Retirement Income Blog

The biggest problem early retirees face is failure to change spending habits when they retire early.  I worked with a couple who provides an example.  I set up their portfolio to provide a retirement income of $40,000 annually which combined with social security and pensions gave them an income of $80,000 annually. The brother of the wife became ill and she made three trips cross country.  I told her that she could not afford to take such trips because their early retirement budget did not allow for such discretionaryexpenses.  Next thing I knew, she paid $8,000 for elective dental work.  I resigned as their advisor because she refused to change her spending habits. This couple was fortunate enough to retire early but the wife’s unchanged spending habits was leading them to a life of poverty.
 
When you retire early, many estimate that you can probably live on about 75% of your pre-retirement income comfortably.  This assumes that some 25% of your pre-retirement income went to work and its associated taxes, transportation and clothes - and savings toward retirement. In fact, you can select any reasonable percentage of pre-retirement income as your goal and they key is to stick to a budget.  If you don’t keep to your budget, you permanently erode the nest egg that is designed to support you for the rest of your life.

The three early  retirement income sources are social security (if you have attained age 62), pension, and your savings. With so many people under funded for retirement, you may want to do some part time work to supplement your early retirement finances. Again, remember that any overspending will PERMANERNTLY erode you nest egg and cause future financial pain.  The fact that you were able to retire early will be offset by poverty in old age.

The maximum possible social security income for 2008 and 2009 is $2,185/mo. and  $2,323/mo. respectively if you start receiving it at your full retirement age. However, whatever your full retirement benefit is, it’ll be reduced by about 25% if you retire early.  It’ll also be reduced if you earn above a threshold income while you’re under your full retirement age (for 2008, you lose $1 of social security income for every two dollars you earn from working above $13,560/yr. $14,160/yr for 2009.

Your savings are composed of your savings accounts and your defined contribution plans – 401(k), IRAs, etc. You’ll want to choose the best way to convert these to income. When you retire very early, before age 59 1/2, you can employ rule 72t to access these retirement accounts without penalty. Possibilities include converting them to an annuity (use the fixed annuity calculators for an estimate), another form such as an IRA, or Roth IRA, and devising your own withdrawal procedure that ensures that your retirement income will last as long as you.

Controlling your expenses helps prevent them from robbing needed early retirement income. You can categorize your expenses under essentials, debts, taxes, and enjoyment. Essentials cover your food, housing, and transportation. Housing and transportation may have more inexpensive alternatives you can choose from. If you are attracted to an area with lower housing expenses, the sooner you make the move, the better.

Debts such as mortgage, car, and credit card payments should be reduced as much as possible when you retire early. Paying off these loans is often the best way to handle them. Downsizing your material possessions is important in these first two expense categories.   While your pre-retirement ego may have had you buy a new BMW every three years, a used Chevy will get you to your destinations just as fast.

When you retire early, income taxes are pretty much dependent on how you choose to handle your distributions from savings and what tax category your savings are in – tax deferred, taxable or tax free (such as a Roth IRA). See a retirement advisor because the order in which you spend your different post of money can affect your tax bill by thousands of dollars each year. Part-time work can produce a very high penalty on your efforts if they diminish your social security benefits if under your full retirement age.

With your expenses minimized, you can better plan on the travel and enjoyments that you’ve set aside for your early retirement years.  Be a smart shopper.  You may have enjoyed staying at the Ritz while working but when you retire early, you need to get accustomed to clean three star hotels in the off season.

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If you’re 5 years from retirement you may be offered an early retirement plan – i.e. an offer of money in return for retiring at an earlier time than you had planned. What should you consider before choosing to accept any particular early retirement plan?  First, you want to make create a retirement plan–start with the retirement planning calculator.

You must look at your financial situation, your family’s needs, and whether or not you have enough money to finance your lifestyle for the next several years (or are readily employable).

The issues of concern are:
• Evaluating your early retirement plan and stock option issues
• Maintaining insurance for health, life and disability (including long term care)
• Generating income for the duration of your retirement years

Let’s look at each issue.

