Life Changes

Are you dreaming of an early retirement? The earlier you retire, the greater the risk, experts warn

Key Points
  • Early retirement may be a dream but it comes with risks and for all but the wealthiest Americans.
  • The earlier you retire, the greater the risks.
  • There is no substitute for crunching the numbers on the expected costs and sources of income you will have in retirement.
Kathrin Ziegler | DigitalVision | Getty Images

Life may be short but early retirement might be, too, if you don't have a solid financial plan for life after work.

Whether it's due to pandemic burnout, a new attitude on life or an optimism fueled by surging stock and real estate markets, more Americans appear to be retiring early, based on U.S. Bureau of Labor Statistics data.

The labor participation rate for Americans over age 55 ticked up 0.7% in January to 39.1% but remains well below the 40.3% recorded in February 2020 and has recovered more slowly than the rate for the general population.

"I think Covid has increased the interest in retirement generally and accelerated the number of people retiring early," said certified financial planner Lazetta Rainey Braxton, co-CEO and senior financial planner at 2050 Wealth Partners in Brooklyn, New York. "People are rethinking everything and often more emotionally than practically."

For those who have the resources, retiring from the daily grind opens a new world of opportunities. However, it comes with risks and for all but the wealthiest Americans — and the earlier you retire, the greater the risk.

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"If you don't have debt, have a track record of living within your means and have enough resources to cover emergencies, knock yourself out," said Danny Artache, a financial advisor based in Jupiter, Florida. "But if you run out of money, you could end up being a greeter at Walmart."

Are you ready to retire both emotionally and financially?

There is no substitute for crunching the numbers on the expected costs and sources of income you will have in retirement. Simply settling on a "comfortable" nest egg figure will not cut it.

Costs include housing, insurance — if you retire early, you'll need to buy health insurance before Medicare kicks in at age 65 — food, gas and vehicle expenses. Major income sources include pension payments, Social Security benefits and withdrawals from your investment portfolio.

Braxton advises her clients not to carry any debt into retirement, except in the rare cases where the value of the mortgage interest tax deduction is greater than the cost of your annual mortgage payments.

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If you plan on traveling and/or taking on hobbies that cost significant money, incorporate that into your ledger.

"Don't be afraid of your numbers," Braxton said. "You need to know what they are.

"The more comfortable you are with those numbers, the more easily you can pivot when things change."

And they will change. A widely accepted rule of thumb is that you will spend about 80% of your working income annually in retirement.

However, no matter how well you itemize expected costs and income sources in retirement, there will be curveballs. There are several major unknowns that make retirement planning particularly difficult.

"Retirement is the mother of all financial planning problems," said Christine Benz, director of personal finance at Morningstar. "There are so many variables in the mix."

The three biggest are your health and longevity, the performance of the investment markets and the level of inflation through retirement.

When you continue earning income, you don't have to tap your investment portfolio and you increase your future Social Security benefits.
Christine Benz
director of personal finance at Morningstar

The first factor is entirely personal. Based on your current health and family history, you may not anticipate a long retirement, but conservative retirement modeling typically uses a 30-year time horizon.

Another rule of thumb, first articulated by financial planner William Bengen, is that with that conservative 30-year time horizon, you can safely withdraw 4% of your portfolio assets annually, assuming a 50-50 stocks-to-bonds portfolio.

The rule could use a tweaking, suggested Benz. The remarkably strong returns on stocks and bonds over the last 30 years may not be repeated in the next 30. In an environment of low bond yields and high equity valuations, investment returns could be thinner going forward.

"The next decade may not be great for market returns," Benz said. "If we are dealing with higher inflation, it adds another risk." Morningstar now estimates that the "safe" portfolio withdrawal rate should be lowered to 3.3%.

If that withdrawal rate combined with guaranteed pension and Social Security benefits can cover costs in your average year of retirement, you're in good shape. However, if you are at all anxious about your financial position heading into retirement, keep working.

"Working longer in a job you hate is no good, but the job market is so strong you may be able to swing a more comfortable work/life balance," Benz said.

The value of additional income-earning years is enormous. It will stretch your resources in retirement and reduce the risk of running out of money down the road.

"It has a multiplier effect," Benz said. "When you continue earning income, you don't have to tap your investment portfolio and you increase your future Social Security benefits.

"Your assets can continue to grow and possibly help you to delay taking Social Security," she said, in order to receive a higher benefit.

Your retirement might be shorter, but it could be much sweeter.