"This section
contains additional data that supplements basic information contained in
Your
Money Matters
and should be used
in conjunction with the material contained in Your
Money Matters.
Ahhh, early retirement! How many times each day do we dream about
being able to bid the workaday world adieu? Turning the dream of
early retirement into a reality is a huge financial challenge.
Unfortunately, many people who are retiring early now will eventually
realize that they could not afford to do so. The truth is that most
people cannot afford to retire early — even if they think they
can, and even with a generous company-sponsored incentive plan.
Many employees who leave their jobs under company-sponsored early-retirement plans often discover — too late — that they won’t have enough income to support themselves. Many end up having to reenter the work force late in life — not a pleasant thing to have to do!
If you would like to retire early, you need to take a hard look at
how you will be able to meet your living expenses — not just the
year you retire, but ten, 20, 30, or more years thereafter. If you
have been or expect to be offered an early-retirement
“package,” some down-to-earth advice for evaluating such
offers appears later in this section.
If you aspire to take early retirement, inflation is even more of an
issue in determining whether your pension and savings are sufficient
to support you than it would be if you retired at 65. Why? Since you
will be spending more years in retirement, you will therefore be more
heavily affected by inflation. The table below gives you an idea of
how much more inflation affects early retirees. It shows how much
living expenses will increase between retirement and the time you
reach age 80. As the table shows, people who retire at normal
retirement age experience a 90 percent increase in living expenses by
the time they reach age 80. Those who retire at 60 experience a 120
percent increase, and those who retire at age 55 will experience a
170 percent increase in the cost of living by the time they reach 80.
Many early retirees (and for that matter, age-65 retirees) who
neglect to account for inflation in their retirement planning are
headed for an unpleasant surprise.
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EFFECTS OF INFLATION ON EARLY RETIREES
Retirement Age How Much Living Expenses Will Increase by age 80*
65 80%
60 120%
55
170%
*Assuming a 4 percent annual inflation rate.
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Many people mistakenly assume that their tax burden will lighten significantly at retirement. You will avoid some taxes, but on the other hand, taxes could go up again and cost you more than they do now. One thing you can be sure of: Income tax rates will never be lower than they are now.
Unless you are willing to curtail your lifestyle considerably, you should figure on spending about 75 percent of the amount you spend during your working years. Many retirees spend more than 75 percent.
One commonly overlooked expense is health insurance. Unless you’re taking an early-retirement package that extends your company health insurance coverage until age 65, you’ll need to factor in high health insurance premiums for an individually purchased policy until you become eligible for Medicare at age 65. Most early-retirement incentive plans extend your company health insurance coverage after you leave work. If yours doesn’t, you’ll have to pay high premiums for an individually purchased policy until you become eligible for Medicare at 65.
Many early retirees count on working part time to supplement their retirement income. Part-time employment answers the two most frequent complaints of early retirees: too much time and too little money. But don’t count on this option. Good part-time jobs that are financially and emotionally rewarding may not be as plentiful as you think. Good part-time jobs may be even harder to find than good full-time jobs. Don’t simply assume you’ll be able to get a part- or full-time job.
Planning for part-time employment should take into account not only the additional income it produces, but the additional costs it may incur, such as higher income taxes and reduced Social Security.
Your Social Security benefits will be reduced if you opt to collect before age 65. You can receive reduced benefits upon your 62nd birthday. Not only are the monthly checks lower, but the future cost-of-living increases are also proportionately lower because they are calculated from a lower initial benefit amount. As a result, benefits for early retirees will lag further and further behind inflation.
It still may be appropriate for you to begin drawing Social Security benefits at age 62. But one rule of thumb I use in advising people who are considering early retirement is that if your projections show that you will have to begin drawing Social Security benefits at age 62 to help meet living expenses, you probably can’t afford to retire early.
Any funds that you have set aside to supplement your retirement pension through individual retirement accounts (IRAs), Keogh or simplified employee pension (SEP) plans, 401(k) plans, or deferred annuities may be affected by your early-retirement decision. Not only will you have contributed to the plans for fewer years when you retire, you probably also will begin withdrawing from the plans sooner than you would have otherwise.
You generally cannot withdraw funds from personal retirement savings plans before age 59½ without incurring a steep penalty.
Even if you can afford to delay payments and avoid the penalties, there will be less money available to withdraw than if you had contributed for a few more years.
As a consequence of these reductions, personal savings and
investments are even more crucial to early retirees than to workers
who wait longer to retire.
401(k) Plan Penalties
Distributions from a 401(k) or other company-sponsored tax-deferred savings plan may be subject to a 10 percent penalty if you elect to take them before age 59½. Your best bet is to roll any such distributions over into an IRA within 60 days of receiving the funds and let these funds continue to grow free of taxes until you begin withdrawing. Live off your severance and personal savings.
Normally, company pension plans penalize early retirees, and the penalty is often severe. While most early-retirement incentive plans waive this penalty, believe me, you’re going to end up with considerably less than if you had remained with the company until normal retirement age — often less than half as much.
