29 May 2017

Six Issues to Consider Before Retiring Early

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Some investors have hit savings milestones years sooner than seemed likely when the market bottomed in 2009, though a pullback in recent days is a reminder that stock prices can also fall. Others are getting close and are letting their minds wander to what early retirement might look like.

To begin with, that number may need to be higher if the money has to last a few extra years. And don't neglect other factors that may be trickier to quantify. Think first about whether you can live on a budget, and how to tap your assets in the right order to minimize your tax bill.

Take time to plan for potential health-care problems or other unforeseen emergencies that could become costly in a hurry. And don't play down the risk that retiring early could leave you bored and restless when peers are busy and satisfied.

Here's a checklist of six issues to consider before taking the plunge.

Have You Saved Enough? 

Retiring during a bull market may be easier on the nerves. But it can also make the math more complicated.

The S&P 500 dove in 2008, but it has generated a positive return every year since. An investor who had $500,000 in the index when it hit the financial-crisis low in March 2009 would have $1,599,581 as of Thursday, including dividends—a cumulative return of 220%, according to Chicago-based investment researcher Morningstar.

That could feel like money in the bank. But stocks routinely give up some gains, and a selloff that starts just after you stop drawing a paycheck could do serious damage if you are forced to sell off assets at low prices to cover living expenses.

One way to compensate: Discount the current value of your portfolio to account for the possibility of a prolonged and pronounced drop in the market.

There is another way to measure whether your savings will still suffice if you move up your retirement date—figure out how it would translate into an immediate annuity, an insurance product that generates regular payments.

Can You Live on a Budget? 

Controlling spending is crucial to making savings last. That is harder than it sounds.

One way to see whether you can pull it off in retirement is to live on a strict budget for six months, at a rate that would translate to 4% of your savings a year, a common benchmark for annual withdrawals.

Another way to look at that 4% "safe withdrawal" number is that you need to save 25 times your expenses to cover them in retirement.

Moving into a less-expensive home can be another way to cut expenses. For example, a 56 year old client who lived in a home that cost a lot of money to maintain and came with a large tax bill would run out when she was 73. Selling the home and buying one with lower maintenance costs and lower taxes would add $1 million to her savings and meant she wouldn't run out of money until her 90s.

Which Money Will You Spend First? 

Not all income sources are the same. That is particularly true for early retirees.

For one thing, it is often a smart move to postpone taking Social Security benefits until age 70. Delaying from 62, the youngest age of eligibility, until 70 can increase the monthly payout by 76% or more. But that means early retirees have more years during which they have to cover living expenses in other ways.

Make a list of all potential sources of retirement income, including tax-deferred 401(k)-style plans, individual retirement accounts and taxable brokerage accounts. Then come up with a strategy for drawing on them in the order that will make the money last the longest.

Withdrawing some money from a taxable account and some from a tax-deferred account can often be a smart approach for an early retiree. Taxable accounts are useful because long-term investments and dividends are taxed at the rate for capital gains. By contrast, money withdrawn from an IRA or a 401(k) is taxed as ordinary income, which could be taxed at a higher rate. In addition, withdrawals before age 59½ often come with penalties.

Still, taking out some tax-deferred savings earlier in retirement can be worthwhile, if doing so will lower the amount of the mandatory withdrawals from tax-deferred accounts that must begin at age 70½.

Roth IRAs offer greater flexibility than other types of accounts, as there are no mandatory payouts and withdrawals can usually be tax-free.

How Will You Pay for Health Care? 

Getting older can be hard on the body and the wallet—particularly if you call it quits before age 65, when federal Medicare benefits kick in.

That means early retirees often need to find another way to fill the gap. Many companies with more than 20 employees offer departing workers Cobra coverage, which typically allows them to keep the coverage they had while working for at least 18 months.

Insurance exchanges that sprung up as a result of the Affordable Care Act also offer plans. The bad news: Coverage can also be costly, though premiums can vary by state.

Even after Medicare kicks in, health-care costs can add up quickly. Monthly premiums for supplemental plans to help cover services not included in the federal insurance program can run about $200 to $250 a month.

Also, long-term care isn't covered by Medicare or private health insurance. Long-term care insurance can help offset those costs, but often not all of them. A typical private room in a nursing home costs $229 a day while insurance may cover only $100 of that.

Do You Have a Backup Plan? 

Retirement seems like a dream come true for many people. But it is worth giving some thought to nightmare scenarios.

Poor health, unanticipated expenses or a downturn in the financial markets could wreak havoc on the most careful retirement planning.

The first line of defense is emergency cash. Retirees should have enough on hand to cover six months to a year of expenses. Stash it in an account that is easy to access and protected from volatile swings in value, such as a money-market fund or a short-term bond fund.

If something does go wrong, think about whether you could cut expenses or return to work. Early and recent retirees may be able to generate new income more easily than people who have been out of the workforce for a decade or more, but reversing course is still likely to be difficult in many cases.

What if You Don't Enjoy It? 

Of all the nightmare scenarios, the possibility that retirement won't be fun may seem the least likely.

But retirement isn't for everyone. Affluent individuals are more than twice as likely as other people to keep working in retirement. Some 33% of retirees with $1 million to $5 million in assets are working, as are 29% of those with more than $5 million. Most say they do so because they want to, not because they have to.

The results show how important it is to consider what you will do with your time and to think hard about whether that will be satisfying.

Click here to access the full article on The Wall Street Journal.

 

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