Many individuals face the decision about whether to retire early – either by choice, stemming from a desire to enjoy more years of leisure, or due to unanticipated changes in employment or other life circumstances. Whatever the situation may be, there are several important factors to consider throughout the decision-making process. Our top 5 list highlights the more critical financial components in the decision as to whether you really can retire now.
Pension vs. Lump Sum Payout
While pensions are becoming fewer and farther between, there are still certain employers offering defined benefit plans and/or individuals having been in the system long enough to qualify for a pension that may not be available to their younger coworkers. There are also other forms of employer plans that might offer a lifetime annuity option. Many of these plans offer an option between an annual pension payment versus a lump sum payout. The decision matrix for determining the optimal strategy is unique to each individual. Some of the primary factors include inflation protection, tax planning, market volatility, longevity, legacy/beneficiary wishes, and control over timing of payments. To determine how this decision will impact your long-term retirement goals, you should run illustrations to look at different benefit start dates and the associated benefit levels, considering a lifetime annuity, lump sum payout, period certain lifetime annuity or partial lump sum/partial annuity. By statistically modeling various disbursement options for your specific situation, you can determine the range of outcomes to successfully meet your goals.
Survivorship Planning
If you select a lifetime annuity option and are married, there are even more decisions to be made. While the level of pension benefit decreases as survivor benefits increase, the spouse might not receive 100% of your pension benefit. As a result, it is important to consider the following when determining which option to select:
- Level of income needed by surviving spouse if pension holder passes first
- Other investment assets available to support surviving spouse
- Longevity expectations
- Impact of life insurance coverage
Life Insurance
The decision about whether to carry life insurance depends on several things, including level of survivorship benefits selected (if you have a pension), amount of investment assets, age of dependent children, other dependents such as special needs or elderly adults, insurability/health rating and premium cost, just to name a few. If you select an annuity option for your pension under an early retirement, there might be a time period you need to bridge should you die sooner than expected to make up for any reduced spousal survivor benefit. Life insurance might be the most appropriate means to bridge any shortfall. Many individuals have employer-provided life insurance coverage, some of which may be portable upon retiring. You should determine whether this is an option for you, and if so, whether you would need to submit to a new medical exam and what the new premiums would be. If this is not an option, consideration as to your insurability should be reviewed to determine if life insurance is a cost-effective solution. Early retirement likely means more years of spending down assets, so know your options for insuring any potential shortfalls.
Social Security
Deciding when to file for Social Security is not straightforward and becomes more complex as you consider the coordination between your benefit and your spouse’s, potential windfall provisions (WEP and GPO), whether you plan to work part-time in retirement, longevity factors and other considerations personal to your situation. Retiring early does not necessarily mean you should claim your Social Security benefit at age 62. In fact, it is possibly more beneficial to wait. It is important to optimize your claiming strategy to determine whether you and your spouse (if applicable) should file at age 62, full retirement age (FRA), age 70, or likely some combination. Optimizing your social security is an important strategy for a long and successful retirement. Going back to the conversation around survivorship planning – it often makes sense to have the spouse with the higher benefit wait to collect until age 70 since the other spouse would “step up” into this higher benefit if their significant other were to pass.
Retiree Medical
Among the most significant inputs into a retirement plan is the cost of health coverage. With costs currently rising at a rate far beyond normal inflation, healthcare costs can quickly derail a retirement plan, especially when looking to retire early. Medicare coverage becomes available at age 65, so early retirees need to plan for coverage prior to this age. Some employers provide retiree health coverage, either paid for entirely by the employer or under some sort of cost-sharing arrangement. If coverage is not provided by the employer, retirees will need to look for private policies, which can get very expensive depending on deductible and services covered. Understanding how to bridge the cost of health care coverage prior to Medicare is a critical part of early retirement planning.
There are many decision-making criteria when considering early retirement, with these being some of the more important factors for our early retirees. We have significant expertise assisting clients through the decision matrix, modeling the necessary components tailored to your specific situation to ensure success in reaching retirement goals.
Cathie Straub, CPA, CFP®
Director, APCM Wealth Management for Individuals
Meghan Carson, CPA, CFP®
Financial Advisor
2/23/22
