When you think retirement, you may think 65. Since the 1930s, when Social Security was introduced and employee pensions became increasingly common, that’s been the traditional retirement age. At 65, you’re eligible for Medicare, which was designed to provide health care coverage for retired people. And 65 is when you get a small break on your taxes by being eligible to take an additional personal exemption.
Despite the pull of tradition, and the financial advantages that sometimes go with retiring at 65, many people don’t wait that long — though they often go back to work after leaving their full-time jobs.
- Less time in pension plan
- Less in personal investments
- Smaller Social Security benefits
- Smaller pension payout
- Receive the most you’re eligible for from your company pension plan
- Receive a larger Social Security benefit
- Have more personal investments
THE EFFECT, IN $s and ¢s
Financially speaking, the biggest effect of retiring early is having less income. The most obvious reason is that you’re not working. But retiring early can also mean a reduction in the retirement income on which you were planning.
To begin with, you’ll accumulate fewer years of contributions to your retirement plan. Since you typically earn the highest salary at the end of your career, retiring early may mean losing contributions based on those amounts. The consequence is usually a smaller pension check than you might have received had you stayed longer.
If all or part of your pension comes from a traditional plan, the amount may also be reduced to offset the greater number of years you are expected to collect — though that policy isn’t the same with every employer. Sometimes a pension is based on your salary and the number of years you’ve worked rather than your age when you retire. In other cases, you can retire with full benefits at age 55.
If you apply for Social Security at 62, the first year you’re eligible, you’ll receive a smaller benefit each year for life than if you begin collecting at the full retirement age. If you were born before 1938, for example, you collected 80% of what you would have been eligible for had you started benefits at age 65. If you were born between 1943 and 1954, you’re eligible for 75% at 62 because the age at which full benefits are paid is 66. You can find the specific percentage that applies to your year of birth on the Social Security website, www.ssa.gov.
RETIRED BUT WORKING
People who retire before age 65 tend to continue to work in increasing numbers. One reason seems to be that while you can get your pension and Social Security benefits early, you aren’t eligible for Medicare until you reach 65. Plus, many employers have been reducing healthcare coverage for retired workers, prompting the need to earn additional income to cover insurance costs. What’s more, people whose retirement savings have declined may not have enough left to live as they had planned. Some others are just plain bored.
THE INVESTMENT DIFFERENCE
Choosing to retire early can also have an impact on your investments. You’ll have to stop adding assets to some of them when you’re no longer earning a salary. You may have less money to invest in the ones that don’t have contribution restrictions. And if you start drawing retirement income from your accounts, they have less time to grow undisturbed.
One solution is to continue to invest even after you’re eligible to withdraw or actually begin withdrawing. You can reinvest your earnings directly in some stocks and most mutual funds, and you can use the principal of maturing bond or CD investments to purchase new ones. And, if it’s financially possible, you can postpone withdrawals from tax-deferred plans. With a traditional IRA, for example, you can wait until you are 70½ to start taking money out, and with a Roth IRA there’s no required beginning date.
NEEDING IT LONGER
The other side of retiring early is being retired longer. That means you’ll need retirement income for more years. To take a simple example, if you retire at age 60 instead of 65, and need an income of $40,000 a year to live comfortably, you’ll increase the amount you need in retirement income resources by $200,000 even before accounting for the impact of inflation.
What’s more, retiring early often means you start withdrawing money from your retirement accounts sooner, reducing the base on which they can grow. That means you need a larger nest egg if you want to ensure your income will last as long as you need it.
CALLING IT QUITS
While one of the attractions of early retirement is more time to do the things you enjoy — and maybe less time at a job you’ve grown tired of — there are other reasons for retiring early.
One is being downsized. While age discrimination is illegal, it’s alive and well according to many people who have been forced to retire before they were ready. Older and more highly paid employees may have little choice about early retirement if their employers insist. In that case, having additional sources of long-term income may be crucial.
And, if you are offered an incentive to retire early but aren’t forced out, you’ll want to weigh the benefits of the package that’s offered to be sure there’s a financial benefit.
WEIGHING THE CHOICES
If you’re offered a choice of early retirement packages, here are some questions to ask:
- Will the base on which my traditional pension is figured be increased? By how much?
- Will the offer increase the percentage of my salary that’s being replaced?
- If I take a lump sum, is that on top of my regular pension or instead of it?
The advantage of a lump-sum payment is that you can invest it to produce another long-term source of income, though a larger pension might add up to more income over time.