Choosing Early Retirement

At 65, you’re eligible for Medicare and an additional personal exemption on your income taxes. But that doesn’t mean you can’t retire sooner than the traditional retirement age.

If you’re financially secure and confident that you will remain that way even without the income you currently earn from your job, you might decide you’re ready to retire early. In that case, you’ll have the opportunity to do the things you’ve had to put on hold because there was just not enough time. But there are some potential drawbacks to leaving the workforce early. So before you take the leap, it pays to take a second, careful look.

WHAT MAY GIVE YOU PAUSE

On the negative side, retiring early means less time spent contributing to your employer-provided retirement plan and your personal investment portfolio, including money you may be putting into an individual retirement account (IRA).

If you are taking money out of those accounts to cover living exenses, or because you’re required to start taking distributions, it also means you’re limiting the opportunity for accumulating tax-deferred earnings on those investments. And an earlier retirement doesn’t just mean less time spent investing. It also means more time spent drawing down savings and investments in retirement.

If you retire early, you may receive a smaller pension payout if your pension is based on years worked with your employer. And since you’re likely to earn your highest salary later in your career, retiring early means you may forgo some of your most lucrative years of income that would boost the amount of your pension.

Furthermore, if you apply for Social Security the first year you’re eligible, at 62, you’ll receive a smaller annual benefit than if you began collecting at full retirement age (FRA), and those reductions are permanent. Specifically, if you were born between 1943 and 1954, you’ll be entitled to 75% of what you would receive at 66, which is your full retirement age (FRA). If you were born between 1955 and 1960, the amount you’re eligible for at 62 drops gradually to 70% of the FRA amount.

The closer to your FRA that you start to receive Social Security, the smaller the percentage you lose by taking the benefits early. You can estimate the amounts that you would receive at different ages on the Social Security Administration’s website, www.ssa.gov/estimator.

While you can take your pension and Social Security benefits before full retirement age, one of the largest potential impediments to early retirement is that you won’t be eligible for Medicare until you reach 65. Your employer may cover health insurance for retired workers, but not all do. If that’s the case, you will need to consider the cost of buying individual insurance for yourself and possibly your dependents until you turn 65. If you have any pre-existing health problems, you may find the cost prohibitive.

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TAKING ANOTHER PATH

Retiring early from a long-time job does not necessarily mean you have to leave the workforce. You may be able to work as an independent contractor, or as a consultant to your former employer or another firm in the same industry, especially if you have marketable skills based on years of experience. That arrangement may not solve your health insurance problem, but it probably means you can postpone withdrawing from your retirement accounts and continue contributing to your IRA.

If that’s your plan, you may want to roll over your 401(k), 403(b), or similar plan to an IRA. That way, you can put off withdrawals until you turn 72, provided you don’t need the money. And, if you have a defined benefit plan, it’s worth asking your employer if you can delay starting your pension payout. It may not be doable, but it won’t hurt to ask.

Similarly, you may want to start a second career, perhaps one that you believe will provide a new level of job satisfaction. The possibilities are virtually limitless, though you may need the encouragement of family and friends and consultation with your financial adviser to take the leap. But remember, a transition of this sort takes advance planning. You probably don’t want to wait for your last paycheck to be deposited to start thinking about what you’ll do next.