How to Decide if You Can Retire Early

RETIREMENT

Ginger Applegarth

Decision Center

..........................................

WEB LINK

Ask the Experts

Financial Planners

ake this job and à

Everyone, at one point or another, has had this thought. If you're working to support yourself, you've undoubtedly daydreamed about early retirement. This vision may come to mind once a year, once a week or once an hour, depending upon how you feel about your job and career.

The thought of early retirement has always been tempting for workers, but it's all the more tempting now that our view of retirement has changed from a few decades ago. We no longer see retirement as a time when our productive life is over, spending our remaining years reminiscing about the past. Now, retirement is viewed as the time when we finally get to enjoy all the things we would love to do - if only we didn't have to work.

If you want to retire early (before age 65) you are not alone. In a recent survey of workers ages 30 to 50, more than half plan to retire at 60 or younger and only 6 percent plan to work past 65. The problem with early retirement is that it's often so appealing that it becomes easy to make the decision before you really consider the ramifications. And if you do leap before you look, you may be leaping to an early financial death.

Many experts estimate that a huge percentage of future retirees will have to cut their expenses dramatically once they stop working if they want to make sure they don't go broke. The real answer to the question, "Can I retire early?" is: "Of course you can, but you may run out of money."

If that happens, the best scenario would be running out of money while you were still able to work, but chances are you would only get a mediocre job at best. The worst circumstance would be going broke when you're no longer able to work, so your only options are to live on whatever monthly benefits you have (such as Social Security and a pension) or to turn to your children or other relatives for help.

When thinking about retiring early, there are two issues to consider:

Can I afford to retire early?

Do I really want to retire early?

Depending on how your day went at work today, or how your career is progressing in general, you may think the second question is absurd. But if you look at how long you will be retired, you may want to rethink that second question.

The reality is that if you retire early, you may be "retired" for as long as you were in the working world. Based on actuarial tables of how long Americans actually live, if you retire at age 55, you can expect to live to age 83. If you retire at 65, you get another year's reprieve to age 84. And if you keep working until age 70, you're expected to live to age 86. Couple that with the fact that if you're married, one of you is likely to outlive the other by four to six years or longer and you can see how early retirement requires serious financial planning.

To be practical and conservative in your financial planning you should probably tack three or four more years onto these "average" death ages. If your relatives tend to live into their 90s, you had better add on a few more years.

Some of those later years may not be as active as the early ones, but they will be just as expensive thanks to medical costs. The only good news about living to 100 is that if you own a life insurance policy you're usually considered actuarially dead by that time. That means you'll get the full death benefit while you're still alive and kicking (although you might not be kicking very high).

If you assume you'll enjoy at least an average life span, taking early retirement at age 55 or 60 means you have 30 years or so of retirement ahead of you. That's a long time without a paycheck or a structured schedule.

Now, don't think I'm trying to talk you out of your dreams. I'm not. What I am trying to get you to do is to think about what it will take and what it will mean. Before you allow yourself the luxury of daydreaming about what you would do with all those years of free time, look at the numbers first and see whether you can afford to retire early.

There are three financial factors to consider:

1. How much do you expect to have in monthly retirement income?

This would include any money from a traditional pension plan, Social Security or other sources.

Many people don't realize that even if they retire at 55 or 60, the earliest they can start receiving Social Security is at 62. And if you start then, the benefits are only 80 percent of what they would be if you waited until "normal" retirement age (currently age 65 or older). Many people choose to defer their Social Security benefits for as long as possible to increase the monthly benefits.

Before you make this decision, ask your accountant or financial planner to help you calculate whether to start taking benefits at age 62 or to defer. Usually you're better off starting at age 62 even though the benefits are less. Why? You get almost three years of extra payments that you can then invest in the interim.

2. How much in assets will you have accumulated by retirement?

These include retirement plans that do not have the fixed-income payout of pension plans (such as 401 (k) plans, profit sharing plans, Individual Retirement Accounts, and so on). You also may have other sources, such as an inheritance or the profits from selling your house for a less expensive one.

3. How much will you spend?

Planners recommend that you estimate your retirement expenses to be about 80 percent of those you incurred before retirement, but many people want to keep the same standard of living and replace those work-related expenses with travel, entertainment and other new costs.

Don't forget about the impact of inflation as you consider your days in the RV rolling down Highway 1 in south Florida. What looks like a hefty retirement income at age 55 or 60 may be near the poverty line by the time you're 70 or 75. For example, let's assume that inflation increases at 3 percent a year. If you retire today at age 55 on a yearly income of $40,000, you'd need $72,000 by the time you're 75 to maintain your standard of living. At age 80, or 25 years after you retire, you'll need $83,800. And look at the difference a mere 1 percentage point change in average inflation makes: If that 3 percent inflation rate actually averages 4 percent, you'll need $87,600 at age 75 and $106,000 at age 80.

