While the common question is, “Can I afford to retire?” an increasingly common question we’ve seen among clients is, “Can I afford to retire early?” It mainly comes down to if you have saved enough money to accommodate your lifestyle.
To best answer the question, we recommend working with a financial professional to have a comprehensive cash flow analysis done to consider all of your options. While you may not be living a lavish lifestyle currently, once you retire, you will likely have the time to travel and explore hobbies that may increase your spending.
Another concern is having spendable retirement money. If all of your assets are in tax-deferred savings such as IRAs or 401(k)s and you’ve been living off of your salary, retiring before 59 ½ may require careful planning. Before 59 ½, if you withdraw from your retirement accounts, your withdrawals are subject to a 10% early distribution penalty. If you are 55, there are options you can explore, such as taking substantially equal periodic payments. However, your options depend on how much you need, which is why a detailed cash flow analysis is so important.
Many investors also question taking retirement benefits early at a reduced rate. Retirement benefits, such as Social Security benefits or defined benefit plans, offer a reduced benefit for retiring before age 65. For example, a pension benefit of $1,250 a month could be reduced nearly 30% if taken early at age 58. Savvy investors may decide to take the reduced benefit of $875 and invest it. With a 20-year time horizon, invested at an 8% annualized return, you could potentially grow your benefit to nearly $515,000. However, if you waited seven years to receive your full benefit and then invested the $1,250 monthly income stream at the same 8% annualized return, by 2035, your investment would be closer to $341,000.
While this simple math may certainly tip the scales toward taking the benefits early and investing, this also assumes you’ll be spending other money to fund your retirement. The analysis becomes complicated if you need to spend any of this money during that time. Additionally, an 8% annual return also assumes your investment is fully invested in stocks, avoiding today’s low interest rate environment on fixed-income investments. Whether you are able to make an 8% annualized return is also a variable to consider.
We’ve seen the mindset shift among retirees, in that they are beginning to accept that they may live into their 90s, with their concerns on whether they will outlive their money. A 30% reduction may cost them significantly over their lifetime. Of course if you expect you will live into your 90s, you should likely delay your retirement and take the higher benefit, but if you expect you will die earlier, it makes more sense to take your benefits now. The caveat is that you don’t know when you’ll die; therefore, there is no right or wrong decision on when to begin your retirement benefits.
The Social Security Administration looks at actuarial lifetime tables and assumes a breakeven point to determine the age range where you are likely to receive the same amount of money based on your life expectancy, but these statistics are also based on the whole population. If you’re healthy, have access to good medical care and take care of yourself you may be an outlier on the statistical tables.
When considering retiring early, you also have to look at potential medical care issues. You may have access to COBRA health benefits through your former employer for up to 18 months, but afterwards, you may be faced with the cost of an individual policy for several years until you are eligible for Medicare. While Medicare does not erase all of your medical costs, it certainly reduces the cost. You’ll also want to consider your long-term care. In your detailed cash flow analysis, you’ll need to consider the difference between your annual spending and your maximum spending amount. The narrower the gap between the two, the more important a long-term care policy becomes. These are material spending items that need to be incorporated into the cash flow projection that serves as the basis for the early retirement decision.
Deciding when to retire in a complex decision with many variables that will affect your outcome. If you would like to know how the assumptions you are using affect your overall financial plan, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
Disclosures: This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
