Just under half of all workers retire earlier than they expected – and not by choice – according to research by LIMRA, the insurance industry research firm. The most commonly cited reasons included health problems, job loss or burnout and negative work conditions. The LIMRA numbers confirm annual surveys by the Employee Benefit Research Institute, which consistently find that workers don’t have as much control over their retirement dates as they expect.
If you’re facing an unplanned early retirement, it’s time to reassess your financial plan. Here’s a checklist of items to consider.
Covering short-term needs
Meeting immediate living expenses may be a concern, especially if there isn’t a spouse who is still working.
Go first to your most liquid assets, and avoid tax-deferred 401(k) or IRAs, which generate taxes, early withdrawal penalties or borrowing costs. A second choice would be longer-term taxable assets or a Roth IRA.
401(k) and IRA withdrawals
Traditional IRAs and 401(k)s can be tapped if no other cash options are available, but keep these two factors in mind:
- Income tax. Withdrawals generate an income tax liability, which might be acceptable if overall household income falls into a lower tax bracket due to retirement.
- Penalties. A 10 percent early-withdrawal penalty generally applies if you are younger than age 59 ½ – although there are a couple exceptions. If you are at least 55 years old and retires, quits or is fired, you can withdraw funds from the 401(k) plan of that employer without penalty under the 72(t) section of the IRS code. This applies to people who leave jobs any time during or after the year that they turn 55. If you have a 401(k) at other former employers, those funds must wait to be tapped until age 59 ½.
Early retirement is a key reason many Americans file early for Social Security – 38 percent of men, and 43 percent of women, filed for benefits at age 62 in 2012, according to the Social Security Administration. Although it’s a tempting source of cash, drawing on nest eggs to meet living expenses while pushing back Social Security claiming is a good strategy for many. This is especially true for married couples, who can take advantage of Social Security’s valuable spousal and survivor benefit rules.
Medicare eligibility begins at age 65, but the Affordable Care Act (ACA) creates valuable new options for younger retirees. First, insurers can’t turn down enrollees due to preexisting conditions. Second, the overall cost of insurance will be held down for many by cost-sharing subsidies and advance-able, refundable tax credits on premiums.
This year the subsidies are available for individuals with annual income between $11,490 and $45,960, and from $23,550 to $94,320 for a family of four. The definition of income is modified adjusted gross income (MAGI), which includes wages, salary, foreign income, interest, dividends and Social Security benefits.
If you’re approaching Medicare age, it’s important to know how to time your filing, and give thought to key decisions, such as whether you’ll want traditional fee-for-service Medicare or a managed care Advantage plan. Also take time to understand your options shopping for prescription drug plans.
If you are fortunate enough to have a defined benefit (DB) pension, the natural inclination may be to file for benefits immediately. Not all DB plans allow early retirees to file for a benefit before full retirement age, but if yours does, check on how taking a pension early will affect payouts for the beneficiary and for a surviving spouse.
The Pension Rights Center also advises early retirees to check the plan’s rules in the event you decide to return to work after benefits start. Some plans require that benefits be suspended under certain circumstances; failure to navigate those rules properly could result in recoupment claims down the line.
A growing number of plan sponsors now offer lump sum distributions from DB plans – another possible temptation for an early retiree. Lump sums can make sense if you’re in poor health, or if you have other reliable sources of regular income – for example, a spouse with a defined benefit pension — and might benefit from the flexibility of access to the lump sum. But as a rule of thumb, lifetime income streams will be more beneficial. The Pension Rights Center offers this lump sum fact sheet.
Re-think spending plans
One bit of good news: you may not need as much money for retirement as you think. Recent Morningstar research finds that the typical rule-of-thumb on pre-retirement income replacement is off the mark, and that actual needed replacement rates vary from under 54 percent to over 87 percent. A key finding: spending actually falls over the course of retirement, especially for wealthier households, which have more discretionary pre-retirement spending, and thus have more flexibility in retirement to cut back if funds aren’t available. This is especially true as people reach advanced ages, when their interest and ability to spend on travel, entertainment and clothes declines.
Do a careful projection of spending needs, starting with a blank sheet of paper, and look for ways to re-examine your assumptions. A book I often recommend that can help is Retire on Less Than You Think by Fred Brock, a former retirement columnist for The New York Times.