If you are still seriously considering early retirement, there are some courses of action to start taking today:

First, when you estimate your expenses, put in a 5 percent fudge-factor. In other words, assume that your expenses will be 5 percent more than you anticipate.

Assume an inflation rate of at least 4 percent. Long-term, it has averaged about 3 percent but over the last 20 years it has been closer to 6 percent.

Start planning now, which usually means slashing your budget so that you can sock away every dollar you can. (This is good advice anyway, whether you plan to retire early or not).

Remember that the earlier you retire, the longer your retirement portfolio is going to have to work for you. So just because you're planning to be retired doesn't mean you need to move more money into conservative, lower-yielding fixed-income investments. (Remember that all of your income does not need to be from dividends and interest; it is perfectly acceptable to take some capital gains too.)

If you retire at 55 or 60, you will probably (hopefully!) need a substantial part of that money in 20 to 30 years, so a good portion of your funds should be invested in the stock market.

Finally, and this is critical, see a competent, experienced financial planner every couple of years to run the numbers for you or to double-check your own numbers. The planner can serve as a sounding board to give you a second opinion about your retirement strategy and investment allocations.

If, after doing this "number crunching," you find that you can retire early, the burning issue becomes what will you do with your time. When you're exhausted from work, the possibility of day after day stretching with no required attendance anywhere sounds delightful, but this can get old very quickly. When you start making a financial plan to retire early, start planning what you're going to do with your time when that day comes. Even the best made plans can change; many an early retiree has returned to work because she cannot stand the thought of not working for the rest of her life.

At a time when most people can't afford to retire and maintain their standards of living, taking the chance of retiring early is a big risk. However, if you start planning as early in life as possible, do your homework and understand that you are likely to be around for the next 20 to 40 years and your money needs to be, too, early retirement may be for you. The only downside from a social perspective is the envy of everyone else you know who would give anything to be in your early retirement shoes.

When can I retire?

Articles

Will Social Security Live as Long as You Do?
It's Never Too Soon to Start Saving
Is a Million Dollars Enough?

