There’s an exciting idea floating around called early retirement extreme – a theory based on math. Instead of saving 10 percent of your income over a long period of time, you save 90 percent of your income over a shorter period of time, and then you retire early. Sounds like bliss, until you look beyond the math.
Thanks to changes in our lifestyle, longevity, healthcare and tax law, early retirement at any age will require careful planning. Before you take the plunge, make sure you understand the risks. Here are the 5 biggest obstacles that most people tend to overlook.
PROBLEM #1: YOUR EXISTING LIFESTYLE
Followers of the early retirement concept cut down on their living expenses by growing their own food, making their own furniture, and using free or recycled goods. But if you’re a college graduate, your biggest obstacle to early retirement is likely your debt. The Project on Student Debt reports that 69 percent of graduates from public and nonprofit colleges have student loan debt. Figures from the Bureau of Labor Statistics show that the average college graduate earns about $60,000 a year. This could be the start to a retirement nest egg, but debt makes it difficult to think about saving at all. In a recent PEW Charitable Trusts study of retirement plan access across generations, almost two-thirds of younger workers born from 1981 through 1990 were found to have NO retirement plan. Millennials had several factors stacked against them including higher amounts of debt and lower access to savings plans. Forty-one percent of millennials who are at least 22 have no access to either a defined benefit plan, such as a pension or a defined contribution plan such as a 401(k). Of those who we offered plans, 48 percent declined because they had other financial priorities.PROBLEM #2: CHANGES TO YOUR LONGEVITY
It’s one thing to save aggressively and grow your money, but it’s quite another to distribute that money so that it lasts during retirement. Let’s look at the math from a different angle: how long are you going to need an income? If a 30-year old worker plans to retire early at the age of 35 or 40, how long do your savings need to last? Twenty years? Thirty years? Try 70 years. Back in 1935, full retirement age according to the Social Security History was age 65, yet the average life expectancy at birth was 58 for men and 62 for women. Today, the average 65-year old can plan to live to their mid-80s, but those numbers are rising. Two out of every three pre-retiree men underestimate the life expectancy of the average man, and according to the Stanford Center on Longevity, if the average lifespan increases 3 years by 2050 as expected, the cost of aging would increase by 50 percent. Financial advisors plan retirements so that the income lasts as long as you do, even if that means age 120.PROBLEM #3: WHAT MAKES YOU HEALTHY AND HAPPY?
For most people, the problem of health insurance is the first obstacle to an early retirement. Retiring at age 62 means you have a three-year gap once you leave your employer’s plan and before Medicare starts. The Genworth 2016 Annual Cost of Care study shows that even the cost of home health care for seniors is rising by nearly 50 percent. For people who want to retire earlier, there are high-deductible HSA-compatible plans to cover expensive medical emergencies, but the best solution for older workers might be to make health care investments that take the stress off your portfolio. Even if you are able to get past the health insurance obstacle, having plenty of money to retire on doesn’t necessarily make for an automatic happy ending. The Center for Retirement Research at Boston College reports finds that we gain a great deal of satisfaction from a job well done. Not working is cited as the single most important negative influence on life satisfaction during retirement. If job dissatisfaction is your main reason for wanting to retire early, perhaps the better solution is to get a different job.PROBLEM #4: LOSING TAX ADVANTAGES
One of the most attractive things about retirement saving vehicles such as the 401(k) and the IRA is the tax-deferred growth. But if you are saving more than 10 percent of your income, then you won’t be able to take advantage of these vehicles for all your savings because these programs have contribution limits. The IRS 2017 contribution limits for a 401(k) plan are $18,000 a year. IRA contribution limits for 2017 are $5,500. Both plans extend those limits if you’re over 50 and trying to play catch-up. Why does this matter? Money grows at a much faster rate when the gains thrown off by the earned interest are not taxed as income. For example, if you invest $5,500 a year earning 8 percent for 35 years in a non-IRA investment and have a marginal income tax bracket of 25 percent, you would save $487,248.57 because the earnings are taxed. OR you could save the same $5,500 a year in a tax-deferred account and save just over $1 million ($1,023,561.81) during the same time period.PROBLEM #5: FAILING TO BENEFIT FROM THE RULES
Another drawback to early retirement is the early withdrawal penalties. According to the IRS, early withdrawals from a retirement plan prior to age 59½ can cost you an additional 10 percent tax penalty. This tax penalty is in addition to the taxes you will pay whenever you withdraw money from these accounts to use as regular income. Retiring before the age of 62 also means that you won’t be able to take your Social Security income. The growth of your non-tax advantaged accounts might also take a hit. Stock market investments perform best when you’re able to take advantage of dollar-cost averaging, a simple rule whereby you continue to put money into the accounts during good times and bad. As long as you’re not taking money out, the account continues to grow. Once you start making withdrawals, however, and the investments suffer a negative return, your account could be devastated. Early retirement has its challenges, but that doesn’t mean it’s out of reach. If you have questions about the best ways to structure your retirement income, give us a call at 888-440-2468 or CLICK HERE to fill out our simple form. We can help run the numbers for you to find out when would be the best time for you to take the plunge.
