Some of your clients may want to retire early. This is
certainly a great aspiration, but like any financial goal, achieving early
retirement takes planning.
Here are six steps to help your clients achieve their goal
of an early retirement.
1. What’s driving the decision?
When clients express a desire to retire early, be sure to
have a conversation with them to help you understand what is driving this
decision. Perhaps a parent died at an early age and never got to enjoy their
retirement. Perhaps they feel they have accumulated a sufficient level of
wealth through all of the work you’ve done for them and they feel comfortable
taking the leap.
For clients within 10 years or so of their normal retirement
age, many companies might offer them a buyout to entice them to retire early.
Whatever their situation, understanding the client’s
motivation is important to the planning work you will be doing to help them make
their early retirement dreams a reality.
2. Define ‘early retirement.’
Early retirement can mean different things to different
people. It can mean retiring “cold turkey” from any sort of paid work. It can
also mean phasing out of a position, perhaps scaling back to part-time work
with an employer for a few years prior to moving to full retirement.
Some clients may decide to retire early to pursue their
passion. This might mean starting a business or perhaps doing consulting work
in their area of expertise.
Defining what early retirement means to a client will help
drive your financial planning recommendations to help them achieve their goal.
3. Review current retirement savings and investments.
Part of the planning process is to review all retirement accounts
and other investments that could be used to fund an early retirement. You will
want to take an inventory of all accounts and other sources of retirement
income. These will typically include items like:
Tax-advantaged retirement accounts such as an IRA or a
401(k)
Taxable investments
Social Security
Annuities
An employer pension, if applicable
Each client’s situation is different and may well include
other retirement resources beyond these.
For a client retiring around their normal retirement age,
all of these potential sources of income can easily be tapped when they retire
or soon after. Clients planning an early retirement, however, will have fewer
options at the outset.
One issue for early retirees is the taxes and penalties that
may come with accessing retirement accounts early. One consideration is to try
and accumulate a sufficient amount of assets in taxable accounts to tide your
client over until they reach age 59 ½ and can access assets in retirement
accounts without incurring penalties.
There are some exceptions to this, such as taking a Series
of Substantially Equal Periodic Payments, or SOSEPP. These are allowed under
IRS rule 72(t). Distributions can be taken penalty-free from an IRA or other
retirement plan prior to age 59 ½ as long as certain rules are followed.
The main rule is that the distributions must continue for
five years or until your client reaches age 59 ½, whichever is longer. While
there are no penalties, these distributions would be subject to income taxes.
Another option is to withdraw contributions made to a Roth
IRA without taxes or penalties at any time. Earnings, however, cannot be
withdrawn without penalties or taxes prior to age 59 ½, though there are other
exceptions, such as in the event of a disability.
Clients leaving their employer at age 55 or older can
utilize the rule of 55 to withdraw funds from their current 401(k) or 403(b)
penalty-free, but not tax-free. The plan must have elected to offer this option
to participants. This can only be done for your client’s current plan at the
time they leave the employer; retirement plans at prior employers or IRAs are
not eligible. Some public safety workers may be able to take advantage of this
option as early as age 50.
SOSEPPs, withdrawing Roth contributions and the rule of 55
all have the advantages of eliminating penalties (and taxes, in the case of the
Roth withdrawals) prior to age 59 ½. The downside that has to be weighed is that
your client is reducing the value of their retirement accounts for the latter
part of their retirement.
4. Plan for health care costs in retirement.
Covering the cost of health care in retirement is a major
issue for those who retire at 65 or a more “normal” retirement age. Older
adults generally have the benefit of being able to enroll in Medicare when they
retire or soon after.
In the case of early retirement, it’s important to be sure
that your client has health insurance coverage in place to tide them over until
they are Medicare-eligible. If they are leaving an employer early, they need to
check into whether there is some sort of retiree medical plan they can utilize.
Some employers may offer extended medical coverage as part
of a buyout incentive, if this is applicable to your client. COBRA is also an
option, but this is expensive and only lasts for up to 36 months.
If the client is married and their spouse continues to work,
coverage under the spouse’s plan is also an option.
For most early retirees, purchasing health insurance on
their state’s insurance marketplace is going to be their best bet. In terms of
budgeting for the cost of the policy, it’s important to keep in mind that while
the costs of this plan will be lower than with COBRA, they should expect higher
premiums and perhaps higher deductible limits than with their former employer’s
plan.
If your client is planning to work for an employer on some
type of part-time or consulting basis, they may be able to negotiate being
included on the employer’s health insurance plan as part of their compensation,
which could save them some money.
An excellent planning tool for clients contemplating early
retirement is to fund a health savings account (HSA) if they can. HSAs allow
for pretax contributions, and the money can be used to cover the cost of health
insurance continuation coverage such as COBRA, as well as other eligible
medical expenses, during the client’s early-retirement period until they are
eligible for Medicare. For those who are eligible, HSAs can be used to
reimburse clients for Medicare premiums for Parts B ad D.
5. Create a retirement spending plan.
As with a client retiring at their normal retirement age, it
is critical to formulate a retirement spending plan. What will it take to
support their early retirement lifestyle? There are a number of issues to
consider here, including:
Housing: Will your client stay in their current home or
perhaps sell it and downsize?
What activities will they pursue and how much will they
cost?
What will their normal monthly expenses look like?
It’s also critical to formulate a retirement withdrawal
strategy for their early retirement years with considerations for what might
change further down the road. Which accounts will be tapped, and in what order
to help your client meet their spending needs? How might this evolve over the
course of their retirement years?
This second question is multi-faceted and must take into
account the client’s tax situation, any employment or self-employment income,
the timing of Social Security and pensions, among other considerations.
6. Weigh the impact of early retirement on the client’s overall
retirement planning.
Early retirement is a valid option for your clients to
aspire to. However, as their advisor, you need to review their situation to be
sure that by retiring early they are not putting themselves at risk of
outliving their assets over the course of their lifetime.
This can help your client formulate what their early
retirement will look like and to make decisions as to a full early retirement
or perhaps a partial one where they do some sort of work or self-employment for
a period of time before totally retiring from work.
Beyond this initial analysis, you will want to run a
retirement projection periodically to determine where they stand for the longer
term and to see if any adjustments need to be made to their investing plan or their
retirement withdrawal strategy.
Click here for the
original article.