An Early Retirement, Maybe

With proper planning, you can.

How do you retire early? With much planning. Sometimes it’s the best move if you have a skill that you can convert into a consulting position. It’s like slowly stepping into retirement and having flex time while still earning money.  It’s common in technical positions like engineering, construction and architecture. Evaluate your field and see if such opportunities exist for you.

Start planning when you’re young.

If you are reading this when you’re young, you have decisions to make. Do you want a shot at early retirement or do you want that $150 a month cable bill now, that new car every three years now, that really nice vacation every summer now? Most people can’t have both a shot at early retirement or financial security and the immediate gratification things now, too.. Choose carefully. I’m not suggesting that you sacrifice everything now for the sake of building your nest egg. I’m saying that you should find balance.

Transition to retirement.

If you are reading this at an age that you are contemplating an early retirement, I hope you made the right decisions related to the above expenses.

The type retirement plan you have plays a big role in this decision. First let’s look a defined benefit plan. Your HR department will have a plan document that will help you determine an estimate of your benefits at various ages. Some plans may not allow benefits to be paid on an early retirement. You may have to wait until at least age 62.

Most pension plans will have multiple payout options, for example, straight life, joint life or life period certain. With a straight life option, you will get the highest payout because it only considers your life expectancy but it ends upon your death. The other two options payout over your lifetime and continue to pay a joint person, usually a spouse, during their lifetime. Depending on the difference in payout, you may be better to take the higher life only payout and use the amount above the joint options to buy a life insurance policy making your spouse the beneficiary as a substitute for the joint life options.

Should you rollover your 401(k)?

Defined contribution plans like 401(k), 401(a) and 403(b) plans can be rolled into a self-directed IRA upon separation of service from your employer. Rolling over your plan will give you additional benefits. You will have more investment options outside the short list available to the plan. Plus, you can invest in income producing securities. Most 401(k) plans have a few bond options but you’ll need something designed for retirement income.

The plan stays tax-deferred as long as the assets are transferred directly from custodian to custodian and you do not have constructive receipt of the money. Therefore it was never a taxable event. It is very important to understand to keep the plan tax deferred. I came across a case once where the retiree took his 401(k) plan in a check then deposited it into a brokerage account. It was all included in his taxable income that one year causing him to pay all taxes due that year and some of it at the highest tax bracket. Once the mistake is made you have a tight window to correct it. Otherwise the damage is done.

In addition, a rollover IRA can be converted to a stretch IRA for the benefit of your survivors. Subscribe to this blog for a future article on this topic. When withdrawing money, deplete your taxable accounts first to keep your other assets tax-deferred longer.

Consider a guaranteed income

It may be worth your time to investigate annuities with a GMWB, guaranteed minimum withdrawal benefit. This means that the issuing insurance company will guarantee at least a minimum retirement income payout based on the highest account value regardless of the current account value.

The guarantee is only as good as the company making the guarantee. There is no FDIC or similar program for insurance companies, however you can check with your state’s insurance commissioner to see if there is a state guaranty association that makes good on at least the minimum guaranteed income should the issuing company not be able to meet it’s obligation.

Be careful of high fees associated with some contracts. I’ll cover annuity fees in a future article. Subscribe so that you’ll be notified.

The Case Against Early Retirement

Now for the case against retiring early. Of course, an early retirement means fewer income earning years and more years that your money needs to last. By working an additional 10 years and averaging a 7% return in your investment accounts your balance will double. (Check back for a future article on the “Rule of 72” which explains how long it takes for money to double). Plus, investing $1000 per month for 10 years and averaging 7% return would result in an additional $150,000.

In addition, a 60 year old has a life expectancy of 83. Consider family history and your own health to arrive at your own estimate. Retiring early may well mean accepting a lower standard of living to get your money to last through life expectancy.

Your purchasing power will erode.

Inflation will have more time to work against you as well. Historically at 3%, that means prices double about every 24 years. Include the effect of increased prices in your plan.

How much will you need to retire? First you need to establish your minimum acceptable annual income. Let’s say that’s $50,000. Subtract Social Security, annuities and pension benefits. Let’s assume the average SS annual payment but no annuity or pension in this example, $16,416. Subtract $50,000-16416=33,584. Now divide that by .04, $33,584/.04=839,600. That’s what a person would need in this example, $839,600 yielding 4% provides $33,584 plus the $16,416 average social security payment equals $50,000 income. The details are a little more complicated, but as a rule of thumb this will work.

Closing Tips

Here are a few more tips. First, your portfolio should be more conservative during the withdrawal phrase. If your investments are subject to high volatility you may find yourself selling equities at a time that their value is down just to fund your income needs. Bonds, preferreds and high dividend stocks may work better.  Secondly, don’t take all of your income monthly. Take a portion during regular quarterly asset allocation rebalancing.

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