Last Week’s Question of the Week: How many dollar bills are in a pound of money? Is it 250 or 454 bills?
ANSWER: 454 bills. (454 grams = a pound by the way!)
HOST: Today you are discussing what happens if you find yourself in the situation where you can consider retiring early, maybe as early as 55?
KLAAS FINANCIAL: Yes, for those of you who are thinking about retiring earlier than the traditional age of 65, you may want to listen! Sometimes retiring sooner is not an option due to financial and health insurance considerations, and for others we may have to retire early due to health considerations. A survey from Allianz Life Insurance Company in January of 2020 finds that half of Americans retired earlier than they expected. Most respondents said that they did so for reasons outside of their control, with 34% citing job loss and 25% health-care issues.
But today’s topic is about really evaluating the question as to when would you ideally like to retire? And secondly, when will you have all of your ducks in a row to accomplish this? We would encourage our listeners to think through this decision carefully before deciding to make this transition and enlist the help of a financial planner. Stress-testing an early retirement plan which can account for market volatility, taxes, or other changes to your cash flow or expenses that can impact the outcome is really important to know.
We are going to focus on what an early retirement at age 55 can look like and the challenges and opportunities that this age brings us. Some challenges to retiring at 55 include:
Generating income before you can take money from your IRAs:
Generally, if you withdraw funds from your IRAs before age 59 ½, you’ll trigger an IRS tax penalty of 10%. You will have to pay income tax on these funds plus the penalty. Taking an early retirement is not one of the exceptions to the 10% penalty for early withdrawals from a traditional or Roth IRA. So, you may need to wait until you turn 59 ½ to access these accounts.
Age 55 and 401(k) and IRA withdrawals:
- Rule of 55: Under the terms of this rule, you can withdraw funds from your current job’s 401k or 403 (b) plan with no 10% tax penalty if you leave that job in or after the year you turn 55. (Qualified public safety workers can start even earlier, at 50.) It doesn’t matter whether you were laid off, fired, or just quit. **Remember that 401ks are required to hold back minimum taxes of 20% on distributions. Keep in mind this does not apply to your IRA! So be careful about automatically doing a rollover into an IRA if you are retiring prior to 59 ½.
- Substantially Equal Periodic Payments (SEPP) is another option for early retirees to access funds in an IRA or old 401(k) before age 59 ½ without incurring a penalty. But the rules can be very complicated. At a high level, you have the choice of one of three IRS-approved distribution methods. Your required withdrawal is calculated according to the method you selected. You don’t get to decide how much you want to take out and when. The payments must continue for at least five years or until you turn 59 ½, whichever is later. If you start a SEPP program at age 55, you’ll be able to stop at 60. Failure to follow the SEPP rules can trigger penalties and interest. There is a lot to know about this and you don’t want to get it wrong. And keep in mind, distributions from traditional 401(k)s or IRAs are fully taxable as ordinary income.
Consider Reduced Social Security Benefits:
Remember that eligibility doesn’t start until 62 which is the earliest you can begin your benefit. Remember that Social Security benefits are calculated based on 35 years of earnings. If you don’t work for at least 35 years, zeros are averaged in and result in smaller retirement payments. Remember that if you begin Social Security benefits at age 62, payments are reduced unless you wait until your full retirement age to begin benefits. (Your full retirement age depends on the year you were born and is 67 if you were born in 1960 or later).
HOST: If I decide to retire at 55, what do I do about health insurance? And should I be putting away extra savings to use for an early retirement?
KLAAS FINANCIAL: Great question! Yes, this is another area requiring a lot of consideration. You will likely be paying for your health insurance before Medicare kicks in at age 65. So, what are your options for health insurance if you retire at 55 or anytime sooner than 65? In general, early retirees have five options for health insurance before Medicare:
- Retirement health insurance continuation from your employer/COBRA coverage
- Public exchanges
- Private insurance exchanges
- A spouse’s plan
- Part-time job that offers benefits
Keep in mind, COBRA continuation health coverage generally only lasts for 18 months (if you retire at age 55, you’ll need 10 years.) The COBRA coverage allows you to remain on your employer’s plan for a certain amount of time and you will pay up to 102% of the plan cost (this includes the amount you and your employer paid for coverage plus 2% for administrative costs). Generally, COBRA applies to all group health plans maintained by private-sector employers with 20 or more employees. Speak with your employer for details, or learn more about COBRA at the Department of Labor website.
