Retirement planning is best done early because the future is never certain. We have prepared a comprehensive guide to help you navigate the Retirement Risk Zone (RRZ). The Retirement Risk Zone is the 10 years preceding and following your retirement.
Retirement income plans prepare you for the decisions you will need to make in the RRZ. A series of nested decisions to consider may come from crafting an income plan. Distribution timing, investment selection, risk management and tax planning are all factors.
Making financial decisions with clear understanding helps reduce anxiety. We hope this guide will help you feel confident in the financial decisions ahead of you.
Before you answer the question of "how early can I retire?" we need to understand what early retirement means to you. Everyone has a different goal for retirement age.
A growing online trend called the FIRE movement. FIRE stands for "Financial Independence, Retire Early". Recently young people starting to consum content related to personal finance suggest spending less and increasing savings during working years. The sooner you start saving and investing, the more money you will have saved as you age.
While a broad and difficult thing to define, full retirement age as defined by social security is age 67.
People often try to retire around age 65, when they qualify for Medicare benefits. Data shows that men retire at an average age of 64, and women retire at an average age of 62. Having a plan helps ensure you can retire earlier than you may have thought.
Retirement plans are all about answering the question "Do I have enough money to last until the end of my life?" Early retirement means more years of income needed. This requires a larger pool of money on the day that you retire. The first step is reasonable projections.
There are a lot of variables that need to account for. These include income, asset selection, and retirement benefits. Not everything has the same level of urgency or importance. Keep this in mind and remember to tackle one step at a time. Be as detailed as possible without overwhelming yourself to improve quality of life.
Remember, the best plan is one that you can manage, not the one with the best numbers on paper. We recommend starting with a budget based on your current cash flows.
Create a mock monthly retirement budget to make the transition easier. Remember to include insurance, travel, and medical expenses. You want to account for what you will continue paying once you stop working, and everything you may add on. A common rule of thumb is estimating 80 - 100 percent of your pre-retirement expenses.
Often forgotten categories are small or infrequent expenses. Things like subscriptions and coffee shop visits, or repair/ replacement of your vehicle. Changes to remember might include less eating out and more travel. Allocating your retirement savings with accuracy makes a plan more reliable.
Remember your desired lifestyle may also change as you age. Your later years may swap traveling costs, for higher health care health care bills. You may need to remodel your home if you want to age in place. You might consider a retirement community to have extra help in your senior years.
As for income, consider pensions and Social Security benefits. Anything that helps you withdraw less from your savings.
Next, you can project your likely retirement age by finding the income shortfall. This is calculating your Required Portfolio Income, or RPI. The RPI is the gap between your desired spending level and your guaranteed income.
Here’s where your investment accounts will enter the picture. We want to know if your savings will be able to support any existing shortfalls in your spending desires.
You can claim Social Security at 62, but you'll earn 70% of your full benefits. You can qualify for full benefits at Full Retirement Age (FRA). If you're born after 1960, your FRA is 67. Delaying social security to age 70 earns an extra 30% of benefits. Remember survivor benefits of 50% are available as well. Social Security will not pay back benefits for any month preceding FRA.
This assessment has many steps, but we will walk you through the math. Less preparation means more unknowns for your future self. The goal is to feel educated on the outcomes and tradeoffs.
The most often ignored and most important part of retirement planning is cash flow.
It's a given that your financial goals will shift during your life. If you start with a solid baseline plan and monitor progress you can minimize friction.
The key takeaways are how much will you make in retirement and how much will you spend. If you retired today, you would likely feel some anxiety about where your money is going to come from. This is completely normal. You can arrive at a reasonable age after making a budget and calculating RPI.
Strategize for Pension and Social Security Benefits
In an ideal world you have predictable income streams for retirement. With many sources, the earlier you start payments, the lower your monthly benefits will be. This means trading off earlier income and raising RPI to bridge the gap. Claiming benefits earlier backloads the risky years of retirement. Think about when you face the most risk to your financial security.
Benefit amounts will also change with survivor benefits. Survivor benefits are how much your spouse or beneficiary gets should you pass first. If you elect for higher survivor benefits your monthly benefit will often decrease. The primary earner can raise survivor benefits to ensure loved ones have income.
Spousal benefits are how much your spouse claims on your record while both alive. The greatest spousal benefit for Social Security is 50 percent of the benefits.
Pressure-test Your Retirement Accounts
Once you have a budget and RPI, you calculate how long your savings should last you. You can model accuracy in a financial planning tool. You should always double check inputs to retirement planning tools. Keep in mind that these projections are only projections.
Retirement planning tools serve as a good directional model, without details. Think of a Monte Carlo simulation as a destination without the turns and streets you need to take. You have an idea of where to go but not how to actually get there.
- video on retirement planning tools
A fiduciary financial planner fills in the texture for your road map. This means they always protect your best interests no matter the circumstances.
RPI gives you a distribution rate. Remember that distribution rates follow life phases. Things like claiming Social Security or declining physical capability lower RPI. The distribution rate should be something sustainable. Somewhere below 7 % or so.
Employer Accounts and Rollovers
Some employer plans allow you to choose a lump sum payout instead of monthly benefits. This means that you withdraw the balance all at once. Keep in mind this may come with a tax liability. You may also get a lower net payout, in exchange for receiving more money up front.
Rollovers are different from withdrawals. Rollovers are custodian transfers, without you taking full possession of your retirement savings. The real-world difference is the payable party on a check. See our rollover guide here. Direct withdrawals are payable to you rather than a financial institution.
Remember you must be at least age 59 1/2 to avoid early withdrawal penalties in retirement accounts. Withdrawing from retirement accounts earlier incurs penalties of 10% plus any other taxes.
