Four Unexpected Challenges of Early Retirement

by Kevin on April 22, 2013

Thousands of people are hoping and preparing to be able to retire early in life. How early is early? I suppose it could be any time prior to age 65, but the range runs the gamut. 50 is a very popular target age, and there are plans and strategies to get you out of the workforce any time between the ages of 40 and 60.

But what we don’t hear or read much about however is that there are some complications peculiar to early retirement, and if you can’t overcome them, early retirement may be little more than a pipe dream. Here are for that may need your attention.

Making your portfolio last for decades

Generally speaking, when you’re planning for your retirement you should figure that you’re going to live to be at least 85. If you retire at age 65, your challenge will be to have a large enough retirement portfolio to draw on for at least the next 20 years. That’s no small task, but it’s obvious that the earlier you retire, the more years you need to be prepared for.

If you retire at 50, you have to be prepared to cover at least 35 years. If you plan to retire by 40, you’ll be looking at 45 years, and that will be longer than you’ve been alive!

There is one inescapable fact: early retirement requires a larger and more productive retirement portfolio. But there’s virtually a double whammy here too – the earlier you retire, the fewer years you’ll have to prepare. In addition, the short timeframe means a lower time value of money.

So you want to retire early, but how can you prepare for both the longer amount of time you will be withdrawing funds, and a shorter amount of time that you will have to build up your assets?

There is no one way to handle this, so here’s a short list of suggestions:

  1. Start saving early – if you want to retire at 50, you should start saving no later than age 25.
  2. Save more – while others are saving 10% or 15% of their incomes for retirement, you should save 25% to 50%.
  3. Lower your cost of living – the less money you need to withdraw from your retirement accounts, the longer they will last.

Penalty-free withdrawals don’t start until you reach 59 1/2

Unless you plan to wait until you are 59 ½ to begin withdrawing from your retirement accounts, you face the possibility of penalties for early withdrawals. The IRS assesses a 10% penalty on any early withdrawals, with exceptions for special circumstances and hardships. Early retirement is not considered part of either category.

One way around this is to have a generous amount of non-tax sheltered savings you can draw upon between the time you retire and when you reach age 59 ½. For tax diversification purposes alone, it’s always an excellent idea to have non-sheltered assets for retirement anyway. Since money held in retirement plans is merely tax-deferred (as opposed to tax-free), it’s a good idea to have non-sheltered money, just in case a year comes about when you may need a larger amount of money than usual to have for expected expenses.

Health insurance

This could be the biggest problem of all for early retirees. You will leave your employer-sponsored health insurance plan, but you’ll be ineligible for Medicare until you turn 65. That can present more than a few problems.

If you leave your employer or your business, you’ll need to get private insurance. Not only is private insurance expensive and often hard to get, but both problems will be magnified by the fact that you are middle-aged or older. If you are planning to live on say, $4,000 per month in early retirement, but you’ll need $1,000 a month just for health insurance, your plans could change.

There aren’t many options here. Will Obamacare change this? That remains to be seen.

INFLATION!!!

We all know what inflation can do to a retirement portfolio. It’s virtually the retirement planners worst nightmare. If it’s difficult to prepare a retirement portfolio just to reach retirement, how much more complicated will it be if you need to plan for 40 or 50 years beyond?

Since there’s no way to know what future inflation rates will be, preparing for it will be at best an educated guess. But here are some suggestions on that front:

  • Invest in asset classes that are likely to do well in regard to inflation. This can include growth stocks, Treasury Inflation Protected Securities (TIPS), commodities, and real estate. Each will react differently with different types of inflation but a balanced combination of all should keep you covered.
  • Plan to live on even less than you expect.
  • Plan to continue to invest aggressively even after you retire.
  • Keep your business and employment options open – a run of heavy inflation might send you back out to get a paycheck, at least for a while.

Early retirement is a worthwhile goal, but if regular retirement is a challenge, early retirement is an even bigger hurdle.

If you are planning on early retirement, have you considered any of these challenges? What are you doing to work around them?

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