Many people dream of an early retirement. Indeed, retiring early gives you the freedom to enjoy life outside of work while still relatively young, whether that includes pursuing new hobbies, traveling the world, or simply spending more time with your loved ones.
Yet early retirement can also present significant challenges if you’re unprepared. Not only do you need to ensure your nest egg lasts throughout your retirement years, but you must also account for rising healthcare expenses and an influx of free time.
The good news is with proper planning, you can enjoy a prosperous and fulfilling retirement. In this article, we’ll explore eight essential questions you should ask yourself if you’re considering retiring early, so you can ensure you’re financially and emotionally prepared for post-work life.
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Before retiring early, ask yourself the following questions:
#1: Do I have enough financial resources?
Early retirement typically requires a larger nest egg since you’ll be relying on your savings and investments for a longer period. Thus, it’s essential to ensure you have sufficient financial resources to cover your living expenses throughout your golden years.
Unfortunately, there’s no magic number when it comes to retiring early. The dollar amount you should have saved can vary greatly depending on your personal circumstances, desired lifestyle, and health.
However, a common rule of thumb is to have at least seven times your annual salary in savings by the time you’re 55. If you’re behind on your retirement savings, the following strategies can help you catch up:
- Take advantage of catch-up contributions. If you’re over 50, you can make catch-up contributions to your retirement accounts. In 2023, for example, you can contribute an additional $1,000 to an IRA and an additional $7,500 to a 401(k) beyond the standard contribution limits.
- Reduce your expenses. If you’re worried about a potential savings shortfall, look for areas in your budget where you can cut back your expenses. Reducing current expenses can free up more money to put towards your retirement savings and may lower your income needs once you stop working.
- Invest according to your goals. Make sure you’re investing your retirement savings appropriately for your lifestyle goals, risk tolerance, and time horizon. This can help grow your savings over time and ensure your retirement dollars keep up with inflation.
#2: Do I have a plan for health insurance?
Retiring early means you’ll need health insurance from when you stop working until you qualify for Medicare at age 65. In general, early retirees may have the following options:
- Employer-Sponsored Coverage. As of 2022, 21% of large employers offer retiree health benefits, according to a KFF report. If you have access to employer-sponsored health insurance, this can be a convenient and cost-effective way to continue your coverage until you turn 65.
- COBRA. The Consolidated Omnibus Budget Reconciliation Act (COBRA) allows you to continue your employer-provided health insurance for a limited time after you leave the job. However, COBRA can be quite expensive as you’ll have to pay the full premium yourself.
- Spousal Insurance: If your spouse is still working and has access to employer-provided health insurance, you may be able to join their plan.
- ACA Marketplace: You can purchase insurance through the Affordable Care Act (ACA) Marketplace during the annual Open Enrollment period or a Special Enrollment period if you’ve recently lost coverage. Plans can be costly depending on your healthcare needs and coverage preferences. However, depending on your income, you may be eligible for the Premium Tax Credit, which can help defray your costs.
- Short-Term Health Insurance Plans. In Connecticut, retirees can renew or extend a short-term health insurance plan for up to 36 months. The state also prohibits insurers from denying coverage to anyone with a preexisting condition if certain conditions are met. However, different states have different rules, and some states like New York don’t allow short-term health insurance plans.
If you’re considering retiring early, health insurance is crucial to protect against unexpected medical costs and ensure you have access to the care you need. Be sure to review your options carefully and consult with a financial planner or insurance specialist if you need guidance.
#3: Have I considered the impact of taxes on my retirement plan?
Understanding the tax implications of various financial strategies and decisions is essential for a successful early retirement. Indeed, about two-thirds of retirees say if they had to advise their younger selves on a financial matter, it would be to better understand how taxes affect their retirement savings, according to a recent Thrivent survey.
For instance, many retirees don’t realize that a portion of Social Security benefits are taxable at the federal level if your income exceeds a certain threshold. At the same time, Connecticut is one of the only states to tax Social Security benefits depending on your income level.
Being aware of these nuances can help you avoid penalties and costly mistakes. In addition, proper tax planning can help you mitigate the risk of outliving your assets by minimizing your lifetime tax bill. A fee-only financial planner can help you develop a tax-efficient income plan and implement strategies to lower your tax liability in retirement.
