Most of us dream of retiring early and spending our days pursuing our passions. Oftentimes, though, people who retire early find themselves returning to the workforce a few years later.
There are many reasons why people unretire, but the most common one is underestimating expenses. Whether it’s out-of-pocket healthcare costs or property taxes on a new home, there are several easily overlooked factors that can derail plans. Unexpected life changes and boredom can also dramatically shift the ideal vision of what life without the 9-to-5 grind looks like.
Here are some tips and considerations to think through before entering an early retirement.
Prepare for the costs of healthcare and leisure. Healthcare is one of the biggest expenses in retirement. Let’s say you plan to retire at 50 years old. That means you may have to pay for healthcare totally out of pocket for the next 15 years. The costs today are high, so imagine what they will be like 15 years from now. Your savings could also take a hit if you or your spouse were to develop a major illness, especially one that requires hospitalization. On the other hand, if you are healthy, you will likely be spending more than you did during your working years as you have more time to socialize and travel.
To account for these potentially unexpected costs, evaluate your current investments. Will they keep up with rising costs? Based on your health history, how much money do you plan to save for existing or likely health issues? Do you plan on traveling more often? Then, factor these answers into your financial plan. While you are still working, consider increasing your contributions to your health savings account, which will enable tax-free spending on healthcare in retirement. Similarly, consider putting aside “fun money” into a high-yield savings account to get an accurate picture of how much you can afford to travel. We can’t predict the future, but it’s wise to save more money than you think you’ll need.
Anticipate slowing growth of retirement savings. Once you stop receiving a paycheck, you will likely stop contributing to your 401(k) and/or IRA. That also means you could be missing out on years of employer-matched contributions. As you begin drawing from your retirement accounts to pay for everyday expenses, the growth of those assets may slow, therefore decreasing your available savings and savings potential. Similarly, claiming Social Security before full retirement age means your benefits will be reduced.
Before withdrawing any savings or locking in your Social Security benefits, assess your retirement accounts and where you stand financially. Is what you have saved (or plan to have saved) enough to comfortably get you through 20 years without additional contributions? Then, devise an appropriate withdrawal strategy, which may determine what kind of income is used for certain types of expenses. Factor into that strategy when you plan to begin taking Social Security benefits. A financial professional can walk you through the pros and cons of that timing.
Account for the cost of taxes. Taxes are a huge factor to consider in estimating your costs in retirement, including property tax, sales tax, and income tax. The type of asset from which you withdraw will also have different tax implications, including your pension, 401(k), and Social Security. Taxes may also vary from state to state, making where you plan to live in retirement an important consideration.
Your retirement plan should include the total cost of taxes, and it all starts with location. Where do you plan on living? If you plan to move, research how the cost of living in the new city compares to your current city. If you plan to purchase a new or additional home, find out what those property taxes cost.
Reconsider passing off your business to your kids. Often, business owners who retire early will sell or transfer the business to their children. Sadly, this may not work out if the child doesn’t have the same drive and determination. There is a big difference between starting something from scratch and being handed something. That same gritty determination from the original creator is hard to replicate, and sometimes the parent ends up stepping back in to get the company back on track.
Before handing over the reins, have an honest conversation with your child. Let them know there is no pressure to take over the business if they are not truly passionate about the work. To understand their commitment, ask them about their short- and long-term goals for the business. Depending on their answers, you might want to consider holding on to your business a little longer while you search for the right person to take over.
Keep busy. Aside from the financial challenges, boredom drives people back to the workforce more often than you would think. We need a sense of purpose, a reason to swing our legs off the bed in the morning. As cool and romantic as the thought of early retirement sounds, few have planned for all that additional time. The wish list often gets exhausted quickly, and then your calendar is wide open.
Think about mapping out what your day to day would look like without the structure of work. Remember, you can only go to the beach, ski, and travel so much. Then what? If most of your friends are still working full time, will you be able to make new friends easily? If your plan is to spend 100% of your time with your spouse, come up with a plan B, quickly, for their sake and yours.
The bottom line is that life is expensive and unpredictable. It’s fine to dream, and it’s important to work toward goals, but it’s crucial to be realistic when it comes to planning for your financial future.
Mike Lynch is managing director of applied insights at Hartford Funds.
This post was originally published on Market Watch