The Affordable Care Act guarantees access to health insurance regardless of pre-existing conditions. You can’t be charged a higher rate for any health conditions, but premiums are based on age. Coverage between the ages of 55 and 65 can be expensive, costing $1,000 per month or more depending on the type of plan you choose and where you live. According to the Kaiser Family Foundation, the average cost of a silver (mid-level) plan for a 55-year-old purchased through the Marketplace is $804 per month. For two 55-year-old adults in Boston, MA would pay a premium of $995 per month in 2020 for a silver plan, assuming they’re not eligible for subsidies. The same couple would pay $1,590/month in Jupiter, FL and $1,359/month in Houston, TX.
Veteran’s Health Insurance: If you’re a veteran who served with honor, you’re eligible to enroll for VA Health Care. The Veterans Health Administration is America’s largest integrated health care system with more than 1,700 VA medical centers and outpatient clinics across the U.S. If you served in the active military, naval or air service and are separated under any condition other than dishonorable, you may qualify for VA health care benefits. National Guard and reservists activated for federal duty can qualify for a number of health care services provided by VA.
So, if you have a handle on how you will likely handle the health insurance aspect, consider doing the following to set yourself up for an earlier retirement:
Take a close look at your monthly expenses: Estimating your expenses in retirement is important and sometimes people overestimate their retirement spending needs. Whether or not you’re financially able to retire is more about your expenses than your savings. If your lifestyle is relatively inexpensive, retiring at 55 may not be terribly challenging.
Putting away extra savings for an earlier retirement: Another area of consideration is understanding that an earlier retirement means that you will want savings outside of retirement accounts. Keep in mind that since you will potentially be tapping your savings earlier (to pay for that health insurance), you will also be shortening your saving years. So, most people want more control over their day-to-day after they retire, not less. You’ll generally have the best opportunity to live the lifestyle you want in retirement and retire early if you have investment assets outside of your retirement accounts. A taxable brokerage account is the most flexible type of investment account. There is no contribution limit or rules about when you can sell funds and withdraw the cash. In exchange for this unlimited flexibility, you sacrifice the tax-deferred growth and tax deduction you receive with 401(k) or 403(b) contributions.
HOST: What drawbacks to retiring early should we be aware of?
KLAAS FINANCIAL: Some potential drawbacks:
Lifespan: Consider that the average lifespan in the U.S. in 2020 was just shy of 80 years. If you retire in your 50s or earlier, your savings may need to last for more than three decades. Since you have spent probably three to four decades accumulating your retirement nest egg, upon retirement you will need a withdrawal strategy in order to not be at risk of outliving your savings for a longer retirement.
Reduced Retirement Contributions: Consider that if you retire 5-10 years early, you are losing those years when you normally would be putting away a lot in retirement contributions into your portfolio.
Risks To Your Mental Health: Many people derive their identity from their work and retiring may leave you with feelings you weren’t expecting such as a loss of connection or worth and value. If you don’t have a plan for how to spend your time, the new hours in your schedule could lead to boredom and loneliness whereas work provides social, mental and physical stimulation. If you don’t have hobbies lined up and commitments with friends or volunteer organizations in place, it could become difficult to maintain a sense of purpose.
This Week’s Question of the Week: If you separate from service from your company at age 55 and take money from your 401k/403b account, you will be able to avoid the 10% early withdrawal penalty. True or False?
Catch C.J. Klaas and Maleeah Cuevas on Money in Motion every Thursday on Madison's 1310 WIBA from 8:05-8:35am.