Forced to Retire Early? Here's What You Need to Know

At some point in our lives, we will stop working.  For many of us, we will choose when that will happen.  But for others, it may not be your choice. An unplanned retirement can lead to some difficult decisions.  Here is what you need to know if you are forced to retire early.

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Most people have an idea about when they want to retire.  For some their ideal retirement date might be 55.  For others, it could be 85.  If we are fortunate, we can control this.  But the choice could be outside of our control.  Here is what you need to know if you are forced to retire early. 

1.  Get Organized

`Things did not happen in an ideal way, so it is time to evaluate every part of your financial life.  Here are some basic questions to ask...

Your assets...

• What assets can generate income? 
• How are those assets taxed?
• Can I access them without penalty?

Your spending...

• What are our expenses?
• What expenses are essential to our well-being?
• If I have to cut back, where can I do that?
• What new expenses am I going to incur?

Other key things...

• What are you going to do about health insurance?
• How will Social Security impact your situation?
• How will your tax situation change?
• The Impact of Early Retirement on Your Social Security

Retiring early can impact your Social Security benefits in two key ways.  It can result in a smaller benefit due to fewer higher earning years.  Secondly, that smaller benefit can be future reduced by early retirement discounts.

Your primary insurance amount factors your 35 highest years of earnings, and those generally happen at the ends of our careers.  When you reduce or eliminate some of those higher earning years, it affects the math behind your primary insurance amount.  

The bigger impact will likely come from the early retirement discounts.  This happens when you begin your Social Security before your normal retirement age.  For people currently nearing retirement, that is now 67 years old.  If you start your benefits at age 62, your benefits will be reduced by 30%.  

Health Insurance Is a Big Expense

If you have to buy health insurance you are in for some sticker shock.   Here are your basic choices.  

• COBRA — This is continuation of coverage under your employer's plan.  In most circumstances, you continue your health insurance benefits at the current cost.  But instead of your employer paying a portion of those premiums, you bear the entire cost.  This coverage can be continued for 18 months, and in some cases, can be extended for an additional 18 months.
• Buying your own insurance -  Individual health policies can be very expensive.  Depending on your age and health, you could easily pay $1,000 per month per person for coverage.  This can quickly eat into your budget.
• Affordable Care Act Marketplace - The ACA created a marketplace for health insurance coverage.  And in some cases, you may qualify for tax credits to offset the premium costs.  Depending on where you are located, the coverage options may be limited.

While this is a temporary problem—you will be eligible for Medicare at age 65—it may put some stress on your cash flow in the earlier years.

Understanding Income Taxes

Income taxes will also be an expense you incur. And understanding how this will affect you is critical—especially if you are younger than age 59 1/2!  Most people accumulate their retirement savings in their employer's retirement plan.  And what we currently see, the biggest portion of their savings was accumulated from pre-tax contributions.   The Roth options are newer and there has been less time to accumulate funds in those tax- advantaged accounts. 

Distributions from your 401k or IRA are fully taxable, and this may be a small surprise for some.  Let's say you need $2,000 per month from your 401k to make ends meet.  To cover the taxes, you would need to withdraw $2,500.  This extra amount can increase the risk and stress you place on your nest egg.

What if you are younger than 59 1/2 when you are forced to retire?  Distributions from retirement plan accounts and IRAs could be subject to a 10% penalty.  There are a couple of exceptions:

•  Distributions directly from an employer retirement plan - Many plans allow for penalty-free distributions for workers over age 55.  Some plans, like a government-sponsored deferred compensation plan (section 457) may not have an age restriction.   You need to check your plan's summary plan description for details.  
• Substantially Equal Periodic Payments - this is a complex rule in the tax code that allows for penalty-free withdrawals from an IRA.  If this is something you want to consider, please speak to someone who has done this before.  Mistakes can be very costly!

Cash Flow is Key!

Whether you are forced to retire early or retire exactly when you plan, managing your cash flow is the key to your financial success.  Withdrawing too much from your retirement savings increases your risk of outliving your nest egg.  In most cases, using a 4% withdrawal rate has been a reasonable guideline.  But the longer you need to rely on your savings, the more important it is to manage your withdrawal rate.  

Being forced to retire before you are ready is not ideal, and it may require making some significant changes to your lifestyle.  Having a good understanding of what expenses are essential and which aren't can be a good starting point.  

Talk to People Who Know Retirement

Our team has 5 CFP® Pro's, and a Chartered Financial Consultant.  We can help you navigate through a tough time.  Give us a call or complete the form to arrange a time to talk.