Keeping Your Financial Plan in Sync with an Early Retirement Goal
The pandemic has given us all a new perspective on our lives and our work. I think that’s a big reason why we’ve had a number of our clients at Keen Wealth ask us about early retirement scenarios this year. After a year of locking down, missing friends and family, working from home, and in far too many cases, losing loved ones, folks want more than just financial security. They want to use their assets to live their best lives for as long as they can.
That’s what we want for our clients as well – in retirement and every step along the way. But the listener questions we answer on today’s show are a reminder that adjustments to your financial plan aren’t made in a vacuum. Each decision causes ripple effects that can be extremely hard to manage if you’re not working with a fiduciary advisor.
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1. “What are the implications if one decides to retire early, at 60 or possibly even 55?”
Early retirement will have the biggest impact on your withdrawal strategy and your health care planning.
If you make withdrawals from your IRA or 401(k) accounts before age 59 ½, the IRS charges a 10% penalty. We have helped clients work around that by using the “rule of 55,” which allows anyone who is fired from or quits their job between age 55 and 59 ½ to make penalty-free withdrawals from their 401(k) or 403(b) accounts. Another option is Rule 72(t), which allows for penalty-free withdrawals as long as you make substantially equal periodic payments (SEPPs) for five years or until you reach age 59 ½, whichever comes later.
Of course, early retirees can also lean on after-tax assets that are outside of their retirement accounts, such as cash savings, investment accounts, and real estate holdings. A comprehensive spending strategy will coordinate all your assets as well as their specific tax ramifications so that you don’t run into any surprises come April.
As for your health care, Medicare eligibility doesn’t kick in until age 65. Some companies are required by law to allow retirees to keep buying their current insurance plan through COBRA until they reach age 65, at a cost of 102% of the premium. Jumping on a working spouse’s employer-subsidized plan or purchasing insurance through your state’s health insurance marketplace is usually a more affordable option. But whatever you end up spending on health insurance to keep you covered until you turn 65, that’s a new item on your monthly budget that has to be accounted for in your spending and withdrawal plan. Like I said, turning one knob on your financial plan affects all the other gauges as well.
2. “I am 55. My wife is 52. Can we retire with $1.5 million in our 401(k)?”
Whether the retirement number someone asks me about is $1.5 million, $15 million, or $500,000, the answer is the same: it depends!
Doing some very quick back-of-the-napkin math, if this couple took 4% out of their 401(k) per annum, they’d have around $50,000 to spend after taxes. The listener didn’t mention what kind of additional assets he and his wife have, but we do know that they’re a few years away from Social Security eligibility at age 62.
So, the real question becomes: can you and your wife live the life you want to live spending $50,000 per year, maybe closer to $55,000 if you both take Social Security as soon as you’re eligible?
If the answer is yes, then I’d still pose a couple follow-up questions:
- Do you have a bucket of savings that will cover an emergency, such as a sudden illness or a repair to your home?
- Is $50,000 per year just going to cover your monthly expenses? Will you be able to travel, enjoy hobbies, have a few date nights every month?
- When you’re thinking about your monthly budget, is that $50,000 going to cover more than ten years of health insurance premiums for you and your spouse until you’re eligible for Medicare?
- Are you or your spouse considering part-time employment to supplement your income and keep yourselves busy?
3. “At what point do you start paying for Medicare Part A? Is the premium based on your tax bracket?”
Based on how this question is phrased, I think this listener is getting Medicare’s alphabet soup a little jumbled, which is totally understandable. Let’s start with some definitions:
- Medicare Part A covers hospital stays and some in-home nursing care and hospice services.
- Medicare Part B covers doctor’s visits and services like testing and X-rays.
- Medicare Part C, also known as Medicare Advantage, is insurance you buy from a private insurer that includes Parts A and B.
- And Medicare Part D is prescription drug coverage.
You don’t have to pay any premiums for Part A, although, technically, you’ve been buying into the program via payroll taxes ever since you started working.
The premiums you’ll pay for parts B and D are based on your adjusted gross income from two years ago. In some cases, you might have to tell Medicare about fluctuations in your retirement income so that you aren’t subject to income related monthly adjustment (IRMA) surcharges on your premiums
Again, sorting through your Medicare options is often more complicated than new retirees are expecting. We have some excellent resources on Medicare on our website if you’d like to dig a little deeper. And we always recommend that seniors talk to a health care professional every fall during the open enrollment period.
4. “How should pension income be accounted for in retirement tax planning?”
The IRS considers your pension taxable income, same as standard IRA and 401(k) distributions or Social Security benefits. However, as you’re nearing traditional retirement or thinking about an early retirement, it’s important to dig into the details of that pension. While most pensions are fixed, some do give early retirees a bit of a bump until Social Security kicks in. Others give you the option to name a beneficiary, which could reduce the size of your monthly benefit.
Projecting how those specifics could play out for the next 20 or 30 years could affect your withdrawal strategy … which could affect what you can afford to pay for health insurance until you turn 65 … which could affect when you decide to take Social Security … which could affect your plan to retire early in the first place!
Again, every part of your financial plan is connected. Whether you’re planning to retire early or sticking to a more traditional timeline, let my team at Keen Wealth help you keep all these pieces in sync. And if you have a question or topic you’d like us to tackle in a future episode of our podcast, drop me a line at info@KeenWealthAdvisors.com.
About Bill
Bill Keen is a CHARTERED RETIREMENT PLANNING COUNSELOR℠ and independent financial advisor with more than 25 years of industry experience. As the founder and CEO of Keen Wealth Advisors, a registered investment advisory firm, he specializes in providing personalized retirement planning designed to help people thrive before and during their retirement years. With a passion for educating others, Bill regularly blogs about retirement planning, hosts the podcast Keen on Retirement, and has contributed to U.S. News and World Report, Reuters, Wall Street Journal’s Market Watch, Yahoo Finance, and other publications. Based in Overland Park, Kansas, Bill and his team work with clients throughout the greater Kansas City area and across the nation. To learn more, connect with him on LinkedIn or visit www.keenwealthadvisors.com.
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