For many people, the effects of saving outweigh rates of return on investment. Saving more money has greater impact until your assets reach a significant level. Returns on investment will make you less money for the majority of your life. This means you should shift your attention to good habits that allow your wealth to grow. Give mental energy to saving rather than daily portfolio changes. All you need to do is learn the fundamentals of what you invest in and potential options.
As you approach the RRZ reassess your investment strategy and consider risk tolerance.
Invest in a Bridge Account
Save into qualified accounts at least up to your employer match. If you can also save into taxable accounts, you may pay less tax for withdrawals. This makes regular brokerage accounts a valuable asset. Saving into taxable accounts helps build more tax favorable withdrawals. Withdrawing from cost basis means lower tax upon distributions. Remember, this is not direct advice as your situation may be best suited to another strategy.
Also be familiar with timing when it comes to withdrawals. Using cash means you will have to sell investments to refill cash balances. Most stocks and funds will settle the business day after your sale. This means if you sell a stock on Wednesday, you can withdraw cash on Thursday.
Take caution and use liquid investments for cash planning. Allow a cushion of at least a few days between withdrawals and when you pay your expenses. You can set up a reminder system to prompt liquidating assets and transferring money.
Longer retirement means more years to support expenses. Delaying benefits claims, means higher sequence of returns risk in the early years. You need to balance growth potential with risk management.
We at Peak Financial Planning don't believe in following only asset allocation. Having 60% stocks and 40% bonds without more knowledge of your investments isn't enough. Risk management is crucial for retirees, especially during the early stages.
Asset allocation pigeonholes is a one size fits all strategy that isn't individualized. We track metrics like max drawdown, beta and market correlation. These are more specific measurements that can help protect your best interests.
Remember how your retirement budget fits into your strategy as well. Many investment plans exist. Your RPI and available assets are big factors in investment strategy.
No one method is always prudent for everyone. But there are some worth considering. If you put in time and research, you can find safe options for investment that best suit your needs.
We recommend you review your portfolio quarterly or more and adjust upon life events. We review quarterly, at important life changes, and when markets experience significant changes.
Retiring early may come at the cost employer health insurance plans. Healthcare costs can add up fast, so this is something to consider in your plan.
One of the options is COBRA. COBRA is a law that helps you stay under your previous employer's health plan upon retiring. COBRA insurance is often limited to 18 months, so most people use this at age 63 and a half.
There are requirements to be eligible. Common circumstances to take COBRA include:
If you qualify due to one of these events, you can notify the employer. COBRA will be more expensive though. If you don't sign up for Medicare at 65, in some circumstances your Medicare coverage may be late and cost more.
There is also traditional marketplace insurance, which may offer ACA Premium Tax Credits. This involves many rules, but we will cover the basics. Household earnings can’t exceed 400% of the Federal Poverty Level. You can’t have employer health care or be eligible for Medicare or Medicaid. You must also be a lawful resident of the United States. You must meet all three tests to be eligible.
Marketplace health care includes bronze, silver, gold and platinum plans. Bronze to platinum trades higher premiums for lower out of pocket expenses. Your benchmark plan is the second lowest cost silver plan available to you.
The benchmark plan yearly premium must be above 8.5% of your household incomes. Higher incomes mean higher expected premium contributions. A sliding scale uses a percentage of your income to calculate expected contributions. Premium Tax Credits = benchmark plan premiums - expected family contributions.
Many retirees keep a low income because they want to preserve their Premium Tax Credits. You should not constrain your financial independence for fear of losing out on the PTC. If you have enough money to enjoy your savings, why not make the most of it?
Single filers income limit is $58,320. A family of four maxes out at $120,000. $4,800 per month is nothing to scoff at. Some people enjoy life for less than that. But if you have substantial wealth, enjoy your savings and hard work. The best time to travel and make new memories is your young and healthy years.
Having a good idea of what your goals are will help you with the next step. Start to visualize what your ideal retirement looks like. Do you have activities to fill your days?
A good reading list, social network, and self-exploration are some ideas. Consider a vacation you always wanted to take. Think about volunteer opportunities in your community that resonate with you.
What about family and friends that would appreciate gifts in the coming years. Retiring early means gaining another chance at missed opportunities. Let's turn retirement from fear to fun, even without millions of dollars in the bank.
Develop projections for your retirement income and expenses. Once you have a budget, you can find your Required Portfolio Income. Using a budget and RPI will help you assess whether or not you can retire. After you create a plan, you can start to implement. These are all part of a comprehensive financial plan. You can view a sample plan and detailed breakdown here.
Consider your retirement income when investing and planning for an early retirement. The most important part is your riskiest years. Claiming retirement benefits early shifts risk to later years. Taking benefits and distributions later shifts risk to the front of the plan. With a reliable budget and RPI, you can plan for how to retire in more detail.
As long as assets and benefits support you, then your retirement goals can become reality. Developing a regular income strategy depends on your personal resources. You want to balance payments with need for growth. Some strategies structure investment income into the budget without worrying about depleting principal. In any case, you must be prudent with your risk management.
Consider consulting a certified financial planner for personalized and professional advice.
1. When can I retire?
You need to run the numbers for your individual plan. Measure assets available, retirement income and RPI. Develop an accurate budget and decide how many years you can support yourself.
2. Can I retire early?
If you have a reasonable level of wealth or reliable income, retiring early isn't out of the question. Don't let fear stop you from making an assessment, even if it's a bit premature. It's better to know what your finances look like than to be making decisions in the dark.
3.When should I claim Social Security or Pensions
Decide when you can afford to tolerate more risk and consult with a fiduciary. Remember the tradeoff between early security and future risk or vice versa. These are decisions that can greatly impact a plan. For those who can't rely on savings for basic expenses, this is an important decision.
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