About 10,000 Americans retire every day. If you’re considering joining the life of the intentionally (and permanently) out of work while you’re still young enough to really enjoy it, then smart financial planning is a must.
Retiring early has its advantages — who’s going to say no to more leisure time and less work stress? — but it also has drawbacks if you’re not aware of the early withdrawal penalties for IRAs and pensions or the coverage gaps you may face if you don’t yet qualify for Medicare.
Don’t put your future in jeopardy because of an early retirement penalty or fine. Here are some financial pitfalls to keep in mind when it comes to early retirement, and how you can avoid them.
Early Withdrawal Penalties for IRA and Pensions
Many people think of 65 as the standard retirement age. But for the purposes of a qualified retirement plan like an individual retirement account — or IRA — this isn’t the case.
As far as an IRA is concerned, the magic number is 59 ½. If you withdraw money from your IRA before then, you’ll pay an early retirement penalty in the form of a 10% tax. The money will also be included as part of your gross income, which may be subject to its own federal, state and local income taxes. There are some exceptions to this rule, however, such as if you become permanently disabled or need to withdraw money to pay for health insurance premiums after a job loss.
Although the rules vary by pension plan, and some plans do offer a lump sum option, you typically can’t withdraw money from your pension until you reach 65. True, some plans let you access your pension as early as age 55 — the catch is that you’ll receive a reduced monthly payment for the life of your pension.
You also might consider taking your Social Security benefits early as you transition into full retirement. These benefits can start as early as age 62, but here you’ll hit a similar snag: Collecting early means you’ll only receive about 73% of your monthly benefit.
If you don’t desperately need the money right now, put off withdrawing from your IRA or pension early. It generally also makes sense to wait until you reach full retirement age to start collecting Social Security. As tempting as the alternative is, try to rely on other sources to fund your retirement until you reach the qualifying age for your plan.
Reviewing Early Retirement and Medicare
It’s no secret that America’s employees like having access to health insurance through work. When you retire early, you risk losing coverage: To qualify to receive health care coverage through Medicare, you need to be at least 65, no matter when you retire.
Anyone planning to retire before 65 will have to bridge the gap between their employer-sponsored plan and Medicare. If you’re not too far off from retirement age, a short-term plan might protect you in the interim. Short-term insurance plans offer coverage for up to 364 days in some states, with the possibility of up to two renewals. These plans don’t always provide the same comprehensive coverage that major medical plans do, but they’ll effectively shield you from some costly medical expenses.
If you predict needing several expensive medical procedures or treatments in your near future, it could also be worth looking into private insurance or an Affordable Care Act (ACA) plan. Private insurance can be pricy — and so can an ACA plan if you don’t qualify for a subsidy — but depending on your needs, either option may end up being less expensive (and safer) than going without insurance entirely.
Timing Your Early Retirement
When you retire matters. Not just at what age. The time of year you make your exit can also have financial repercussions.
If you work for a company that matches retirement contributions or gives bonuses, track when this happens before setting your retirement date. Some companies issue matches and bonuses at the end of the year, while others do them quarterly or throughout the year. If you have to wait until December for a company match or bonus, it may be worth retiring in January of the following year to maximize your retirement savings.
Follow the same principle for your unused vacation time. Companies typically pay out unused vacation time in your last paycheck of the year, but if you’re set to retire, there may be different rules. Talk to your HR department to figure out your company’s policy before you decide on a retirement date.
The perfect retirement doesn’t just materialize automatically at the age of 65. It’s an ever-shifting phase of life that you get to choose according to your wants and needs — and one you have to financially prepare for. If you want to retire early, you have options. Plan out what’s possible and see if it makes sense for you to bump your professional timeline up a little.