The early retirement plan and stock options
Your company’s plan administrator must provide a written explanation of your options 30 to 90 days before the final date on which you must take action. Make it clear when you can start receiving plan benefits, what form they take, and what are the consequences of beginning early retirement benefits early.  The tax impact of your alternatives must also be disclosed.  With your early retirement plan in hand, head to your accountant or retirement financial planner.  

Health insurance
Find out if your employer, as part of your early retirement plan, offers any permanent health insurance for your retirement years. If so, how much does it cost? Employer-provided coverage may end on the day you’re laid off or soon after. But, by U.S. law, the Consolidated Omnibus Budget Reconciliation Act (COBRA) allows you to continue your current coverage, including qualified physician, hospital, dental, vision and other medical expenses, at group rates plus a small administration fee. You have a limited time to elect COBRA coverage before it lapses.  Note that Cobra is not a permanent option as it could be much more expensive than what you had been paying as your ex-employer will not subsidize any part of the premium.

Life/disability/long term care insurance
Is it part of your early retirement plan? Other than health insurance, no other types of insurance are provided for under COBRA. But your ex-employer may pay it for a month or more as part of your severance pay and benefits, and then offer a continuance option. It usually isn’t cheap either; and you may be able to find a better deal. Alternative, you may be able to negotiate for longer coverage as part of the total early retirement plan. But as with health insurance, new private plans may not cover you for previous or existing conditions. Investigate them thoroughly, before you decline your ex-employer’s plan.  Consulting an insurance specialist is a good idea.

Income
How much income do you need?  (Use the retirement income calculator). How will you generate income?  Will you qualify for unemployment benefits – and if so, how long will you need to wait before qualifying? Determine other options to work for the duration of the time you expected to work.  In fact, because you are usually given some time to elect or negotiate an early retirement plan, you should be able to take interviews and possibly secure other employment before you job ends.  or, this may be ther opportunity to start your own business.  Your early retirement plan may have some silver linings.

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You must have sufficient capital, mathematically determined before you retire. If you don’t have the knowledge to make use of a financial calculator or financial software and factor in the impact of inflation, your current expenses, changes in future income, a safe withdrawal rate from your portfolio and use Monte Carlo simulation or other tool to estimate the probability of success, then hire a retirement planner. Too many people pursue early retirement with the notion, “I think I have enough.” The lack of planning to retire early leaves people in their 80s eating dog food wishing they had invested a couple thousand dollars for a sound financial plan with an experienced retirement financial planner.

Retention of Capital
Assuming you retire early with sufficient capital, you must have a method to retain it—to limit draw downs that can be caused by a falling stock market and oversight to limit taxation and fees and expenses. If you don’t feel you have sufficient personal knowledge of retirement income planning and how to retire early, then get help. For a few hundred dollars a year you can get a retirement planner to help monitor your results and give you direction, stay on course and make early retirement a success. Alternatively, hire a fee-based money manager and pay 1% of your portfolio (a typical fee) to have it managed full time.

Expense Control
You must have a budget that you will not violate. As a retirement planner, I placed a retired couple on a budget. But the wife always had reasons for “special withdrawals” from the portfolio such as unexpected dental work and three plane trips to visit her dying brother. Even after my explanation that the couple could not afford these unplanned expenses, they continued and I resigned as their retirement planner. The couple was headed for the poor house because of their inability to understand that capital in retirement is limited and hard choices must be made and budgets adhered to. Their knowledge of how to retire early may have been sufficient, but their implementation and discipline was not.

Additionally, you must know enough about tax planning, tax minimization and minimzation of brokerage costs, investments fees and insurance costs. Many of these costs are hidden so if you don’t know where to look, get a fee based planner to help you.

Health Insurance
Anyone could go bankrupt from a single major illness without proper insurance. Make sure you have permanent coverage (i.e. non-cancellable) that you can renew for a lifetime. Note that many health insurance plans are regional and not national so before you retire, be sure you are content to remain living in the area in which you retire. Your health plan may not be portable. With these few areas being welled planned beforehand, your ability to retire early and successfully is enhanced.

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