Early retirement sounds tempting, but the math can be a major reality check
I laughed when my daughter recently said she was ready to retire.
Of course, she wasn’t serious, but nine months into full-time employment and she’s already thinking about how she can retire early at 55. And she’s not alone.
Early retirement was typically a choice reserved for the more prosperous. But then a global pandemic hit and, at least for now, it has changed the trajectory of a lot of workers.
A significant share of people leaving their jobs in “Great Resignation” are early retirees. Rising house prices and a supercharged stock market are giving them the financial confidence that they can afford to call it quits.
But analysts warn that high housing prices and a possibly overheated stock market could be giving people a false sense of financial security. Before you join the ranks of retirees, you need to consider a number of factors to see if you’re financially ready. Here are five questions you should be asking yourself.
Is this the right time to retire?
By the third quarter of this year, about 50 percent of U.S. adults 55 and older had left the labor force due to retirement, according to a recent analysis by Pew Research Center.
Between 2008 and 2019, the ranks of retirees 55 and older grew by about 1 million per year. But just in the past two years, that population has jumped by 3.5 million, Pew found.
This retiree resignation trend contrasts to with the Great Recession, when retirement rates declined, which is what typically happens in an economic downturn, according to the Pew analysis.
Watching so many people become ill and millions die of covid may have you re-evaluating your own life and how much time you have left.
A long commute, stressful job or bad boss may just not be worth it anymore, you tell yourself. Yet, the decision to retire early, if you have that choice, should be done with careful consideration of affordability.
Facts, not just your feelings, have to reign. This means running your numbers.
Think about what your retirement budget is going to look like and how that might be different from your pre-retirement budget, says Christine Benz, director of personal finance and retirement planning for Morningstar, an investment research and services company.
Many retirees underestimate their retirement expenses. Yes, you may cut costs associated with working, but you’ll still have to budget for your living expenses, such as rent or a mortgage. A LendingTree study, which looked at Census Bureau data, found that nearly 10 million homeowners paying off their mortgage are 65 and older.
Depending on where you live, travel plans and health-care needs, you could still have expenses that amount to 70 percent to 80 percent of your preretirement budget.
What additional factors should I consider before retiring?
After you’ve created a retirement budget, consider sources of income other than your investment portfolios, such as a pension, annuity income or Social Security.
“You want to just see how much of my baseline income needs can I replace with these very consistent lifetime sources of income,” Benz says.
Part of this analysis will entail deciding when to take Social Security. Whether you start collecting at 62 when you’re first eligible or wait until 70, when your benefit maxes out, depends on your personal situation and financial needs. Once you’ve evaluated your noninvestment income, move over to your investment portfolio and start thinking about your withdrawal rate.
What’s a reasonable withdrawal rate for my investment portfolio?
Generally, experts have advocated a 4 percent starting withdrawal rate, adjusted for inflation, as an appropriate level for retirees. In other words, if your account has $1 million, you would budget to withdraw $40,000 in the first year of retirement.
Here’s the thing. Some retirees may be overconfident about this typical advice given current factors, according to a recent report from Morningstar.
Taking into account estimates of future investment performance and rising inflation, Morningstar argues the standard rule of thumb might need to be lowered to 3.3 percent for some retirees.
“Because of the confluence of low starting yields on bonds and equity valuations that are high relative to historical norms, retirees are unlikely to receive returns that match those of the past,” according to Morningstar.
It’s important to keep in mind that even these withdrawal rates assume someone is retiring in their mid-60s with an estimated 30-year horizon. If you’re retiring earlier, you might need to limit your withdrawals even more.
“You might want to be even more conservative with your assumptions,” says Benz, a co-author of the Morningstar withdrawal rate report.
Some seniors may be able to withdraw higher amounts.
“We don’t want to scare people because I do think that 4 percent is probably a decent starting point, at least for stress-testing do I have enough,” Benz says. “And if you want to be more conservative, which I think is probably realistic, you could maybe take that down further still.”
Should I be worried about keeping money in the stock market after I retire?
Position yourself to have savings you could draw upon early on in your retirement so that you’re not having to touch stocks while they’re down in the dumps, Benz recommends. You are not being unreasonable to be scared about downturns in the stock market.
“New retirees or prospective retirees especially should be on guard because that’s the killer when big market sell-offs hit early on in your retirement, when your portfolio’s at its largest,” Benz says. “And, if you’re simultaneously spending too much during that period, it leaves less of your portfolio in place to recover when the market eventually does.”
Do I need help from a financial planner?
Retirement planning encompasses so many decisions that you may need a professional to help you run the numbers. So, yes, consider hiring a financial planner.
“I would encourage people to engage with a financial planner even on a one-time basis to just get a checkup,” Benz says. “They may be able to point out things that you hadn’t considered such as, ‘What would your plan be if you had big long-term care costs later in life?’ This is important enough that it’s worthwhile to get a second set of eyes on the plan.”
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