Through the years, REAP Financial has had the privilege of helping many families retire. We always strive to prepare our clients for early retirement and the risks that come with it. Today, 7 out of 10 Americans retire sooner than they were planning. Sometimes, this isn’t because they want to retire; it may be to take care of aging parents or a spouse, due to medical issues, or a layoff. Whatever the case may be, there are some key considerations when it comes to early retirement.
5 Hidden Early Retirement Dangers
Here are some of the dangers of early retirement and important considerations if you want or need to retire early:
Health Care Costs
When we think about health care costs, often we think of it as a monthly expense. However, long-term care, nursing home costs, and home health care costs are also part of the picture. Retirees must think about medical care costs throughout their retirement, as well as the costs of long-term care. If you retire early, before the Medicare age of 65, you’ll have to self-insure through COBRA, the exchange, or the ACA marketplace. These options can be expensive, easily costing $600-$1,000 a month per person. This is manageable as long as you have a plan for these costs built into your budget.
Covering your own medical costs in retirement can be expensive, meaning you may need to withdraw funds more aggressively. This could reduce the compounding effect of your wealth over time. Although many families retire before age 65, some do not consider how they will cover their medical and emergency costs before they qualify for Medicare. It’s important to build a plan to accommodate these costs if you may retire early.
Tax Efficiencies
Not having a tax-efficient plan can be a big danger of early retirement. Though tax efficiency may sound complex, it is one of the most important factors to help your portfolio last as long as you do. By keeping more of your money through tax-efficient strategies each year, you can take better advantage of the compounding effect. Many people who retire early don’t build tax-efficient strategies for both their investment and income plans. It’s beneficial to have a plan to withdraw money in early retirement to avoid overpaying in taxes, avoid pulling from one account too early, and prepare for your future tax obligations.
Many early retirees don’t receive a true paycheck, which places them in a lower tax bracket—a potentially advantageous position. However, once Social Security kicks in, you start taking required minimum distributions, or other income sources begin, your tax bracket may start to increase. That means more of your income going to taxes. For this reason, it’s essential to have both a tax-efficient income plan and a tax-efficient investment plan.
If you’re still working and not touching your investments, consider ensuring you’re not overpaying in taxes on your investments year over year. For example, many people hold stocks that pay dividends, selling and buying those stocks. They may be generating ordinary and qualified dividends, and those dividends for many investors are just reinvested. However, it will still show up as income or capital gains on your tax return each year. If you’re in your late working years, potentially your highest-earning years, you may be in a very high tax bracket. In essence, it’s best to avoid paying taxes on money you’re not using along the way. That is just one of many ways we at REAP Financial see successful people overpaying in taxes. Watch out for this danger in early retirement and build a tax-efficient plan for your income and investments.
Inflation
The third danger of early retirement is not having inflation built into your plan. If you don’t account for inflation, in the years to come, your lifestyle could be impacted, requiring you to trim expenses as the dollar’s value decreases. In recent years, inflation has been high. Although we’re seeing inflation rates come down, as of the writing of this article, inflation will likely continue into the future. For this reason, consider assuming an inflation rate of 3.5 or 3.6% in your plan. This reflects a 100-year average inflation rate as of 2024. Factoring in an inflation rate throughout retirement can help you maintain your standard of living in the long term.
Taking Social Security at the Wrong Time
Before you take Social Security, you need to have a solid plan. The majority of Americans today take Social Security early, but does that mean it’s the right decision for you? Conventional wisdom suggests waiting as long as possible. At REAP Financial, we find that the higher wealth you have, the less emphasis there may be on waiting to take Social Security. The timing of when you start taking Social Security can affect the total value you receive over retirement, so careful planning is essential.
If you retire early and don’t have any other income sources, you’re likely drawing from your 401Ks, IRAs, and investment accounts in the early stages of retirement. It’s important to manage your growth rate and withdrawal rate. If you’re not taking Social Security, chances are you’re drawing more heavily from your accounts in the early years of retirement, which could reduce the compounding effect in the long term. Depending on your situation, you may want to take Social Security early, have a spouse take their benefit early, or both take Social Security early to reduce reliance on investments early in retirement.
Not Having a Budget
No matter when you retire, the most critical number in your retirement plan will be your budget. You need a concrete budget and guardrails to help you avoid overspending, so your portfolio lasts as long as you do. While we can’t know our exact lifespan, longevity is a crucial factor here. Your portfolio’s longevity must align with your own. Not having a budget locked in at early retirement is a key danger. For this reason, the budget is one of the first things we focus on with our clients at REAP Financial.
If you’re interested in learning more about why your budget is the most important number in your retirement plan, check out this article! Prefer to watch a video? Click here instead!
Financial Planning for a Secure Retirement
If you’re considering early retirement, navigating its hidden dangers with a well-thought-out plan is essential. At REAP Financial, our fiduciary advisers specialize in creating tailored strategies to help protect your wealth and address risks like healthcare costs, tax efficiency, and inflation. With our experience in retirement planning, we’re here to support your long-term financial goals, ensuring a smoother transition to early retirement.
Based in Austin, Texas, REAP Financial provides comprehensive retirement strategies for high-net-worth individuals and families. Schedule a complimentary consultation today to explore how we can help you build a secure, sustainable retirement plan that aligns with your unique needs.
