Early retirement is a goal of some people and a dream of many. There’s a lot of appeal to the idea of being financially independent and leaving the work force when we’re still young enough to engage in a wide range of activities. Early retirement can mean living wherever you want and doing what you want for a long time.
Yet, there disadvantages and drawbacks to leaving the work force at an early age. Early retirement has its risks. Some of them are financial, and some of them aren’t. Not all early retirements are voluntary. Some people retire early because of disability or because they lost their jobs and couldn’t find acceptable new positions. For this post, I’m going to assume early retirement was voluntary, and that you have a choice of whether or not to continue working.
“Early retirement” is a subjective term. For some, it means retiring decades earlier than the traditional benchmark of age 65. For others, it means leaving the work force just a few years earlier. In either case, the key issues are the same.
What about medical insurance? Most people aren’t eligible for Medicare until age 65 and few employers provide medical insurance to retirees, especially early retirees. You don’t want to “go bare” by self-insuring all your medical risks until you can enroll in Medicare.
There are only a few coverage options to early retirees, and they usually aren’t as attractive as employer-provided coverage. Most people don’t realize that employers on average subsidize about 80% of the cost of medical coverage.
You can purchase COBRA coverage through your last employer, but that can be expensive. You pay the full cost of the coverage plus an administrative fee that often is 3% or 4%. Plus, COBRA coverage lasts a maximum of 18 months.
The individual health insurance market is an option. The policies available in this market have decreased significantly since 2008, and the cost of coverage increased substantially. In some areas, only one or two insurers offer individual coverage.
Medical insurance might be available through a professional or trade association, alma mater, social organization or another group to which you belong.
I’ve seen many people take part-time work or low-key full-time work after “retiring” primarily to obtain employer health insurance.
You need to thoroughly research the medical insurance options well before considering an early retirement date. Know where you will obtain coverage and how much it will cost. One key risk, however, is that the coverage available and premiums can change dramatically from one year to the next. Once you turn age 64, begin researching your Medicare options and be sure to sign up Medicare by age 65.
How much can you spend? Retiring early means your savings has to last longer, especially since life expectancy is increasing. It’s becoming common to find people who live more of their life in retirement than in their working years.
The low interest rates we’ve had since 2009 make it difficult for most people to keep their principal intact and life off the interest from safe investments such as certificates of deposit, treasury bonds and the like. You either have to restrict your lifestyle to the income from interest payments or take more risk with your money.
Riskier investments, such as stocks, can bring higher returns and cause your nest egg to increase in value even as you spend money. Riskier investments also increase the probability you’ll experience a bear market and see the value of your nest egg decline, perhaps substantially. Instead of spending income and gains, you’ll be spending principal until the portfolio recovers.
You need to stress test your portfolio. Determine how much the portfolio is likely to decline in different market conditions and how that will affect your plans.
Also, your spending plan should be flexible. You want to minimize fixed expenses. You’ll need to be able to eliminate or delay some expenses when the portfolio is down so that you’re not spending too much principal while waiting for the recovery.
Don’t forget to factor inflation into your projections. One of the most frequent retirement planning mistakes is to overlook inflation. Even 2% inflation eats away at your purchasing power over 10 years and longer. Too often people retire believing that their income and expenses match, and then after a few years of rising prices find that their income isn’t sufficient to fund their life styles.
When will you begin Social Security? Most people can begin taking Social Security retirement benefits as early as age 62. That doesn’t mean it’s a good idea to begin claiming benefits just because you’re eligible to.
Think about the long term. Your benefit increases about 8% each year that you delay receiving it through age 70. Your lifetime benefits, and your spouse’s survivor benefits, might be much higher if you wait before claiming benefits.
I recommend using one of the software programs that shows you the results of claiming benefits at different ages and changing assumptions about life expectancy and other factors. Several are available online for modest fees.
How will you replace work? There are things about work and a career that you’re happy to leave behind for retirement. But work and career provide some important things you have to replace.
Work often provides both a daily structure and social interaction. Studies show these are keys to longevity, good health and happiness. You need a plan for how you’ll spend your time. You also will need regular social interaction and friendships. Some studies find a close connection between retirement and death. They find that early retirement leads to a higher probability of death within a few years or reduces overall longevity. Other studies don’t find as strong of a connection.
There is a clear connection, however, between good health and staying active socially, physically and cognitively.
What is your margin of error? A traditional retirement is likely to last 20 years or longer for someone who lives to average life expectancy. An early retirement will last longer, perhaps considerably longer.
Many things will change during an extended retirement. Some things will turn out better than expected, while others will be worse. You have no way of knowing before retirement what the balance will be.
Think twice about retiring early if your plan shows retiring is barely feasible, especially if you have optimistic assumptions. It’s safer to stress test your plan. Take a look at what would happen under different circumstances, including some pessimistic events such as a serious bear market and high inflation. You want a plan that has some flexibility and a cushion, so you can make it through tough times without drastic lifestyle changes. If your plan shows you can just make it average or good times, you might want to delay retirement and increase the size of your nest egg.
