Considering Early Retirement? Five Things to Know

A couple who embraced early retirement sit on the beach together.

(Image credit: Getty Images)

last updated 11 October 2023

Recently, I received an email titled “early retirement” from a client who has been working for the same Fortune 500 company for over 40 years. He was planning to retire soon but had not put in his notice. Their offer: 14 months of pay plus health benefits for that period, which carried him to the day he became eligible for Medicare. Talk about a big win! Sadly, this is an anomaly in early retirement packages. They often come too early and with too few zeros to justify an actual retirement.

In any period of economic volatility, you will start to see layoffs and buyouts. We saw this in 2022 with tech firms. We saw it in 2020 in the early phases of COVID. We will see it again at some point in the future. Below, you will find five necessary steps to take if you’re offered an early exit.

1. Figure out whether you are retiring or a free agent

Most of the folks who took COVID buyout packages or decided to retire early with all the unknowns that the pandemic brought have not returned to the workforce. However, I expect this to change as loans adjust up, bank balances deplete from COVID stimulus and necessary expenses remain high. This is a good time to objectively evaluate how employable you are if you are out of work for 12-18-24 months.

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From a financial perspective, you need to figure out if you are in a “work-optional” position. A CFP professional can help you run the numbers to see if you are financially independent, but if you are looking for a back-of-the-envelope way to assess your current position, consider this example:

Monthly expenses (including taxes): $10,000
Monthly income streams (pension, Social Security, etc.): $4,000
Monthly gap: $6,000
Annual gap: $72,000
Necessary nest egg to fund gap: $72,000/.04 = $1.8 million

This utilizes the 4% rule, which is by no means foolproof. That said, if you are significantly below the target, you need to cut your expenses or consider yourself a free agent. Work is not yet optional.

2. Know your expenses

Not having a grasp of your monthly expenses is either a luxury for those who make more than they spend or a critical mistake for those with consumer debt. When you flip the switch or slide the dimmer from worker to retiree, it is no longer an option. You’ll notice that the primary driver and the first number in the above example of figuring out if you have enough money to retire is monthly expenses.

“I pay my property taxes in July, and of course, I always spend more money during the holidays. Last year, we renovated the bathrooms. That doesn’t count, does it?” This is a typical response I get when I start the expense conversation. This is a daunting task for most, but it doesn’t have to be.

The simplest way I have found to come up with an accurate monthly number is to take all debits from all bank accounts over a two-year period and divide by 24. If you have online banking, this should take a grand total of five minutes.

And yes, the bathroom renovation does count for this exercise. There will never be a point in your life when you don’t have larger expenditures. Build them into your budget. For those who would rather use technology to handle this task, online resources Goodbudget and EveryDollar will work.

If you’re under 65 and don’t have health insurance from a source other than your employer, think twice before considering yourself a retiree. It may not seem like it, as you’re shelling out a few hundred bucks per month for health premiums, but it’s likely that your employer is paying a significant chunk of your premium.

When you walk away pre-65, you’re going to have to find a plan on your own, and if you haven’t already shopped around, you’re going to be shocked by the premium, the deductible or both. While COBRA is thought of as being “expensive,” it is likely to be your best option. This expense won’t come up in your expense apps, as it’s a payroll deduction. Figure out what’s realistic and add it to your monthly budget.

3. Create an income plan

When you signed your last offer letter or employment agreement, and it said, “We will be offering you a gross annual salary of $100,000,” that was your income plan. The money gets deposited a couple times per month, and you live off of your wages. When you switch sides and live as a retiree, you don’t have that income plan. I often speak to people with advisers, transitioning into retirement, who have no idea where they’ll pull their money from. Perhaps this is why, according to the Social Security Administration, significantly more than 50% of people take their benefits before full retirement age.

When Social Security was enacted in 1935, full retirement age was 65. Eighty-five years later, people still think of 65 as “normal retirement age.” Extending that theme, it is common for people to “turn on” their Social Security whenever they retire.

However, so long as you have a nest egg that you will draw down in retirement, you need to decouple those decisions. Between your full retirement age and 70, your Social Security income will increase by a guaranteed 8% per year. When considering your income plan, you want your fastest growers to be the last buckets you pull from. These are usually Social Security and Roth IRAs.

I buy a bag of coffee weekly from Whole Foods. As I walk down the aisle, I look to the right, hoping to see those glorious yellow tags. Recently, one of my favorite brands, La Colombe, had all of its coffee almost 50% off for about a week. I grabbed as many bags as I could hold. Essentially, I was saving $4 for every bag of coffee I bought.

The same is true when you pull money from your investments. If your tax rate is lower because you’re not working, you will pay less to pull the same amount out of a 401(k). It is a tax sale. If your tax rate is high, you may be better off pulling from a Roth IRA. Drawing from the right account at the right time can often lead to six-figure differences in taxes over the length of your retirement.

4. Consolidate your accounts

Finding $20 in the pocket of a pair of shorts you just pulled out of the closet is exciting. Finding $5,000 in a retirement account that you forgot existed should be embarrassing. I keep all of my investments, outside of my 401(k), and my bank accounts at one institution. It’s not because I believe that institution is the best at everything; it’s because I want to be able to log into one place to see everything. If my investments change in one account, I can see the impact on my overall asset allocation. This is even more important as you start to draw down your investments.

In 2016, I met with an 88-year-old who had 18 different bank accounts. That’s not a typo. I’ve heard more extreme examples from estate attorneys. If this is you, you’re creating a nightmare for your heirs. If you’re walking across the street and get hit by a truck, you want a checkbook to fly out of your pocket, not a handful of change that your beneficiaries will have to spend months or years looking for.

5. Invest like a retiree

You’ve just peaked Everest. You’ve determined you have the resources and desire to walk away. Now it’s time to head down the mountain. The muscles and strategies you used to get to the top are not the same ones you’ll use to safely navigate the descent. Said differently, what got you here won’t get you there.

I always tell people that volume gets you to the point where you can retire. Volume of savings. Volume of time. Volume of return. When you are spending your money, it takes consistency, discipline and planning.

Consistency is related to your investments. You want them to resemble more of an escalator than a roller coaster. While this is easier said than done, properly diversifying your portfolio with stocks and high-quality fixed income is a good first step. My firm specializes in retirement income planning, so we utilize a dynamic strategy that systematically increases or decreases stock exposure based on the markets. This is formula-based and would be difficult to replicate from your living room.
Discipline is often a function of investing within your risk tolerance. If you are comfortable seeing your portfolio go down only 10% and you saw it sink by two times that in 2022, you were at risk of making a bad decision before it rebounded. In retirement, you have an allowance of only a few really bad decisions before you are back on LinkedIn looking for opportunities.
Your plan puts it all together. It should say how much you can spend and where it will come from, while accounting for tax efficiency and inflation. Once again, easier said than done, but there is software that will do this job for you.

When I was 19, my pediatrician finally forced me out of his practice. In between appointments measuring the head size of infants, he had a 6-foot, 180-pound college student sitting on the fire truck table. I no longer fit in his practice or his expertise. As you transition into retirement, it’s possible that you have become that patient for your adviser. Consider using someone who specializes in retirement finances.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

After graduating from the University of Delaware and Georgetown University, I pursued a career in financial planning. At age 26, I earned my CERTIFIED FINANCIAL PLANNER™ certification. I also hold the IRS Enrolled Agent license, which allows for a unique approach to planning that can be beneficial to retirees and those selling their businesses, who are eager to minimize lifetime taxes and maximize income.