plans.  Many clients are surprised at how stripped-down the plans are, so they opt for the Gold or Platinum level plans (and pay more) to have similar benefits to what they are used to in the workplace. 

There are other options such as COBRA coverage or a using spouse’s employer plan, but keep in mind that CORBRA is limited to only 18 months of eligibility following retirement.  Funny side note:  it’s always “dirty look time” in the office when one spouse says they are going to retire while the other is still working.  If time is on your side and retiring early is a primary goal, funding a health savings account (HSA) now could help fund your future healthcare needs.  These “triple tax advantaged” accounts, frankly, are amazing – they lower your current tax bill today, grow tax free, and distributions are non-taxable when used for qualified medical expenses. 

3.)   Think of Social Security as a life expectancy game

“When” to take social security is a heavily debated topic and often misunderstood.  For starters, some people confuse their options by thinking that they can only elect 62, 65, 67, or 70 – that is incorrect – you can take it as early as the month you turn 62 and any date in time following.  While you may retire early, starting benefits at age 62 may not always align with your long‑term goals.  And “getting it right” can positively influence income planning, taxes, and how long your assets last.  It seems daunting - here’s how we try to simplify the social security conversation in the context of retiring early:

A.)   Do you need it right now?  If it is not essential because your spouse is working, you are working part-time, or you have significant assets in non-qualified accounts (savings, brokerage, etc.), it likely benefits you long term to wait.  If your social security benefit “allows” you enough income monthly to meet your early retirement goal, and therefore keeps other assets intact, we likely lean toward to old adage:  go for it.

B.)   Are you going to keep working in some capacity?  If you continue to work, be mindful that the Social Security Administration frowns upon “double-dipping”.  In 2026, if make over $24,480, your benefit amount will be reduce $1 for every $2 earned above that threshold.  Insider tip:  you do not “lose” the benefit (it’s not a penalty), SSA will pay those held benefits back to you once you reach your FRA. 

C.)  How long are you going to live?  Serious question, which comes with a myriad of funny responses.  The reason why this is so important is not necessarily because of the planning implications but instead the human rationalization of your timing decision.  Most people think they are “penalized” for taking SS at 62 and “rewarded” for waiting until 70.  Hogwash.  The SSA has a life expectancy for males and females and an actuary table used to calculate your benefits.  If you die at that exact life expectancy they’ve identified for you, the present value of your benefits are the same whether you take it at 62, 67, 70 or 64.3 years.  It does not matter.  It matters only if you outlive the life expectancy (the longer you wait the more you’ll get), or pass before the life expectancy (take it as soon as you can get it).    

4.)   Understand the nuances of your pension and employer retirement plans, and know the IRS Rule of 55 and the 72(t) option

Payout options from pension plans can be complex with varying eligibility/service requirements, “hard to find” benefit estimators, and varying ways to structure payments (i.e., single life or joint payouts for surviving spouses).  Employer-based 401K or 403B plans are more mainstream, but there are many options to consider when planning for early retirement as a goal.  For example, maybe it’s smart to contribute to both Traditional and Roth buckets to allow for more retirement distribution flexibility.  Also, there is a little-known IRS guideline called the Rule of 55.  Most people know that you must wait until 59 ½ to take penalty free distributions from your 401K/IRA accounts.  However, the Rule of 55 lets you take money out of your current workplace plan - without the 10% penalty - if you leave your job during or after the calendar year you turn 55 (i.e. early retirement).  This rule only applies to the specific employer plan you just left – it does not work with past employers or IRA accounts/rollovers.  Also, the 72(t) option, commonly referred to as SEPP (substantially equal periodic payments), allows you to make penalty free withdrawals at any age from your 401K, 403B or IRA accounts.  But, you are subject to a strict 5-year continuation schedule or until you reach 59 ½. 

5.)   Tax planning is critical

There are often more tax moving pieces, opportunities and pitfalls in early retirement than while working.  Most people receive a W-2 with federal and state taxes withheld automatically, and their tax return is relatively straightforward with somewhat predictable tax brackets.  In early retirement, you could be reporting substantially less income and living off savings, which increases the possibility for tax (and investment) strategies that can save big dollars long term.  Or maybe you are purposefully keeping your income low to qualify for Health Insurance Premium Tax Credits.  Conversely, you could be maintaining a moderately expensive lifestyle while being young and retired, which might result in you paying higher Medicare premiums when you turn 65.  There is much to discuss and high potential for unlocking value here. 

Careful planning can help you achieve an “early” retirement.  Our goal is to avoid common mistakes such as withdrawing funds too quickly and not planning ahead for adverse market periods.  As Certified Financial Planners™, we help educate clients to plan for a successful and tax-conscious retirement, however “early” they may want that to be.