The vast majority of financial planning literature and advice is based around an assumption of retirement at age 65, a figure that dates back to the signing of the Social Security Act by FDR in 1935. Much has changed in the decades since, but age 65 has remained something of a magic number, still codified by law as the age of initial Medicare eligibility (even though Social Security itself has gradually moved higher over the years, scheduled to settle at age 67 by 2027).
However, the reality on the ground is that very few American workers actually retire at age 65. According to the Federal Reserve’s 2017 Survey of Household Economics and Decisionmaking, more than half of workers already identified as “retired” by age 62 (even if they were still working on a part-time basis, or otherwise self-employed), and most surveys tend to report that the average retirement age has hovered around 62 for the last decade or more. So, we’ll take some time to investigate the specific challenges and considerations that come with early retirement, since chances are that you’ve considered it, if only briefly.
The financial considerations
Naturally, “early” retirement feels a bit uncomfortable, especially as average life expectancy continues to rise. Even at age 65, the average American can expect to live another 20 years, and each additional year of retirement requires an extra financial cushion in order to compensate for the extra years of income-free living. And, since the primary sources of Federal retirement assistance do not come into play until age 65, the early years of early retirement are a particular challenge, requiring an additional level of planning and financial vigilance.
Perhaps unsurprisingly, one of the primary factors for individuals who are considering early retirement is health insurance. Because health care expenses tend to increase exponentially with age—and because Medicare benefits do not begin until age 65—early retirement requires a comprehensive plan for how to obtain and afford private health insurance, and how to cover any health-related costs. Finding out if your employer provides any sort of coverage or support for these expenses is an important first step in determining if early retirement is feasible. Indeed, research from the RAND Corporation (a public policy think tank) suggested that workers with access to employer-provided retirement health insurance were nearly twice as likely to retire early as those without such access.
Unfortunately, since that research was first published, employer-provided retirement health benefits have become less prevalent, as costs have increased. Recent estimates indicate that only about 1 in 3 American employers offer any sort of retirement health insurance option, leaving the vast majority of workers uncovered. That said, some of that decrease is likely due to the passage of the Affordable Care Act (“Obamacare”), which has dramatically expanded the availability—as well as affordability—of individual health insurance plans. Generous Federal subsidies are available for individuals seeking such insurance, although strict income limits do apply. Managing income in early retirement years in order to qualify for Obamacare subsidies can require a delicate balance, necessitating a bit of a dance to make sure that there is enough income to cover all required expenses, but not too much to threaten subsidy eligibility. Of note: the so-called “subsidy cliff” that abruptly shuts off all subsidies for individuals with income above 400% of the Federal Poverty Level has been suspended from 2021 to 2025 due to a provision in the Inflation Reduction Act, but it is scheduled to return in 2026, making income planning even more important, barring any corrective legislative action.
Of course, health insurance is not the only financial consideration for early retirees. Shutting off the primary income stream forces careful planning, including a reassessment of appropriate levels of risk in the investment portfolio. For retirees with substantial amounts saved in tax-deferred retirement accounts, a strategy that incorporates partial Roth conversions can also be a useful tax management tool, although any income from conversions could unfortunately threaten eligibility for health insurance subsidies. Similarly, determining whether or not any sort of part-time retirement employment is desired will greatly assist in planning, both from an income perspective and beyond.
Social Security claiming strategies must also be considered. Is claiming early a good idea (benefits can begin at a reduced amount at age 62, regardless of the retiree’s “Full Retirement Age”)? How should any pension benefits be accounted for, and what is the best claiming strategy? For risk-averse investors, are annuities a viable option, especially as our higher interest rate environment makes their terms more attractive? The questions and considerations are seemingly endless, and many of them need to be weighed against each other, in order to arrive at a comprehensive plan for retirement income.
The social-psychological considerations
Beyond the nuts and bolts of financial planning for retirement, early retirees also need to grapple with familiar retirement-era questions. What will retirement actually look like? Are you actually ready to be done working? Feelings of boredom and social isolation are prevalent complaints among all retirees, and early retirees can often arrive at those difficulties sooner than others, especially since friends and colleagues may still be working while they are not. In order to combat feelings of loneliness, many retirees take up new hobbies or opt to travel more; these lifestyle changes can impact budgets, requiring additional financial cushion. Just projecting work-year expenses out into the future may not be appropriate, if your retirement lifestyle proves to be substantially different.
What about other family members? Where do they live, and what will it mean if you opt to spend more time with them? Is relocation an option? If so, how much more (or less) will it cost versus your current living situation? Again, most of these questions are important to consider regardless of retirement age (that is, they are not unique to “early retirees”), but with an extended retirement timeline, even small changes can compound to make for big differences in long-term projections. If you’re considering whether or not early retirement is right for you (or trying to determine how to know), we at Cypress are always here to help.
