Retiring early, usually considered prior to Age 65, can present a unique set of circumstances. As a result, the normal financial planning process can become encumbered by rules relating to minimum age to access funds or income sources, ability to access quality health care coverage prior to Medicare eligibility, and planning for a longer retirement plan period than average.
Below are Ten Early Retirement Planning Items that anyone considering an early retirement should review and discuss with their Financial Planner and CPA:
- Easing into Retirement: More workers than ever are transitioning into retirement by cutting back hours, rather than stopping work completely. Those considering early retirement may be able to transition from full-time to part-time, gradually reducing workload moving forward. If your current employer does not offer a phased retirement option, consider a consulting role outside of your existing firm.
Having part-time earned income in early retirement can help alleviate strain on the investment portfolio’s ability to provide income over a longer retirement period. This part-time income could also help to delay any Pension, Social Security, or Annuity payments that could result in increased income payments the longer you delay collecting.
- Health Insurance: Medicare is available once you turn age 65, but how will you fund healthcare expenses early in retirement? Employer-sponsored insurance plans do allow you (and possibly your dependents) to stay on your current employer’s insurance plan under COBRA for up to 18 months. Note that employers with less than 20 employees are not subject to the insurance continuation provisions of COBRA.
If you are married, securing coverage under a spouse’s employer-sponsored insurance plan could be an option. Private Insurance could also be sourced from the Marketplace, however it may be prohibitively expensive.
If you’re thinking of retiring early, funding a Health Savings Account (HSA) now could help assist you with funding your future healthcare needs. These “triple tax advantaged” accounts can lower your current tax bill, while funding a spending bucket for future healthcare costs. For more information on HSAs, including who can contribute, annual contribution limits, and special tax treatment, see our HSA Blog: https://www.domaniwealth.com/insights/advantage-of-a-great-tax-savings-opportunity/
- Social Security: Are you eligible to begin taking Social Security, and if so, when is the optimal time? Collecting these payments at the right time can affect several financial factors in your life. While you may be in a position to retire early, drawing Social Security immediately at age 62 may not be in your best interest. Weighing factors such as conditions of health, ability to live on assets in the existing portfolio, and tax implications of qualified distributions can help guide the decision.
Keep in mind that Social Security Estimates received from the SSA assume that the worker is employed through their Full Retirement Age (FRA) when calculating your future benefit amount. Depending on how early you retire, your Social Security Benefit may be decreased due to less earnings, in addition to the normal reduction in benefit that applies when one starts collecting prior to their FRA.
- The Rule of 55 & Penalty-Free Retirement Plan Withdrawals
Under these IRS guidelines, you can withdraw funds from your current employer’s 401(k) or 403(b) plan prior to age 59 ½ with no 10% tax penalty, if you leave the job on or after the year you turn 55. The terms of your job departure are not relevant as you could be laid off, fired, or just quit, and still utilize this early-withdrawal approach.
This rule only applies to the current employer’s retirement plan. Any old employer retirement plans would need to be rolled into the current plan in order to qualify for penalty-free early withdrawals.
Just because you are able take a penalty-free early withdrawal, does not necessarily mean that it is in your best interest to do so. Consult with your financial advisor to assist in developing a tax-efficient cash flow plan that complements your early retirement goal and specific financial circumstances.
- Pension Plans: Learn the details of any pension payments or defined benefit plan payments you are eligible to receive as there may be certain age requirements that must be met prior to starting the receiving of distributions. The details surrounding your payout can be complex, and there are often several options to structure the payout. If you are married, should you select the joint payout option to also include an annuity for your surviving spouse if you were to predecease your spouse? Is there a guaranteed term to the payout? Reviewing the risks and benefits of each payout option will be beneficial.
- Employer Retirement Plans: Take the right steps for any employer-based 401(k) or 403(b) plans: What elections do you need to make? Do you plan to rollover the amount from those plans into an individual IRA, and how might that help you with the investment options available to you? Do you have any employer stock in a stock purchase or stock option plan? There could be tax-efficient ways to distribute that stock to you.
- Retirement Income: Prepare for retirement by making sure you are comfortable and understand where your cash flow will come from each month when a paycheck will no longer be deposited automatically. Knowing the tax consequences of where your cash flow comes from is incredibly helpful. You will be affected differently if you pull funds out of your traditional IRA vs. a Roth IRAor your personal investments. A tax planning strategy coordinated between your financial planner and your accountant around this will be key.
- Income Taxes: What is your plan to pay your income taxes moving forward, since they will no longer be withheld from a paycheck? You may need to estimate taxes or determine what needs to be withheld from pension payments, IRA withdrawals, and Social Security payments. In the early years of your retirement, there may be a possibility for a Roth Conversion between your retirement date and age 72, when your Required Minimum Distributions will begin as it’s possible you could be in a lower tax bracket.
- Home Equity Line of Credit: Consider a home equity line of credit (HELOC) loan before you retire, if you own a home. Banks often lend more readily to those with regular paycheck-based income. Having a HELOC may enable you to be more flexible with access to cash during an emergency, or if markets may be volatile. This access can also help you balance income to minimize tax consequences or help you manage healthcare costs.
- Professional Management: Decide if you feel comfortable managing your retirement plans and investment funds yourself or if you would like professional help as you prepare for retirement. Working with a financial planner to manage your portfolio can help you ensure your retirement needs are met and coordinate your overall risk to match your goals. You will be able to answer questions such as – will your tax rate change? When should you begin pension or Social Security income? What risk level and investment options are the best for your specific plans and goals? How will charitable giving and tax planning affect your retirement?
Retirement is a big decision; retiring early is an even bigger decision. Working with a wealth advisor at Domani Wealth can help you navigate the complexities of your financial decisions, tax planning, and creating the best roadmap for your future as you prepare for retirement – so you can sit back and relax! Selecting a local advisor (rather than a national firm with one-size-fits-all or templated plans) who will develop a tailored plan just for you will most benefit you and give you confidence in a future you can enjoy.
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