Forbes - July 21, 2020
Having the option to take an early retirement is a really nice thing to have. But is 55 too early to retire? If you want to retire early, you'll need a solid plan, masterful control over your expenses, and savings outside of retirement accounts. Here's how you'll know if 55 is too early to retire.
Is 55 too early to retire?
Perhaps you've worked hard and want more free time to enjoy your success. Or maybe you're wondering if you should take the early retirement package you were offered. Either way, retiring at 55 is considered early. For some investors, it's too early. But if you've been diligently saving and can manage your lifestyle expenses, retiring at 55 could be within reach.
Top five challenges to retiring at 55:
Generating income before you can take money from your IRAs
Strict rules about 401(k) withdrawals at age 55
Social Security eligibility doesn't start until 62
Paying for health insurance before Medicare eligibility begins at 65
Tapping your savings earlier, while shortening your saving years, and extending how long the money needs to last is a challenge
Hands off: Penalty-free IRA withdrawals don't start until 59 1/2
Even after you retire, you might still not be able to access money in an IRA without incurring a 10% penalty. Taking an early retirement is not one of the exceptions to the 10% penalty for early withdrawals from a traditional or Roth IRA. So you'll need to wait until you turn 59 1/2 to access these accounts.
In addition to reaching age 59 1/2, for Roth IRAs, the account must also have been opened at least five years ago. Though you can always withdraw contributions (just not any growth and earnings) tax and penalty-free.
Taking money from your old 401(k) at age 55
Even though your IRAs are effectively off-limits, you may still be able to live off money from your 401(k). It's called Substantially Equal Periodic Payments (SEPP) and it permits early retirees’ access to their old 401(k), penalty-free. But there are rules.
At a high level, you have the choice of one of three IRS-approved distribution methods. Your required withdrawal is calculated according to the method you selected. You don't get to decide how much you want to take out and when.
The payments must continue for at least five years or until you turn 59 1/2, whichever is later. If you start a SEPP program at age 55, you'll be able to stop at 60. Failure to follow the SEPP rules will trigger penalties and interest.
If your 401(k) isn't large enough to meet your income needs for the first five years of retirement under the prescribed payout methods, you'll need to figure out how to supplement your income...or reduce your expenses.
And keep in mind, distributions from traditional 401(k) plans are fully taxable as ordinary income. If the distribution is less than ideal, you'll wind up with even less to maintain your lifestyle. If you've been at your job for a very long time and have a large 401(k), the Substantially Equal Periodic Payments could leave you with little control over your tax situation and force you to take more from your tax-advantaged accounts than you need long before Required Minimum Distributions begin at age 72.
55 may not be too early to retire, but it is too soon for Social Security
As you work to navigate the income equation in hopes of retiring at 55, cross Social Security benefits off your list of potential income sources in the short-term. Eligibility for Social Security benefits starts at 62 for retirees. Also, you'll want to weigh whether you should file for benefits as soon as possible or hold off for larger checks. This might mean taping retirement accounts to delay Social Security longer, at least after you turn 59 1/2.
Social Security benefits include 35 years of average earnings, so unless you started working at age 20, the Social Security Administration will use $0 salary for the last few years when calculating your benefits.
Health insurance options before Medicare
Unless your spouse is still working and you can join his or her health insurance plan, paying for health insurance on your own may be prohibitive. With Medicare eligibility beginning at 65, what are your options for health insurance if you retire at 55?
In general, early retirees have five options for health insurance before Medicare:
Retirement health insurance continuation from your employer
Private insurance exchanges
A spouse's plan
COBRA coverage generally only lasts for 18 months if you retire early, and you need 10 years. The public exchanges (Obamacare) will usually be more affordable than private insurance, but it's still really expensive, and the cost varies by state.
According to the calculator from the Kaiser Family Foundation, two 55-year-old adults in Boston, MA would pay a premium of $995 per month in 2020 for a silver plan, assuming they're not eligible for subsidies. The same couple would pay $1,590/month in Jupiter, FL and $1,359/month in Houston, TX.
To retire at 55, you'll want savings outside of retirement accounts
Most people want more control over their day-to-day after they retire, not less. The thought of having restricted access to your own retirement savings is probably less than ideal. But no one said retiring early at 55 was easy, right?
You'll generally have the best opportunity to life the lifestyle you want in retirement and retire early if you have investment assets outside of your retirement accounts . A taxable brokerage account is the most flexible type of investment account. There is no contribution limit or rules about when you can sell funds and withdraw the cash. In exchange for this unlimited flexibility, you sacrifice the tax-deferred growth and tax deduction you receive with 401(k) or 403(b) contributions.
But that's not to say a brokerage account is tax in efficient, either. Long-term capital gains tax rates are much more favorable than 401(k) or IRA withdrawals which are taxed as ordinary income. In fact, a married couple filing jointly with income under $80,000 in 2020 would pay a 0% tax rate on long-term capital gains !
Figuring out if 55 is too early to retire requires financial planning
At any age, you'll want to make sure you've fully thought through your retirement plan (financially and otherwise) before retiring. Retiring early requires even more planning as the traditional sources of retirement income aren't available and new challenges, like health insurance, arise. Here are some financial planning tips for executives looking to retire at 55.
Hone in on your expenses
Estimating your expenses in retirement is difficult and some investors actually overestimate retirement spending needs. Whether or not you're financially able to retire is more about your expenses than your savings. Put another way, what you're going to spend drives how much you'll need saved so you don't run out of money.
Here's a simple example:
If your portfolio is $2,000,000 and you need to take out $100,000 per year (increasing 3%/year), you'll run out of money when you're 84 assuming a 6% annual return. But if you only needed $80,000/year instead, your income could last until age 96.
If your lifestyle is relatively inexpensive, retiring at 55 may not be terribly challenging. But being able to retire early gets harder as lifestyle inflation takes over .
Don't underestimate how long you'll live
People are living longer. This means your retirement savings have to last you longer.
Here are some statistics according to data from J.P. Morgan:
A 62-year-old man has a 61% probability of living until 80 and nearly a one in four chance of living until age 90
A 62-year-old female has a 71% probability of living until 80 and one in three odds of living until 90
As a couple, there's an 89% chance at least one spouse will live until 80 and almost a 50% probability that one person will live until 90
Put another way, the odds of either you or your spouse living past 90 are roughly 50/50. If you retire at 55, you'll probably spend more time in retirement than you did working. It sounds nice, but affording it requires lots of planning and a disciplined approach to saving and investing.
Stress-testing an early retirement plan
The simplistic calculation above doesn't account for market volatility, taxes, or other changes to your cash flow or expenses that would impact the outcome. For guidance on a complex question that takes your entire financial situation and retirement goals into account, you'll really want to develop a financial plan with the help of a CERTIFIED FINANCIAL PLANNER™ professional.
To feel confident that 55 isn't too early to retire, your plan should include a Monte Carlo simulation to account for market volatility. A Monte Carlo analysis is essentially a way to stress-test a retirement plan .
In the analysis, also consider the role timing plays in your plan. Expenses are often the highest at the beginning of retirement, but this is also when you're going to be most exposed to a market downturn . If you can avoid large purchases and overspending at the beginning, your plan will be stronger for it.
Putting everything together in a comprehensive financial plan is often the best way to figure out if you can retire at 55. Even if it's too early to give you the lifestyle you want, perhaps working for a couple more years will get you there. Running the numbers will help you understand what trade-offs exist and what options best suit your needs and goals.
By Kristin McKenna, Senior Contributor
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