#4: How will retiring early affect my Social Security benefits?
In the United States, you can currently claim Social Security benefits as early as age 62. But if you can wait until your Full Retirement Age (FRA) or later, you stand to increase your benefit amount substantially.
For example, suppose your FRA is 67, and your estimated monthly benefit is $1,000. If you wait until you turn 67 to claim your benefits, you’ll receive the full $1,000 each month.
However, if you claim Social Security at age 62, your benefit amount will be permanently reduced by 30% to $700 each month. Meanwhile, your benefit amount increases by 8% each year past FRA until age 70.
The right time to claim Social Security benefits depends on many factors, including your financial needs, life expectancy, and lifestyle goals. Nevertheless, the longer you can afford to wait, the higher your lifetime benefit amount will be.
#5: Does my retirement plan account for inflation?
Inflation can significantly impact your cost of living in retirement by lowering your purchasing power over time. This is especially true if you retire early, as your retirement may last up to 30 or 40 years, or longer.
Thus, your retirement plan must account for inflation to avoid running out of money prematurely. In many cases, this means investing an appropriate amount in stocks and other growth-oriented assets so that your savings outpace the rate of inflation over time.
If you’re nearing retirement, you may also want to consider investing in Treasury Inflation-Protected Securities (TIPS), a type of U.S. government bond designed to protect your investment dollars from inflation. A fee-only financial planner can help you develop an investment strategy that supports your retirement goals and proactively adjust it as your circumstances and needs change.
#6: Am I prepared for unexpected expenses and potential financial setbacks?
No matter when you retire, you’ll inevitably encounter expenses that you haven’t accounted for in your budget. Indeed, an unexpected medical bill or home repair can be financially challenging, especially when you’re living on a fixed income.
At the same time, market fluctuations can quickly and, at times, meaningfully change the value of your retirement resources. While these changes may not be permanent, they can be particularly painful in your early retirement years due to sequence of returns risk.
Sequence of returns risk occurs when your investment portfolio declines in value early in retirement, right as you begin taking distributions from your accounts. This makes it more difficult to recoup your losses when the market recovers, thereby increasing the risk that you’ll outlive your assets.
To prepare for unexpected expenses and offset sequence of returns risk, it’s helpful to have an emergency fund. This can help you cover expenses without tapping into your investment accounts at inopportune times.
Most experts recommend retirees keep at least 6-12 months’ worth of living expenses in cash or cash equivalents. Therefore, you may want to consider delaying your early retirement plans if you need more time to build your cash reserves.
#7: How will I spend my time during retirement?
Many retirees experience a lack of purpose once they stop working, particularly if they don’t have a plan for how they’ll spend their time. This can have adverse effects on your mental and physical well-being and generally make for an unfulfilling retirement.
Thus, it’s important to find a new sense of purpose if you’re considering retiring early. Engaging in hobbies, volunteer opportunities, part-time work, or travel and making an effort to maintain social connections are just a few ways to find meaning in your post-work years.
Moreover, planning your retirement activities can help you develop a more robust financial plan. For example, if you plan to travel extensively, pursue expensive hobbies, or live in a high-cost area, you’ll need a larger nest egg than if you plan a more frugal lifestyle.
On the other hand, lack of planning can lead to unexpected costs, which can quickly deplete your retirement savings. For instance, you might decide to pick up a new hobby that requires a significant upfront investment, or you may find yourself dining out more often simply because you didn’t plan your days.
By having a plan, you can better anticipate these costs and incorporate them into your retirement budget.
#8: Have I consulted Milestone Asset Management Group about retiring early?
Retiring early often requires hard work and careful planning. However, with a sound financial plan and knowledgeable guide, you can turn your early retirement dreams into reality.
A fee-only financial planner like Milestone Asset Management Group can provide invaluable assistance when it comes to planning your retirement. We’ll review your current financial situation, including savings, investments, income sources, and expenses, and help you create a comprehensive plan to achieve your financial goals. In addition, our in-house team of tax experts and estate planning attorneys can help you minimize your lifetime tax burden, so you can preserve more of your hard-earned wealth.
To learn more about how we can help you reach your early retirement goals, please schedule an introductory call.