Early Retirement Takes Consideration, Planning

For individuals considering early retirement, tax planning will be a major factor in their plans, Aaron Clarke, a wealth advisor at Gainesville, Virginia-based Heritage Financial, said in a phone interview.

“Most of the financial strategies for early retirement are around tax planning,” he said. Clarke notes that clients would typically be advised to avoid withdrawing from retirement accounts, like IRAs, at younger ages. They would be taxed on that income and have to pay a penalty (prior to 59 and a half years old).

Kenneth Chavis IV is a senior wealth counselor at Phoenix-based Versant Capital Management. He says that if someone is thinking of retiring early, they should “strongly consider working with a wealth manager or wealth advisor.” The advisor can put together a comprehensive plan that ensures they’ll have ample income to sustain their lifestyle, any traveling goals, and major purchases that may come up.

A plan for early retirement would also account for health insurance coverage. Further, it should include “wiggle room for major events and unknowns,” that would have a financial impact on individuals, Chavis added.

“Something people may not account for: early death of a spouse or divorce. Or later in life, if you are fortunate to live into your 80s or 90s, long-term care. So not only medical costs, but care costs,” he explained.

Versant Capital does a “capital sufficiency analysis” for individuals’ retirement plans. Under that comprehensive analysis, the firm typically want clients to have a probability of success above 90% to retire early.

“We broadly define success as someone not running out of money, even if they live to 95 or 100,” Chavis said.

This could seem like an aggressive savings approach, or assumption of risk. However, Chavis says that one of the major drawbacks of retiring early is that individuals have less time for retirement savings, and other investment accounts, to grow.

“Having less time for those assets to grow and compound is a challenge. And typically, if you’re retiring early, you need to sustain your adjusted-for-inflation assets for a lot longer period of time,” he explained. “That can be a lot more challenging and risky. A lot more prudent planning needs to be done to ensure that eight to 10 years out, you don’t have to go back to work if you don’t want to.”

Taking all of this into consideration can allow individuals to enjoy the benefits of early retirement, Chavis said.

“Earlier in life, while you’re still healthy and have a lot of energy – not only for you, but the people you love – you get to enjoy the important things in life. I think that’s the major benefit, essentially living life to the fullest when you’re fully able to do so,” he added.

Clarke noted that, over the years, he’s seen an expanded, or alternative, definition of early retirement. Some individuals plan for what he calls an “inverted retirement” option.

“You can position things so that, at 60 to 70, you don’t work, but then you have some form of income from 70 to 75,” he explained.

This can be attractive to some individuals, as their 60s may be a period where they can travel more.

One nonfinancial factor to consider regarding early retirement is what to do with that time, Clarke said.

“Pretty much everyone deals with this: What do you do with this time? Sometimes they don’t answer that question before they retire early. You see things like the divorce rate goes up in the window right after retirement. Spouses that haven’t spent a lot of time together for the last 20 or so years are spending a lot of time together. Are you retiring to something? ‘What am I retiring to?’ is a good way to think about it,” Clarke said.

For every great story about an early retirement, he warns there’s usually two or three cases that are “not as rosy.” A contributing factor to the risks are dynamics like the financial markets and costs arising from unexpected events.

“If you retire early, and the market has a really bad year, and you’re withdrawing from the portfolio, you are taking such a big percentage of the portfolio,” Clarke explained.

“You don’t know when a big down market is going to show up. If it happens in the first three to five years of retirement, you’re really more at risk,” he continued. Another risk would be a large purchase, like buying a house in a down market, Clarke noted.

“Something else that doesn’t work is people retiring early because of an expected inheritance. It’s mostly the mindset of: ‘I’m going to be able to retire early, and I expect it to be a certain amount.’ But what if that inheritance comes to you in a down year and you have a big purchase? What if you get 20% of what you thought you were going to get? What if you get the amount you think you’re going to get, but it’s doled out at 5% per year?”

Clarke has a general rule of thumb: “If it’s not in your control, don’t make it the key factor to your client succeeding.”

“We see that with inheritance a lot. People think they’re going to get $1 million, and they may get that. But it’s dolled out to them at $50,000 a year. [But] they thought they were going to get $70,000, for instance.”

Chavis has seen many individuals who successfully retired early were “great savers.” They were able to accumulate a lot of assets by the time they reached their 40s and 50s.

“Some of them were business owners, sold their business, and made the transition [to retirement]. Others were either executives or high-level employees at public and private companies. They got a lot of equity compensation, and their equity grew,” he said.

In his experience, the biggest factor individuals need to consider for early retirement is nailing down their expected lifestyle and spending habits.

“The number you’re using to do the projections, will be projected out over multiple decades. If it’s off, it’s going to be off over a huge time frame. It’s a huge input into the plan. Any adjustment in an input into the retirement plan will have a much more dramatic impact when you retire early, because the time frame [in which you’ll need that income] is so much longer,” Chavis explained.

“Even if the difference doesn’t seem big; let’s say, your spending plan is $120,000 a year. [If] you’re actually spending $132,000 a year, that’s potentially over multiple decades. That’s a different result and viability,” he said.

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