The retirement package
When your employer offers an early retirement package, be aware it may impact your taxes as well as your bank account. For instance, a lump-sum payout may bump you up to a higher tax bracket, says Clarissa Hobson, director of financial planning and senior financial advisor at Carnick & Kubik in Denver. You also may face a tax impact if the offer requires you to exercise stock options, she adds.
If you think you may eventually work again, check any noncompete clauses in your contract, if you have one. Some can be so broad they limit your ability to find positions within your industry.
Evaluate the benefits offered. For instance, if you're offered a pension, how will your employer calculate your years of service?
As best you can, identify the potential consequences of declining the offer. It's not uncommon for employers to eventually lay off many workers who turned down an offer of early retirement. When they do, it's often with a less-generous offer.
It's unlikely any offer, no matter how generous, will allow you to stop working entirely if you haven't prepared, says Rick Kahler, president of Kahler Financial Group in Rapid City, South Dakota. “You might have to provide for yourself for 30 years. It's really hard to make up a deficit with a short-term retirement package."
Indeed, many individuals who want to retire early begin preparing while in their twenties and thirties. Ashley is a Michigan-based millennial who, along with her husband, is on track to retire before turning 40. They plan to spend more time traveling and with family. In addition, her husband faces health issues that may make early retirement necessary.
To meet this aggressive goal, she and her husband have been saving more than two-thirds of their take-home pay in tax-advantaged accounts. They have also embraced a lifestyle that includes vegan cooking at home and re-purposing items that other people have thrown out. They blog about their goals at Kiwi and Keweenaw.
“Health care is huge," says Danielle Howard, a financial planner with Wealth By Design in Colorado, “because it's so volatile and unknown." Before retiring early, you'll need a plan for covering medical expenses until you can access Medicare, which doesn't start until 65 for most people.
While the Affordable Care Act offered some relief by providing individual access to health care plans through the exchanges, the options can be limited and expensive, especially in rural areas, Hobson notes.
Some employers include health care coverage, at least for a period of time, in their early retirement offers. Compare the cost and accessibility of your company's health insurance offer to the options available to you privately.
Review your income streams to maximize your chance of qualifying for a subsidy, if you obtain coverage through an exchange. For instance, money withdrawn from an IRA typically is considered ordinary income, and that could mean the loss of a subsidy for which you otherwise might qualify, Howard says. One possible solution is to make qualified withdrawals from a Roth IRA.
If health care proves to be a stumbling block, check with your employer on whether you can cut back on your hours without retiring completely, Hobson notes. Some employers may let you continue your current coverage, even if you work less than full time.
It may be tempting to make early retirement feasible by claiming Social Security retirement benefits before full retirement age. Most people can begin claiming them at age 62.
Howard advises holding off as long as possible. “Social Security is a hedge against longevity," she says, as it continues throughout your life. If you can use other assets, your Social Security benefits will continue to grow.
If you claim benefits before your full retirement age, the amount you receive each month drops. Assume, for instance, you were born in 1960 or later, making 67 your full retirement age. If you would normally start receiving $1,000 monthly at 67, yet begin claiming benefits at age 62, the monthly amount drops to $700.
One way to be able to afford early retirement is to move to a smaller home. A note of caution, however: Downsizing doesn't automatically lower expenses.
“People fool themselves," Kahler says. Often, downsizing involves the purchase of a smaller home with nicer amenities, or a move to a more expensive location, perhaps to be near family. Either can eliminate savings. To truly reap financial benefits, the new home must be significantly less expensive, Kahler adds.
Before accepting an offer of early retirement, review all your assets — investment, savings, retirement accounts, Social Security, any pension and home equity, to name a few — individually and together, so you can estimate how they might work in unison.
For instance, individuals who've earned a pension and also qualify for Social Security retirement benefits may be able to hold other investments that are slightly less conservative. “They already have a source of stable income," Hobson says. Keep in mind that some assets impose penalties if accessed before a certain age.
Depending on your age, one way around this is to retain money in your 401(k) or 403(b) account, rather than moving it to an IRA. Distributions made after you separate from your employer, so long as the separation occurred in or after the year you reached age 55, may avoid the penalty. Of course, you'll want to check the costs of keeping money within the 401(k) plan.