If a large portion of your retirement income is going to be fixed — a retirement annuity, for example — and you will not be able to save a portion of it each year to help pay for ever-increasing future living costs, you may not be able to afford an early retirement. In other words, you should plan to save some of your retirement income each year.
Another warning sign: If you are likely to have to rely heavily on income from your personal retirement savings plans (IRAs, 401(k)s, 403(b)s, etc.) to meet living expenses before age 65, you may not be able to afford an early retirement.
Early retirement is a very attractive prospect for many people. If you’ve been looking forward to an early-retirement that might be augmented by an early-retirement incentive plan, the above caveats may seem discouraging. It is possible to retire early and retire well, but you need to be very certain of your long-term financial security. If you have accumulated sufficient personal resources, your projections may indeed show that you can afford to retire early.
I cannot overemphasize the importance of making thorough projections. It may be well worth the expense to hire an accountant or financial planner to help you make your early-retirement income and expense projections. All I ask is that you be very careful and realistic in projecting your income and expenses until age 90. If the numbers work and if you want to take early retirement, by all means do so. I envy you.
Early-retirement incentive programs, also called window incentives, are now the most popular means companies use to achieve a reduction in the work force. And for companies in the midst of mergers, takeovers, or downsizing, they have been one way to reduce layoffs.
When times get worse, companies downsize. Early-retirement plans are usually the way they try to do so in as humane a manner as possible. The advantages and disadvantages of the plans are very clear-cut and quantifiable for employers.
Early-retirement incentive plans may sound particularly appealing to you if times are tough and you feel there are no guarantees that you’ll be able to keep your job if you don’t accept the offer. The plans are fairly compelling, but on the other hand, many of them offer a lot less than meets the eye. Making matters worse, chances are that if you’re confronted with an early-retirement incentive plan, you’ll have only a month or so to evaluate the offer. That is very little time to weigh all the financial repercussions of the decision.
Often, company-sponsored early-retirement incentive plans are made to look particularly appealing. For instance, the company’s benefits officer may show you how much more you’ll receive with the plan than if you were to quit your job now without it. But unless you were considering retiring anyway, this isn’t really a useful comparison. A better comparison would be between the package that is being offered and what you could expect if you stayed in your job as long as you originally intended. You would be sacrificing something; if you weren’t, how would your company be saving money?
Even a beefed-up early-retirement pension is likely to be considerably smaller than the pension you could expect if you continued to work. That’s because your pension is probably based on the average of what you earned in the last few years you worked. Even if the early-retirement incentive plan adds bonus years of employment and bonus years of age to your pension formula, it won’t be able to make up the difference between your average salary for the last five years and your presumably higher average salary for your last five years if you were to continue working.
If the extra years of leisure are worth the reduced benefits to you, then the crucial issue for you is not how the early-retirement package compares with the normal retirement options but whether the package is sufficient to meet your retirement-income needs. To answer that you will have to project your retirement income and expenses.
Before you sit down to compare the psychological ramifications of working and early retiring (by drawing up a list of the pros an cons), or before trying to project your retired versus working income and expenses for the next 30 years, you need to figure out a way to assess your situation realistically. If you’re worried about your job future at the company, the early-retirement plan may well be your most palatable option. If future layoffs appear likely, you may have little choice but to participate in an early-retirement program.
The most important thing is for you to be realistic.
Do you know what sort of deal you have been offered?
Do you have it in writing and have you read and understood the fine print? Do you have to take the deal offered you: (If you can't answer this question, then you proabably need to go back and reread the material that you have been given.) What is the likelihood of continued employment if you decline the current offer?
Have you noticed anything that indicates how badly the company is doing?
You have at least one thing working in your favor — you’re on the inside. If things are really bad, the incentive plan might be only the beginning of a reduction in the work force in which you will be laid off anyway, have your pay frozen or cut, or be transferred to a less desirable job.
Have there already been layoffs at the company, and if so, how
were they implemented?
Some companies that have not been able to reduce their payroll sufficiently through relatively humane early-retirement options resort to layoffs.
Is the early-retirement offer itself limited to one plant or one department?
If so, it probably signals significant change for those who remain. If, on the other hand, the company is offering the option across the board — say, to all employees over age 55 with over ten years of experience — your job may not be subject to future eliminations. In general, the narrower the cut, the worse it bodes for those who refuse it. If you have no choice but to take the early-retirement offer, you must plan for the future. If you have some choice, you still need to plan for the future, and your plans may influence whether or not you will take the offer.
Assuming you do have a choice and that you still enjoy working,
you’ve got a lot of factors to weigh before making your
decision. While it’s true that many early-retirement incentive
programs look appealing at first glance — incentives may include
additional or enhanced pension benefits, retiree health insurance,
and lump-sum cash benefits — you should keep in mind that the
high cost of living and the erosion of purchasing power due to
inflation may make such benefits much less attractive in only a few years.