SHOULD YOU RETIRE EARLY?
By Mary Lynne Dahl, CFP®
January 03, 2015
Recent studies and surveys show a disturbing trend in the US. The center for Retirement Research at Boston College reports that their own estimates indicate that 53% of Americans will not have enough money in retirement to maintain their standard of living. According to Alicia Munnell, co-author of Falling Short: The Coming Retirement Crisis, who is the director of the center and a former member of the President’s Council of Economic Advisers and spent 20 years on the Federal Reserve Bank of Boston, the public is unprepared for retirement. I am inclined to agree with her.
Repeatedly, I talk with people in their 40’s and 50’s who state that their goal is to retire early. When I ask why, the responses I get are things like “I want to enjoy myself doing things before I am too old to do them” or “I have worked at this job for 28 years and get no satisfaction from it, so I want out as soon as possible”. This is understandable, but not a plan that is based on rationale thinking. Instead, those responses are based on emotion, which is a big red flag when it comes to making important money decisions.
Upon inspection of their assets and earnings, I am often shocked at how unrealistic this goal is. To retire early, you need to accumulate far more than if you retired at a more normal age of 65. Why? Because if you retire early, you will earn less, contribute less to your 401(k) plan, have a lower Social Security benefit, require more income for a longer period of time and be forced to increase your income in later years by a greater amount to offset the longer term effects of inflation. Add all of these things together and you have a recipe for a cake that will not bake properly. For many people, this unrealistic goal is the equivalent of a plan that is doomed to failure. When this happens, the individual will resort to crisis management, which is stressful and also doomed to failure. There is a better way.
Consider Social Security. Today, a very high percentage of people automatically take their Social Security benefits as soon as they can, which is currently age 62. This is not always a good idea. It may be okay for someone who is married to a high income wage earner who will continue to work and accumulate a much higher benefit. Let’s say that a couple are just turning 62 and 60 and decide that the older of the two will retire and take his Social Security at 62, which is promised to be $1,100 per month. His full benefit, at age 66 would have been $1,467 and his benefit at age 70 would have been almost $1,996. The younger spouse, who earns a much higher income, plans to continue working until age 66, which is 6 more years, at which time her benefit is promised to be $3,000 per month. If she waits until age 70, her benefit will be $4,080 per month and her spouse can switch from his own benefit of $1,100 to a spousal benefit of 50% of hers, which would be $2,040 per month. He would have had the advantage of the reduced benefits for many years then get the higher benefit at her retirement, for a larger overall total. In this specific case, this plan will work well because Social Security increases the benefit by 8% per year for the spouse who is willing to work to age 70. However, it will not work for a couple who earn relatively equal wages and take benefits at age 62 instead of waiting until a later age. It will also not work for a couple who is not married and therefore not entitled to spousal benefits. It will not work for a single person, either, who has no other income on which to rely or share.
Now consider your 401(k) plan. If you stop working before age 65, you will not make contributions for the years between when you retired and age 65 or later. Let’s say that you earn $65,000 per year and have been contributing 10% of your salary to the 401(k), with an employer match of 3%, for total contributions of $8,450 per year being added to your 401(k) account. In addition, it is $8,450 that does not get taxed, which, at the 15% bracket (married filing jointly) is also $1,267.50that you would not pay in federal income taxes every year that these contributions are made. The 401(k) contributions, when added to what you already have and when invested, have the potential to grow dramatically from compounded returns on the entire account balance. If you are healthy and enjoy your job, working to age 70 instead of 60 has the capacity to approximately double the value of your 401(k) plan in that 10 year period, assuming an average return of 7.2% or better. For many people, this is a dramatic increase in their projected retirement income, especially when combined with the increased Social Security benefit payable at age 70 as compared to age 62 or 66.
It goes without saying that you should also eliminate debt before you retire and begin taking monthly income. Not having to spend money on a mortgage payment is like putting extra money in your pocket. This is may seem obvious but it apparently it is not, so I mention it here as a key element in this entire plan to retire, at any age.
The answer for most people is to work longer than age 65. I believe that the new normal is 70, not 65. People in their 50’s and 60’s today will not only live longer, but be more active and healthy as they age. Many people in their 70’s today are still hiking, swimming regularly, bicycling, camping, sailing and skiing. Some are still working.
What if you truly do not enjoy your job? Should you retire early and ignore the reality of inadequate retirement income? Of course not. You should change jobs. Quit the one you no longer like when you find one you do like, but not before that. If you have skills that will transfer, use them and move over to something that provides more satisfaction. Salary is not as important as job satisfaction, so don’t be afraid to take a different job that pays a little less but is really satisfying. Be creative and proactive about this, but most of all, be realistic and honest with yourself.
Another option is to deliberately live on a little less, if you can make this work. Most people can. This will also prepare you for retirement, in case your income at retirement is less than you make while working. Build yourself a spending plan (budget), that makes some cuts, and see how it works out for you after a year of living on less. Many people do this, love it, feel very empowered by it and go on to a secure and comfortable retirement as a result.
Ms. Munnell and other experts like her are justified to be concerned about Americans’ ability to have a comfortable, secure retirement. Studies show that only 45% of workers have access to a company retirement plan, and of those that do, only 34% are participating in their plan. This is not a recipe for a comfortable, secure retirement, and certainly not an early retirement.
Government and experts are considering ways to change this statistic, and are hinting at making retirement plan participation mandatory. This is actually done in other countries such as the UK and New Zealand, but would not likely be popular in the US. In addition, it would help if 401(k) plans did not allow early withdrawals or loans; those just enable investors to shoot themselves in the retirement foot. Other options being considered are to raise the age for full Social Security benefits and increase the earnings ceiling for Social Security taxes. All of these changes would help shore up the Social Security system and 401(k) plan participation, but they require Congressional action, a difficult thing to achieve lately.
The better solution is for individuals to make their own plans. Save and invest more, aim for a higher return on investment (which can increase the level of risk), avoid withdrawals from savings and retirement plans entirely, pay off all debt and work to age 70 or longer, if they are healthy and can do so.
This may not be what you wanted to hear, but it is good advice. In the end, most people will do what they want. Only time will tell if they are making good financial choices. As a Certified Financial Planner TM, my hope is that this advice will make a real difference for someone. That’s as good as it gets and that’s good enough for me. Stay tuned for more good advice that you may not like.
©2013 Mary Lynne Dahl, CFP® is a Certified Financial Planner ™ and partner in Otter Creek Partners, a fee-only registered investment advisor firm in Ketchikan, Alaska. These articles are generic in nature, are accepted general guidelines for investment or financial planning and are for educational purposes only.
Mary Lynne Dahl©2014