What is retirement really?
Is it an age, a number on an Investment statement, or a mindset?
Retirement is your decision to trade in your paycheck for your time, memories, and experiences.
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Being prepared for retirement gives you the power to control your own future and shape your own narrative.
In my experience, the two most common traits shared by almost every early retiree are an exceptional ability to save and the willingness to live within their means when necessary.
However, it’s important to note that early retirement is not for everyone and will require significant sacrifices.
But I can assure you that it will be worth it.
If you’re ready to take on the challenge, be intentional with your spending, save aggressively, and stay committed, then keep reading because this article is for you.
Here are a few factors to consider before deciding if you are ready for early retirement:
Are you retiring INTO or FROM somethin
Let’s start by asking, why are you wanting to retire early?
Is it to get away from a demanding boss or toxic work environment that you just can’t endure anymore?
Is it because you want to watch more TV and order from Amazon?
Or is there a stress-free, part-time job and more time with family that is calling your name?
How you retire matters.
Let me say that again. How you retire matters.
Having a purpose and something to pour into and look forward to on the other side leads to a significantly happier retirement and better outcome.
According to a research study conducted by Boston College, they found the three largest determinants of well-being and happiness in retirement were:
- Having a reason to retire and bigger purpose beyond work
- Having the flexibility to choose when to retire on your term and controlling the narrative
- The state of your physical and mental health/well-being
Simply choosing to get away from your old job or relocate to a new state to get a fresh start oftentimes results in dissatisfaction as the root of the issue hasn’t been addressed.
As you’re reading this, take a moment to pause and visualize the people and things that are most important to you.
WHAT IS IT THAT YOU HAVE ALWAYS WANTED TO DO?
Starting with knowing your why and the purpose and intention behind your retirement is a great place to start.
In fact, when building financial plans, our client work always centers around purpose, intention, and the things, people, and experiences that are most important.
These decisions help drive your investment goals and everything else.
From there, rest becomes easy in crunching the numbers and outlining a course of action,
Make Sure to Include Room in Your Retirement Budget for Taxes & Healthcare
If you are considering retiring before age 65 beware of the steep costs of paying for private health insurance out of pocket.
Current laws have helped cap insurance costs at a certain percentage of household income, yet sticker shock can still apply when being accustomed to having subsidized insurance from your employer for all of those years.
Understand Taxes on Distributions
Additionally, many people fail to remember that when taking distributions from an account, they need to also factor in taxes.
If you find yourself drawing from a retirement account, you need to be sure and build in a line item for taxes.
This means your distribution is going to need to be higher than the actual (NET) amount you need, to account for taxes.
Using the previous example, taking $50,000 from your retirement account would look like:
NET AMOUNT NEEDED: $50,000
Less Federal Taxes at 12% – ($7,228.92)
Less CA State Taxes at 5% – ($3,102.05)
Total Taxes Paid: $10,330.97
Total GROSS Distribution: $60,330.97
What would this same $50,000 distribution look like from a Brokerage (Taxable) Account?
You are taxed differently depending on the type of account you pull your money from.
Distributions from 401k’s and IRAs are treated the same as Ordinary Income (think your paycheck) whereas Brokerage account distributions are subject to Capital Gains tax rates.
Why is this important?
Take a look at the chart below and you can see that if your Income is low enough, your Brokerage account could act as “tax-free” bucket.
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Start Building Your Retirement “Bridge”
You just witnessed the power of Capital Gains from the above example and the importance of having flexibility by having a Brokerage account.
Let’s take it one step further and add:
Before you step away from your job, you may want to consider funding your Brokerage account in addition to saving for retirement.
Adequately funding a brokerage account will allow you to potentially:
- Lower your taxable income in retirement
- Have the resources to be able to choose to delay Social Security
- Keep your Retirement assets growing longer and uninterrupted
- Create other favorable tax planning opportunities
The Amount You Spend Matters
Unpacking Your Withdrawal Rate
Retired Financial Planner, Bill Bengen, created a back-of-the-napkin withdrawal rule for retirees that has been the benchmark for decades.
Bengen states that a retiree can withdraw 4% of the total value of their investment portfolio throughout the lifetime of their retirement without depleting their account.
Due to current market conditions, inflation, and now lower future projected returns for stocks and bonds, this figure may no longer be as realistic.
Instead, new research suggests using a figure closer to 3.3% of your total account balance to calculate how much you can comfortably afford to live off of.
Example- Tom and Suzie have $1,500,000 in their portfolio
- Using the 4% Rule: $1,500,000 x. 4% = $60,000/yr
- Using the 3.3% Rule: $1,500,000 x 3.3% = $49,500/yr
This is a big difference and can translate into a major lifestyle adjustment.
Make sure to consider inflation in your future costs before making your decision to retire to see if your portfolio can sustain it.
If you’re planning on retiring early and having a longer retirement than most, it may be beneficial to use a lower projected number and not put too much stress on your account.
Know the Rules of the Game
Withdrawing from your Traditional IRA account early, before the age of 59.5, will result in you needing to pay a 10% early withdrawal penalty!
And remember those Ordinary Income taxes from earlier?
Those still apply too.
So if you’re planning on retiring before age 59.5, what is your best option to pull your money from?
Your Brokerage Account!
Why? A more favorable tax rate and no early withdrawal penalties.
What if you don’t have a brokerage account?
Assuming you’re retired, your next best bet is to look to your 401k account as most former employers will allow you to begin taking early withdrawals starting at age 55 without penalties, though income taxes will still apply.
Certain conditions must be met and each employer is different.
The most important nuance to remember when pulling from your 401k at age 55 is that the 401k account must still be a part of the group plan and with your former employer.
Thus, if you decide to rollover your 401k into an IRA, the option to take eligible distributions free of penalty at age 55 goes away.
Avoid making BIG purchases early
Using much of the wisdom of the 4% withdrawal rule from earlier, research shows that choosing to take a big withdrawal early in retirement account can have a lasting negative impact on the rest of your retirement.
Why?
You rob your account of being able to take full advantage of compounding interest and time.
Making major purchases early in your retirement puts your investments at a disadvantage from the start.
Thus, the returns in the market your account will experience, now have less power behind them.
Trace that out over the course of 20+ years and the difference can be tens of thousands, if not hundreds of thousands of dollars in lost compounded returns.
No one is saying you can’t enjoy an early retirement or have nice things, but knowing your withdrawal rate and understanding the impact that major purchases have on your account is critical to retirement success.
Be on the same page as your spouse
You are about to embark on a new season of your life and odds are:
- You are going to have more time on your hands
- You may potentially experience a loss of identity through no longer working
- You could find yourself in a new location after having sold your house and moved across the county
- Many of your friends may not be around as they could be still working
Retirement is a major shift and it’s important to work through this transition well before, during, and in retirement with your spouse.
It’s important to be flexible, communicative, and adaptable as getting comfortable in retirement together is going to take some time getting used to.
Have fun with it. Be creative and make it your own.
