Catherine Ziegler | Digital Vision | Getty Images
Life may be short, but early retirement can be too if you don’t have a solid financial plan for life after work.
Whether it’s from pandemic burnout, a new attitude towards life, or optimism fueled by rising stock and real estate markets, more Americans appear to be retiring early, according to data from the US Bureau of Labor Statistics.
The labor force participation rate of Americans over 55 rose 0.7% to 39.1% in January, but remains well below the 40.3% recorded in February 2020 and has recovered more slowly than the general population rate.
“I think Covid has increased interest in retirement in general and accelerated the rate at which people are retiring early,” said certified financial planner Lazetta Rainey Braxton, co-CEO and senior financial planner at 2050 Wealth Partners in Brooklyn , New York. “People rethink everything and often more emotionally than practically.”
For those who have the resources, stepping away from it all opens up a new world of opportunity. However, it comes with risks, and for all but the wealthiest Americans – and the earlier you retire, the greater the risk.
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“If you’re debt-free, have a track record within your means, and have enough resources to cover emergencies, turn yourself around,” said Danny Artache, a financial advisor based in Jupiter, Fla. “But if you run out of money, you could end up as a greeter at Walmart.”
Are you ready to retire both emotionally and financially?
There’s no substitute for crunching the numbers on the expected costs and income streams of retirement. Simply settling on a “comfortable” nest egg figure is not enough.
Costs include housing, insurance — if you retire early, you’ll need to get health insurance before Medicare kicks in at age 65 — groceries, gas and vehicle expenses. Key sources of income include pension payments, Social Security benefits, and withdrawals from your investment portfolio.
Braxton advises clients not to take on debt when they retire, except on the rare occasion when the value of the mortgage interest tax deduction is greater than the cost of your annual mortgage payments.
If you plan to travel and/or pursue hobbies that cost a lot of money, include that in your ledger.
“Don’t be afraid of your numbers,” Braxton said. “You have to know what they are.
“The more comfortable you are with these numbers, the easier it is for you to change when things change.”
And they will change. A generally accepted rule of thumb is that you will be spending about 80% of your earned income annually in retirement.
But no matter how well you break down expected expenses and income streams in retirement, there will be curveballs. There are several big unknowns that make retirement planning particularly difficult.
“Retirement is the mother of all financial planning problems,” said Christine Benz, Morningstar’s director of personal finance. “There are so many variables in the mix.”
The three biggest are your health and longevity, the performance of the investment markets, and the level of retirement inflation.
If you continue to earn income, you don’t have to tap into your investment portfolio and increase your future Social Security benefits.
Christine Benz
Director of Personal Finance at Morningstar
The first factor is very personal. Based on your current health and family history, you might not expect a long retirement, but conservative modeling of retirement typically uses a 30-year time horizon.
Another rule of thumb, first formulated by financial planner William Bengen, is that given this conservative 30-year time horizon, assuming a 50-50 stock-to-bond portfolio, you can safely withdraw 4% of your portfolio assets annually.
The rule could use some tweaking, Benz suggested. The remarkably high stock and bond returns of the last 30 years may not be repeated in the next 30 years. In an environment of low bond yields and high equity valuations, investment returns could be lower going forward.
“The next decade may not be great for market returns,” Benz said. “If we are dealing with higher inflation, there is another risk.” Morningstar now estimates that the “safe” portfolio withdrawal rate should be lowered to 3.3%.
If that exit rate, combined with guaranteed retirement and Social Security benefits, can pay for your average retirement year, you’re in good shape. However, if you are worried about your financial situation before you retire, keep working.
“Working longer in a job you hate isn’t good, but the job market is so strong that maybe you can achieve a more comfortable work-life balance,” Benz said.
The value of additional years of service is enormous. It strengthens your resources in retirement and reduces the risk of running out of money later.
“It has a multiplier effect,” says Benz. “If you keep earning income, you don’t have to tap into your investment portfolio and increase your future Social Security benefits.
“Your wealth can continue to grow and potentially help you delay receiving Social Security,” she said, in order to receive a higher benefit.
Your retirement could be shorter, but it could be a lot sweeter.