How to Plan for an Unexpectedly Early Retirement

The best-laid retirement plans take into account investment-return assumptions and withdrawal rates. They should also include planning for unexpectedly early departures from the workforce.

While an increasing number of Americans say they want to remain on the job after age 65, between 37% and 52% of retirees polled annually since 1991 by the Employee Benefit Research Institute say they left work before they had intended—often due to a health issue or job loss.

As a result, individuals should prepare for the possibility of an early retirement as part of their overall planning. Steps to take include amassing three to six months’ pay in an emergency fund and securing disability insurance, says Anna Rappaport, chairwoman of the Society of Actuaries’ Committee on Post-Retirement Needs and Risks.

Those facing an imminent departure also should focus on decisions about health insurance and any severance pay or disability insurance they qualify for. Here’s a guide to those decisions.

Health Insurance 

If you leave your job when you are 65 or older and don’t have another job with health insurance lined up, the decision about how to replace your health insurance is simple: Before your employer-sponsored coverage lapses, contact Social Security and sign up for either original fee-for-service Medicare or a Medicare Advantage plan, which is a health-maintenance or preferred-provider organization that contracts with Medicare.

Those under 65 must look elsewhere for coverage. Possibilities include joining a spouse’s plan, buying coverage under the Affordable Care Act, or remaining on a former employer’s plan under Cobra, a federal law that requires companies with 20 or more employees to permit former workers to stay enrolled in the health plan, typically for up to 18 months.

Cobra can be expensive. That’s because while many employers subsidize workers’ premiums while they are employed, they often require those on Cobra to pay the entire cost plus a 2% annual administrative fee, says Juliette Cubanski, associate director of the Kaiser Family Foundation’s Program on Medicare Policy.

With an ACA policy, individuals with incomes of up to $47,520 and couples earning up to $64,080 may be eligible for tax credits that cap their premiums on a benchmark plan—designed to cover 70% of medical expenses—at between 2% and 9.5% of income.

If you are using either Cobra or an ACA policy, switch to Medicare once you turn 65, Ms. Cubanski says. If you don’t make the move in the three months before or after your 65th birthday, you‘ll have to wait until the beginning of the following year to sign up—and your coverage won’t go into effect until July 1. For each year you wait to sign up, you will pay an annual penalty of 10% of your premium under Medicare Part B, which covers doctor visits, and about 12% of your Medicare Part D premium.

Severance 

Companies frequently offer severance to employees they lay off. One or two weeks of pay for every year of employment up to a cap, such as 26 weeks, is typical, says Christopher D’Angelo, an employment lawyer in New York at Michelman & Robinson LLP. Some firms also include outplacement services or bonus pay for the portion of the year an employee was on the payroll.

If you feel your employer is pressuring you to quit, you may have some leverage to negotiate severance, says Ms. Rappaport.

In contrast, those subject to a mass layoff typically have little leverage to bargain unless they band together or have “a strong legal claim,” says Mr. D’Angelo, citing someone who recently filed a sexual-harassment claim.

Because companies pay severance only after employees sign waivers releasing them from legal claims, an employer might be willing to pay more severance to encourage someone with such a claim to waive the right to pursue it.

Before accepting severance, have an employment attorney review the agreement, says Ms. Rappaport. The Age Discrimination in Employment Act gives those subject to layoffs involving more than one employee up to 45 days to consider a severance offer—and confer with an attorney—plus seven days after signing in which to revoke that decision.

Unless you have complex issues, total costs for an employment attorney are likely to range from $1,000 to $5,000, says Mr. D’Angelo.

Disability Insurance 

If you become disabled, you may qualify for benefits under an insurance policy or a government program.

Many employers offer free short-term disability coverage for up to 90 days as part of a benefits package. Some also provide long-term coverage or allow employees to buy it at a discounted rate to help plan for the possibility of early retirement due to disability. (Individuals also can buy coverage directly from insurance companies.)

Long-term disability policies typically pay 50% to 60% of a disabled employee’s salary, says Mike Stein, assistant vice president at Allsup, a Belleville, Ill., company that represents people filing disability claims.

To collect, you have to meet your policy’s definition of being disabled. “It’s not uncommon to see policies that say, ‘We will pay you if you are unable to do your former job for the first two years and after that, we will continue to pay you only if you cannot do any work,’” says Mr. Stein.

If you paid Social Security taxes for 20 of the past 40 quarters, you may qualify for Social Security Disability Insurance if your disability is expected to last at least a year or result in death. (Supplemental Security Income is a separate program for low-income people with disabilities.)

If you qualify for both SSDI and private disability insurance, file for both, Mr. Stein says. Generally, your insurer will reduce your policy’s benefits by the amount of your SSDI, says Mr. Stein.

SSDI often adjusts its payments annually for inflation and allows recipients to file for Medicare after two years, among other benefits.