Next Steps

Go to Money's Lifetime Planner

			RETIREMENT

			How to Decide if You Can Retire Early Ginger Applegarth Decision Center

	.......................................... WEB LINK Ask the Experts Financial Planners		ake this job and à Everyone, at one point or another, has had this thought. If you're working to support yourself, you've undoubtedly daydreamed about early retirement. This vision may come to mind once a year, once a week or once an hour, depending upon how you feel about your job and career. The thought of early retirement has always been tempting for workers, but it's all the more tempting now that our view of retirement has changed from a few decades ago. We no longer see retirement as a time when our productive life is over, spending our remaining years reminiscing about the past. Now, retirement is viewed as the time when we finally get to enjoy all the things we would love to do - if only we didn't have to work. Look before you leap If you want to retire early (before age 65) you are not alone. In a recent survey of workers ages 30 to 50, more than half plan to retire at 60 or younger and only 6 percent plan to work past 65. The problem with early retirement is that it's often so appealing that it becomes easy to make the decision before you really consider the ramifications. And if you do leap before you look, you may be leaping to an early financial death. Will you run out of money? Many experts estimate that a huge percentage of future retirees will have to cut their expenses dramatically once they stop working if they want to make sure they don't go broke. The real answer to the question, "Can I retire early?" is: "Of course you can, but you may run out of money." If that happens, the best scenario would be running out of money while you were still able to work, but chances are you would only get a mediocre job at best. The worst circumstance would be going broke when you're no longer able to work, so your only options are to live on whatever monthly benefits you have (such as Social Security and a pension) or to turn to your children or other relatives for help. When thinking about retiring early, there are two issues to consider: n Can I afford to retire early? n Do I really want to retire early? Depending on how your day went at work today, or how your career is progressing in general, you may think the second question is absurd. But if you look at how long you will be retired, you may want to rethink that second question. The reality is that if you retire early, you may be "retired" for as long as you were in the working world. Based on actuarial tables of how long Americans actually live, if you retire at age 55, you can expect to live to age 83. If you retire at 65, you get another year's reprieve to age 84. And if you keep working until age 70, you're expected to live to age 86. Couple that with the fact that if you're married, one of you is likely to outlive the other by four to six years or longer and you can see how early retirement requires serious financial planning. Plan for how long you expect to live To be practical and conservative in your financial planning you should probably tack three or four more years onto these "average" death ages. If your relatives tend to live into their 90s, you had better add on a few more years. Some of those later years may not be as active as the early ones, but they will be just as expensive thanks to medical costs. The only good news about living to 100 is that if you own a life insurance policy you're usually considered actuarially dead by that time. That means you'll get the full death benefit while you're still alive and kicking (although you might not be kicking very high). If you assume you'll enjoy at least an average life span, taking early retirement at age 55 or 60 means you have 30 years or so of retirement ahead of you. That's a long time without a paycheck or a structured schedule. Now, don't think I'm trying to talk you out of your dreams. I'm not. What I am trying to get you to do is to think about what it will take and what it will mean. Before you allow yourself the luxury of daydreaming about what you would do with all those years of free time, look at the numbers first and see whether you can afford to retire early. There are three financial factors to consider: 1. How much do you expect to have in monthly retirement income? This would include any money from a traditional pension plan, Social Security or other sources. Many people don't realize that even if they retire at 55 or 60, the earliest they can start receiving Social Security is at 62. And if you start then, the benefits are only 80 percent of what they would be if you waited until "normal" retirement age (currently age 65 or older). Many people choose to defer their Social Security benefits for as long as possible to increase the monthly benefits. Before you make this decision, ask your accountant or financial planner to help you calculate whether to start taking benefits at age 62 or to defer. Usually you're better off starting at age 62 even though the benefits are less. Why? You get almost three years of extra payments that you can then invest in the interim. 2. How much in assets will you have accumulated by retirement? These include retirement plans that do not have the fixed-income payout of pension plans (such as 401 (k) plans, profit sharing plans, Individual Retirement Accounts, and so on). You also may have other sources, such as an inheritance or the profits from selling your house for a less expensive one. 3. How much will you spend? Planners recommend that you estimate your retirement expenses to be about 80 percent of those you incurred before retirement, but many people want to keep the same standard of living and replace those work-related expenses with travel, entertainment and other new costs. The dreaded inflation factor Don't forget about the impact of inflation as you consider your days in the RV rolling down Highway 1 in south Florida. What looks like a hefty retirement income at age 55 or 60 may be near the poverty line by the time you're 70 or 75. For example, let's assume that inflation increases at 3 percent a year. If you retire today at age 55 on a yearly income of $40,000, you'd need $72,000 by the time you're 75 to maintain your standard of living. At age 80, or 25 years after you retire, you'll need $83,800. And look at the difference a mere 1 percentage point change in average inflation makes: If that 3 percent inflation rate actually averages 4 percent, you'll need $87,600 at age 75 and $106,000 at age 80. If you are still seriously considering early retirement, there are some courses of action to start taking today: n First, when you estimate your expenses, put in a 5 percent fudge-factor. In other words, assume that your expenses will be 5 percent more than you anticipate. n Assume an inflation rate of at least 4 percent. Long-term, it has averaged about 3 percent but over the last 20 years it has been closer to 6 percent. n Start planning now, which usually means slashing your budget so that you can sock away every dollar you can. (This is good advice anyway, whether you plan to retire early or not). n Remember that the earlier you retire, the longer your retirement portfolio is going to have to work for you. So just because you're planning to be retired doesn't mean you need to move more money into conservative, lower-yielding fixed-income investments. (Remember that all of your income does not need to be from dividends and interest; it is perfectly acceptable to take some capital gains too.) If you retire at 55 or 60, you will probably (hopefully!) need a substantial part of that money in 20 to 30 years, so a good portion of your funds should be invested in the stock market. n Finally, and this is critical, see a competent, experienced financial planner every couple of years to run the numbers for you or to double-check your own numbers. The planner can serve as a sounding board to give you a second opinion about your retirement strategy and investment allocations. Now what do you do? If, after doing this "number crunching," you find that you can retire early, the burning issue becomes what will you do with your time. When you're exhausted from work, the possibility of day after day stretching with no required attendance anywhere sounds delightful, but this can get old very quickly. When you start making a financial plan to retire early, start planning what you're going to do with your time when that day comes. Even the best made plans can change; many an early retiree has returned to work because she cannot stand the thought of not working for the rest of her life. At a time when most people can't afford to retire and maintain their standards of living, taking the chance of retiring early is a big risk. However, if you start planning as early in life as possible, do your homework and understand that you are likely to be around for the next 20 to 40 years and your money needs to be, too, early retirement may be for you. The only downside from a social perspective is the envy of everyone else you know who would give anything to be in your early retirement shoes.
			When can I retire?
			Articles \|

			Will Social Security Live as Long as You Do? It's Never Too Soon to Start Saving Is a Million Dollars Enough?

			Next Steps \|

			Go to Money's Lifetime Planner Illustration by James O'Brien Copyright 1998 Microsoft Corporation