Early retirement requires deep consideration, otherwise it might not work out for you.
The dream of early retirement is one that many, many people have. The reality of early retirement can become a nightmare for those who are not prepared, as well as for those that go into it without giving it deep consideration.
Even for those sitting on a tidy sum in assets, it is possible that early retirement simply is not the right move. Here are a few points to consider.
The Traditional Retirement
First, it is important to understand how retirement is designed to work for most people. Once someone reaches retirement age, they have access to all of the funds that have been waiting for them over the years. That includes,
- Social Security
- Other retirement funds
When someone retires, they can start collecting many of these things. However, each of these sources of funds comes with caveats and rules that can upset someone who is seeking early retirement.
Social Security Doesn’t Favor Early Retirement
Generally, for someone to collect their full Social Security retirement benefits, they need to retire at the proper age. As of right now, the full benefit age for those born on or after 1960 is 67. In fact, those who retire even later than 67 can receive more than their full benefit amount.
When were you born?
Those born before 1960 can usually get away with full benefits at the age of 66. For any age before 66 down to around 62, Social Security funds are still available, but only at a permanent reduction. For the SSA “early retirement” is retiring at the age of 62. At that age it is possible to forfeit about 30% of Social Security benefits.
Since social security benefits go by work credits and formulas, it is still possible that someone who retires extravagantly can collect. Social Security benefit amounts are reduced by a percentage for each month before retirement age. Depending on when someone retires early, they can still collect, albeit a ridiculously reduced amount.
A 401(k) Withdrawal Will Come with Harsh Penalties
If an early retirement is predicated on a 401k withdrawal, then it is important to know what early withdrawal entails. In almost all cases, a withdrawal before the age of 59.5 will result in some or all of the following penalties.
- Taxed federally
- Taxed by state
- 10% early withdrawal penalty
Altogether, those taxes and that penalty can equal about 35% to 45% of the full amount. So an early withdrawal can mean giving away nearly half of the funds. Depending on how the plan is managed, there may be some ways to bypass some of the penalty, but that is strictly on a case-by-case basis.
Retirement Plans of All Kinds Don’t Like Early Retirement
If someone would want to retire early, they would do well to go over the plan details of their retirement plan. Not all plans have the same rules, and some may actually cause less of a hassle than others.
For example, it is easier to take withdrawals from a Roth IRA than it is from a 401k. Regular IRAs, like 401(k)s, do not like for anyone to try to take a withdrawal before they reach 59.5 years of age.
However, IRAs offer the ability to annuitize payments for those that would withdraw early. There are many retirement plans out there, so it is important for the early retiree to fully research theirs before they attempt to retire.
Early Retirement Relinquishes Many Future Funds
When someone retires early, they stop contributing to all of the previously mentioned options. There are no more 401k contributions, which means no more company matching as well. There is no more interest accruing on many of the retirement investment accounts. There is no more rate of return, or if there is, it is drastically reduced.
These are important considerations when thinking about early retirement. If someone retires today, they are literally giving up future money, and lots of it.
Retirement Plans Do Not Always Match the Reality of Available Funds
Many people want to retire in either extreme luxury or extreme relaxation. Ideally, they want both. But the goal for most is to live comfortably. But in order to live comfortably for several decades, a lot of money is a requirement.
Regular funds are great for paying for a home to live in, and food to eat. Unfortunately, regular payments cannot always take care of medical costs and many other needs that arise. What many early retirees fail to realize is that retirement requires considerations that go far into the future.
That is one of the reasons why waiting until actual retirement works better for some. When some starts an early retirement flushed with cash, they must watch as that cash slowly dwindles over the years. It is highly possible to hit bottom with a good several decades of life still left to go.
Make a plan that includes the future.
None of this means that early retirement is a poor choice. It just means that it requires a depth of planning that goes beyond what many people ever consider. It is still possible to break it down into steps.
- Determine the proper age to retire
- Consider how many years the retirement plan must account for
- Estimate the yearly expenses for the extent of that plan
- Document current assets, match them against the expenses for the plan
- Develop a budget
- Make changes to portfolios to line up with goals
- Decide when to take distributions and apply for Social Security
- Allocate resources to healthcare and long-term care
There are numerous tools out there to help someone figure out the numbers. These steps are the same no matter what age someone chooses to retire.
Early retirement can definitely turn into a financial risk. But for those that take the time to make sure their finances are ready for the long haul, that risk becomes greatly reduced.
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