Early Retirement: Hidden Risks and Costs You Shouldn’t Overlook
Daphne had a plan. She would retire at age 62 while she was still healthy enough to travel, take on projects she cared about, and spend real time with her grandchildren. She had saved diligently for decades. She felt her retirement accounts were comfortable.
What her projections had not fully captured was the web of financial penalties, benefit reductions, and extended planning horizons that can come with leaving the workforce before traditional retirement age. Within 18 months, several of those gaps had become expensive surprises.
Early retirement, commonly defined as leaving the workforce before age 65 or before becoming eligible for full Social Security benefits, is an appealing goal to many. It can be achievable, but it requires proper knowledge of retirement accounts, Social Security and healthcare options to avoid gaps that can lead to large costs.
“Early retirement can be done, but it requires planning for a timeline that many people underestimate,” explains Patricia Klein, Assistant Branch Manager of the Westport Branch at David Lerner Associates. “Healthcare costs before Medicare, Social Security reductions, and a longer drawdown period all need to be factored in from the start.
The Social Security Penalty
Social Security factors in an individual’s “full retirement age,” which for most people currently retiring, is at age 67. Claiming benefits before full retirement age can result in a reduction that lasts the rest of your life. Claiming at age 62, the earliest possible age, reduces your benefit by up to 30% compared to claiming at age 67. For a benefit projected at $2,500 per month at full retirement age, early claiming means receiving approximately $1,750 per month instead.
If you continue working in some capacity after early retirement, Social Security has an earnings test that can further reduce or temporarily withhold benefits before full retirement age. These rules can be complex and worth reviewing in detail before making any claiming decision.
The Healthcare Gap
Social security and Medicare have different rules. Medicare eligibility begins at age 65. For someone who retires at age 62, that creates a three-year gap.
For those that want to retire before Medicare coverage kicks in and do not have extended coverage from a prior employer, private health insurance must be sourced independently. Depending on your health status and the plan you choose, marketplace premiums for a couple in their early sixties can range from several hundred to several thousand dollars per month. This is one of the most frequently underestimated costs in early retirement planning.
COBRA coverage—short for the Consolidated Omnibus Budget Reconciliation Act—allows you to temporarily continue your employer-sponsored health insurance after leaving your job. It can bridge the immediate transition from an employer plan, but it is typically available only for 18 months and requires paying the full premium, including the portion your employer previously covered.
Planning for healthcare costs between retirement and Medicare eligibility is not optional. It is foundational.
Retirement Account Access and the Rule of 55
Certain retirement accounts can also have hefty penalties if you withdraw too early. Withdrawing from a traditional IRA or 401(k) before age 59 ½ generally triggers a 10% early withdrawal penalty in addition to ordinary income taxes.
There are exceptions, including the Rule of 55, which allows penalty-free withdrawals from a 401(k) if you leave your job at age 55 or older in the same year. However, this applies only to the 401(k) of the employers you left, not to IRAs or older plan balances.
Careful sequencing of which accounts are accessed in early retirement can significantly affect both the tax burden and the longevity of the portfolio. A Roth conversion strategy executed in low-income years before Social Security begins can also be valuable in reducing future required minimum distributions (RMDS).
The Longevity Factor
Retiring at age 62 could mean funding 25 or 30 years of retirement. A portfolio calibrated for a 20-year retirement horizon can look very different from one designed to last three decades. When the time horizon extends, withdrawal rates, asset allocation, and risk management can all be reconsidered to match your goals.
Building a Retirement Plan That Accounts for These Realities
None of these challenges make early retirement impossible. It does, however, require purposeful planning with honest numbers and in-depth retirement conversations.
For you’re ready to take another look at your retirement strategy, consider working with an Investment Counselor at David Lerner Associates. Our Investment Counselors can help evaluate your long-term goals and discuss strategies that can align accordingly.
Material contained in this article is provided for information purposes only. It is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. This material does not constitute an offer or recommendation to buy or sell securities and should not be considered in connection with the purchase or sale of securities. These materials are provided for general information and educational purposes, based on publicly available information from sources believed to be reliable. We cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
The subjects of this article are fictitious and created for illustrative purposes only. They are based on events of a similar nature and should not be interpreted as direct depictions of any specific individuals, organizations, or incidents. Any resemblance to actual persons, living or deceased, or actual events is purely coincidental.