Clients Ask: How Should I Handle Early Retirement?
The economic dislocation resulting from the pandemic has caused many people to take early retirement – whether it’s been their own decision or not. Baird has been asking our clients what their biggest concerns are in regards to retiring early, and these are the answers:
How do I decide when to begin drawing Social Security?
It’s all about the cashflow – what your expenses are and how much other income you have. It can be uncomfortable to think about, but your life expectancy and health are also a huge consideration. The longer your expected lifespan, the better it is to delay taking Social Security. And remember, after one spouse passes, the survivor gets only the higher of the couple’s individual benefits, not both spouses’ benefits. (If the worker takes Social Security early, survivor benefits get reduced as well.)
All else being equal, it’s best to put it off for as long as you can. If you wait to begin drawing Social Security until you are past your full retirement age, you have a guaranteed benefit increase of 8 percent per year that you wait. That’s a good argument for waiting. If you are tempted to take your benefit before your full retirement age, one of the biggest gotchas you can run into is that you can be penalized if you earn too much in other income – and those penalties start with earned income of just $18,240 per year.
How should I handle my health insurance coverage?
Health insurance is one of the trickiest issues for early retirees to handle. If you suddenly find yourself without an employer, your focus can quickly shift from “Do I have enough?” to “What can I afford?” In that case, you need to consider how long a gap you have to fill before you become eligible for Medicare at age 65. Evaluate what you’ve got available to you in terms of your spouse’s insurance or a COBRA policy, then figure out how to bridge the gap.
One of the latest trends has been for people to retire at age 63 and a half - because you can take a COBRA policy at that age before transitioning to Medicare at 65. Without COBRA or Medicare, health insurance is very expensive for older Americans to get on the private market.
But there’s a danger in that as well. Some people tend to lean on a COBRA policy, not realizing that COBRA does not count as “creditable coverage” in Medicare’s eyes. What that means is that if you stay on a COBRA policy past the age of 65 and then sign up for Medicare after 65, missing your enrollment period, it’s considered a “late signup.” That can increase your Medicare premiums for the rest of your life.
Should I take my pension just for my lifetime, or should I add the survivor benefit that keeps paying out to my spouse after I pass away?
Survivorship questions are often overlooked, especially in early retirement, when the retiree is still fairly young. The answer here is that you should always add the survivor benefit, even though it will reduce the amount of your monthly payments. One other option is to take out an insurance policy that would compensate for the payments to the survivor, but it’s simpler to just add the survivor benefit.
How do I know if I am I eligible for a coronavirus-related distribution from my retirement plan?
The qualifications for a coronavirus-related distribution (CRD) that were set forth by the CARES Act last March are very broad, so a lot of people will be able take advantage of it. If you’ve tested positive for COVID-19, or lost your job because of the pandemic, or if you’ve just been affected by the virus somehow, you are eligible to take a CRD from your plan. Note, though, that you can only get this money from your 401(k) if the plan provider allows for such a withdrawal – they’re not required to make it available to you.
Should you choose to take a CRD, you can take as much as $100,000 from your 401(k) or IRA without incurring any penalties, even if you’re under age 59 and a half. You will still have to pay taxes on the amount (although you can spread the tax out over three years).
Should I take a 72(t) early distribution from my IRA?
If you’re forced into early retirement, you should consider taking a 72(t) – which allows for early withdrawals from an IRA as long as they’re “substantially equal periodic payments” - only if you need the money and have no other assets to pull from. You have to take the payments for five years or until you reach 59 and a half, whichever is later, in order to avoid the ordinary penalties.
Be very careful here, because if you don’t dot every I and cross every T, you can undo the validity of the 72(t). One way to ensure its validity: open up a separate IRA containing the assets you plan to draw from for the 72(t). That protects the bulk of your assets from tricky 72(t) calculations going wrong, and in case you need to make an extra withdrawal, you then may do so from the non-72(t) portion.
In which order should I begin drawing money from my accounts (qualified, non-qualified, tax free)?
This decision will depend on your overall cash flow and asset base, and how those two things are constructed. It usually starts with non-qualified (such as a taxable brokerage account), then qualified (such as a 401[k] or traditional IRA), then tax free (such as a Roth IRA or Roth 401[k]). But under certain tax circumstances, it may help to draw from a combination of non-qualified and qualified assets. If you need to control your tax bracket, it might make sense to pull down some of those non-qualified assets sooner.
It also depends on your beneficiaries, and what they need, although new regulations have also changed the strategies for many IRA holders. The SECURE Act, passed at the end of 2019, took away the Stretch IRA, so now your heirs have to take all the assets from an IRA within ten years rather than stretching it out over their lifetime. That reduces the value of an IRA for legacy purposes, and gives you another reason to draw it down earlier.
Retirement is complicated enough without feeling pressured to make decisions before you were ready to do so. If you’re facing early retirement, your Baird Financial Advisor can help you sort out your options and enjoy the retirement you deserve.
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