People who hang it up at age 55 (or younger) are generally considered to have retired early. With careful planning and financial discipline, it’s possible to save enough for an early retirement on a median-range income. However, there are also some lurking financial pitfalls that don’t rear their heads until after you’ve said goodbye to working life. The success of your plan to retire early may depend on identifying and avoiding them. The good news is that if you know about these risks, you can plan for them. And if you can plan for them, you can mitigate them — at least partially. With that in mind, let’s review some of the not-so-nice financial surprises that can affect early retirees.
Expensive Medicare Premiums
The Medicare program was designed to ensure older adults have access to affordable healthcare. Many retirees rely on it to help control their healthcare costs, applying for coverage as soon as they become eligible.
If this aligns with your plans, you should know about the Income Related Monthly Adjustment Amount (IRMAA). Higher-income Medicare recipients will pay more for their coverage. Sometimes, retirees just barely ascend into the next income bracket. This triggers an unexpected increase in Medicare premiums, which can throw a tight budget out of whack.
How To Avoid It:
There are a few things you can do to avoid the IRMAA sting. If you’re married and your spouse still works, see if they can add you to their employee sponsored health plan. But first, check to see if that plan requires the beneficiary to enroll in Medicare upon reaching age 65. If so, figure out a plan to deal with that day when it comes.
A professional financial planner can also help you manage your reported income. Most IRMAA charges fall under Part B costs. Take a look, see where you are, then see what you can do to avoid going up to the next bracket.
ShutterstockPrivate Health Insurance Can Be Pricey
In most cases, Medicare eligibility starts at age 65. Thus, early retirees are probably ineligible — they’re simply too young. If you can’t be added to your spouse’s coverage, you will need to find your own.
The problem is that finding an affordable plan (for which you qualify) is not easy. It gets even harder if you aren’t eligible to claim the premium tax credits offered through the Affordable Care Act. Costs can rise quickly and jolt your budget off stride.
How To Avoid It:
First, see if you can secure continuation of health coverage through the government’s COBRA plan. This will buy you three years, helping to bridge the gap until Medicare eligibility kicks in.
Failing that, you can find a part-time job that offers health coverage as a side benefit. This AARP resource can help you find some ideas on where to look.
The Taxman Cometh
The proverbial “two sure things in life” loom large in retirement — especially the taxes. Retirement is when the government comes looking for its cut of those tax-deferred savings accounts you’ve been building for decades.
On top of that, other forms of retirement income are also subject to taxes you may not have planned for. For instance, certain Social Security benefits are taxable. If you get a pension or start receiving deferred income after you retire, you could also find your income bracket rising. Some retirees even end up in a higher tax bracket than they were in during their working years.
How To Avoid It:
Avoiding taxes is all but impossible, at least for us law-abiding citizens. Your best bet is to shield yourself as much as possible. That should begin with early planning. Again, a personal financial advisor or tax advisor will be your best source of guidance. Determine whether a 401(k), Traditional IRA, or Roth IRA is the best plan for you.
If you can’t plan early because it’s already too late, consider charitable giving. Donating some of the money in your IRA accounts to qualified charities can put you back in a lower tax bracket. This will ease the tax sting, but beware that the government has recently tightened the rules around this strategy.
Sequence of Returns Risk
Sequence of returns risk is a complex concept related to the financial markets. It basically breaks down like this: the stock markets could take a downturn during the initial phases of your retirement. When you factor in withdrawals from your savings, your portfolio could seem to be evaporating into thin air.
This risk is larger if you factor an expected rate of return on your investments into your retirement financial plans. The more dependent you are on that projected return, the greater your risk will be.
How To Avoid It:
The overall state of the financial markets is beyond your control. Your best bet is to mitigate the damage by responding with targeted action if an economic downturn occurs.
One strategy involves limiting your variable spending if the markets take a hit. You can also use strategic (or safer) assets like bonds and certificates of deposit. These asset classes help shield your money from market volatility, effectively capping your losses. You can then reinvest in the markets once they recover. If all goes well, your gains in a bull market will help you recover.
The Vanishing Nest Egg
Even if things work out in the financial markets, unexpected expenses abound for early retirees. Out-of-pocket medical expenses, sudden home or auto repairs, and rising living costs all happen.
This can force you to draw on your savings more often than you would like. Before you know it, you can suddenly see your way to the bottom of your nest egg. That’s scary.
How To Avoid It:
Sound planning and self-education are your best friends in this regard. As you make your budget, factor in what things will cost when you need to buy them, not what they cost today.
You should also educate yourself on budgeting and financial self-discipline well ahead of time. These aren’t skills you want to learn on the fly after you’ve permanently said adios to working (and collecting a regular paycheck).
ShutterstockLong-Term Care Costs
Early retirees are often in relatively good health. As such, they sometimes fail to plan for a day when they will be much older and need regular care.
Most insurance plans only partially cover such costs. Worse, families sometimes fail to figure out a solution until an older member desperately needs care. Scrambling to find a quick solution inevitably costs more. It can also result in getting stuck with a care provider who wouldn’t otherwise be your first choice.
How To Avoid It:
If you’ve got kids, ask for their help. Sit down with them years in advance and come up with a plan to pay for care you may need. Extended families with many working members can be a boon. If everyone can contribute a little bit, nobody will need to bear a costly burden.
Another possibility lies with insurance. Some insurance companies allow customers to buy life insurance plans that include special riders for parental care. If your children have a policy with such a rider, you’ll have access to the financial help you need.
The Bottom Line
Early retirement is a very appealing prospect. You’ll have nothing but time to do all the things you’ve always wanted to do while you’re still young and well. However, unpleasant financial surprises can happen, and that’s not nearly as nice a proposition.
Careful long-term planning is the key. Getting advice from personal financial advisors and tax specialists is also a must. These professionals can delve into your financial details and come up with solutions tailored to your objectives and situation.
