Could you retire early?
When you reach your late 40s or early 50s, it’s natural to start wondering whether you could retire in the next decade.
If you have $225,000 saved, the answer is: Probably. But you have to plan well.
“With proper planning and discipline, the 10-year home stretch can be transformational,” says Samuel R. Scott, a CFP professional and president at Sunrise Advisors in Leawood, Kansas.
Bankrate asked Scott and two other financial planners to make recommendations for a hypothetical worker with the following profile:
- Age: 52.
- Savings: $250,000 in a tax-deferred account.
- Goal: Retire with $500,000 in 10 years.
This individual would live off his savings for three years. Then at age 65, our retiree would start collecting Social Security and withdrawing 4 percent of the remaining nest egg each year.
Read on to learn how to reach this goal and retire at 62.
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Contribute to a retirement plan
An investor who expects 5 percent growth over a 10-year period would need to save $7,500 annually to grow $250,000 to $500,000, Scott says.
“If their employer has any sort of matching component to their retirement plan, it makes sense to take advantage of the ‘free money’ to leverage their savings rate,” he says.
Clarissa Hobson, a CFP professional with Carnick & Kubik in Colorado Springs, Colorado, urges our investor to put aside even more — about $10,000 per year. Hobson expects a slightly higher annual return of 6 percent to build up savings of about $580,000.
Michael Kitces, a CFP professional and director of planning research at the Pinnacle Advisory Group in Columbia, Maryland, is the most optimistic of our trio of financial planners.
He says it’s reasonable to expect a 7 percent return on a well-balanced portfolio. Over a decade, that would double the value of the portfolio, transforming $250,000 into nearly $500,000.
“This goal is actually quite within reach, even without any contributions,” says Kitces, who publishes “The Kitces Report.”
Prepare for retiree health costs
Most people are not eligible for Medicare until age 65, so those who retire at 62 probably will have to contend with health care costs.
“Health care is certainly a wild card in retirement planning,” Scott says. “The best way to prepare for uncertainty is to plan conservatively.”
That means saving money outside of retirement accounts to cover medical bills.
But Kitces says people whose income is lower in retirement than it was during their working years may qualify for Obamacare tax credits that reduce the cost of health insurance “potentially quite significantly.”
Hobson advises soon-to-be retirees to assume that health insurance costs will grow 5 percent to 7 percent a year.
She also encourages retirees to estimate the total annual costs for Medicare Part B, Part D and supplemental policies.
“I think around $4,500 per person annually in today’s dollars is reasonable,” she says. “These costs also need to be increased for inflation.”
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Diversify your portfolio for tax purposes
If you plan to rely on tax-deferred savings in early retirement, keep in mind that your monthly retirement statement doesn’t reflect your actual savings. Every time money is withdrawn from a tax-deferred account, taxes are owed.
For example, $500,000 in an IRA or 401(k) plan does not mean you have $500,000 in spendable funds.
“It is quite shocking how quickly assets are spent down when a tax liability is incurred every time someone needs to replace an air-conditioning unit, buy a car or pay their mortgage,” says Scott, of Sunrise Advisors.
He says it would be better for our hypothetical retiree to have the option of drawing on tax-deferred and after-tax accounts.
Hobson agrees. “If the $250,000 is in a company retirement plan, he should also save in a taxable account to hedge his bets somewhat against future tax rates,” she says.
Another solution: Invest in a Roth IRA or Roth 401(k) because money in these vehicles grows tax-free and is withdrawn tax-free.
Avoid Social Security missteps
If you can retire early without depending on Social Security, you’ll avert the potential mistake of reducing your overall benefits. Hobson urges our retiree to wait until the full retirement age — 66 or 67, depending on year of birth — before tapping benefits.
“And it may make sense to wait even longer than that,” she says.
Kitces says retirees who work part time need to be aware of the earnings test for Social Security benefits. They’re withheld for retirees who earn too much money in any given year before their full retirement age.
“This isn’t necessarily a bad thing,” Kitces says. “Social Security benefits that are delayed due to the earnings test do lead to higher benefits later.”
However, if your part-time income is too modest to fully support you, even if it is substantial enough to trigger the earnings test, you might need to tap your portfolio a little more and a little sooner than expected.
Consider working part time
Consulting work or other part-time work lets early retirees earn some extra cash while building up their Social Security benefits.
“Retirement doesn’t have to be an all-or-none situation,” says Kitces, of Pinnacle Advisory Group.
Earning a little income on the side allows you to keep your portfolio growing without having to tap it.
Hobson, of Carnick & Kubik, sounds the alarm about withdrawing 4 percent from your portfolio annually, saying it “may not be advisable, depending on market conditions.”
The combination of market losses and withdrawals can decimate your savings. Retirees can protect themselves by positioning their portfolio conservatively or waiting until the market recovers before taking withdrawals.
A financial planning professional can help retirees create a portfolio for capital preservation with some room for growth.
Compare CD rates and find the highest yields at Bankrate.
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