According to data collected by the Organization for Economic Co-operation and Development (OECD), people in the US work about 59 hours more per year than the average of all countries included in their report. While 59 hours per year may not seem like a lot, stretch that out over the course of your career and you’re looking at a lot of excess time spent at work. On top of that, Hannah Towey from Business Insider states that “The US is one of the only countries in the world that does not guarantee workers paid time off.”

Looking at these figures, it’s no surprise that the FIRE (financial independence, retire early) movement has been generating heat. Unless you legitimately love what you do, there’s a good chance you’ve spent some time thinking about how to successfully retire early.   

Here are some things to consider if you’re planning for early retirement.

Living Expenses

Barring any extenuating circumstances, you can’t start receiving Social Security benefits until your early 60’s, and any withdrawals from retirement accounts will incur a 10% tax penalty if taken before age 59 ½. However, there are more than a few viable options to support yourself in early retirement.

Rule of 55 – The Rule of 55 [IRS Section 72(t)(2)(A)(v)] allows you to make penalty-free withdrawals from your employer-sponsored retirement plan, provided you separated from service with your employer in, or after, the year you turn 55. Obviously there are some restrictions to this. Penalty-free withdrawals only apply to the plan you had with your most recent employer (it does not apply to IRAs or plans from former employers). The funds also have to remain in the employer plan, they can’t be rolled out into an IRA. You’ll also still be liable for paying ordinary income taxes on withdrawals (unless it’s a Roth account). There’s also the potential that the plan may not allow for these withdrawals.

You’re welcome to start working again (at a different employer) after you begin taking distributions, but that may defeat the point of retiring. If you’re contemplating this option, you may want to consider rolling over any old 401(k) or 403(b) plans into your current employer-sponsored plan to beef up the savings, especially if you haven’t worked there long enough to build a sizeable portfolio.

Substantially Equal Periodic Payments – Substantially equal periodic payments [IRS Section 72(t)(2)(A)(iv)] are similar to regular required minimum distributions (RMDs), in that they’re designed to draw down the balance of your portfolio over the course of your life expectancy. This typically requires the assistance of an actuary and CPA to help determine the proper amount to withdraw every year.

While this one may require a bit more effort, there are no age restrictions. You can retire as early as you want, but the payment amounts will likely be pretty low if you still have a long life expectancy. Regular income taxes still apply (unless a Roth account), and these payments must continue for at least 5 years, or until you attain age 59 ½, whichever comes later. So, if you retire using this method at age 57, you’ll have to continue with these payments until age 62, but if you retire at age 47, you must continue until age 59 ½. Failure to comply with these rules will result in hefty tax penalties, likely including a 10% penalty on all previous distributions and fines for late payments.

Roth Contributions – Roth accounts are similar to qualified accounts in the fact that they charge a 10% penalty for early withdrawals before age 59 ½. However, since contributions to Roth accounts are made with after-tax dollars, you’re able to withdraw contributions tax-free as a return of principal. This could be a viable option if you’ve contributed heavily to a Roth account, or if you’re only retiring a few years early. Just make sure you have adequate records of previous contributions, and that your withdrawals don’t exceed that amount.

Taxable Accounts – Taxable accounts, or regular brokerage accounts, are one of the most versatile investment vehicles out there. These can be used for virtually any purpose, and funds can be withdrawn or added whenever you want. While you do pay taxes on growth, dividends, and interest in the year received, the growth and dividends are sometimes at preferential rates.

Realized growth on investments held for more than 12-months are taxed at the reduced capital-gains rates, and many dividends are taxed at the qualified dividends rate. Any cost basis is considered a return of principal and is not taxed. Short-term gains (held less than 1 year) and earned interest are taxed at ordinary income rates.

Constraints

Now that we’ve covered some potential income options for early retirement, here are some obstacles you should plan for before pulling the trigger on early retirement.

Health Insurance – The cost of health insurance continues to rise at a rapid pace. Without the benefit of an employer’s group plan, you’ll likely be liable for the full cost of health insurance premiums. Unless you’re planning on a very frugal lifestyle in early retirement, you’ll likely be over the income level for discounts on Marketplace insurance. Luckily, there are some other ways to help reduce this cost.

• Get insured through your spouse’s insurance (if they’re still employed).
• Work a part-time job that offers insurance benefits.
• Go without health insurance (not recommended).
• Build up an HSA, and use that to pay healthcare expenses.
• Consider cost-sharing or association options.
• Move to a country that provides ‘free’ healthcare.

I’m sure there’s other options available out there. It’s important to do adequate research to ensure you can afford adequate healthcare coverage without devouring your retirement savings.

Taxes – Unfortunately, taxes are virtually an inescapable part of life. While we know (or can at least find) the current tax laws, no one knows what the future holds. It’s imperative that you plan accordingly to ensure you’ll have enough after-tax income to cover expenses. Keep a close eye on current and future tax brackets and try to avoid getting bumped up to the next bracket if at all possible. By working with a financial planner, you can also have a plan in place to mitigate taxes each year and in the future.

Inflation – Like taxes, inflation is an unfortunate part of life that we all must live with. While the Fed has generally done well over the years to keep inflation at manageable levels, we’ve also recently seen first-hand how quickly things can escalate. You’ll want to keep enough conservative investments to cover cost-of-living expenses but maintain enough aggressive investments to at least keep pace with inflation. Otherwise, you run the risk of running out of money prematurely.

Social Security & Medicare – Social Security and Medicare are designed to provide retirement benefits, so why are they listed as a constraint? First, as I said about taxes, no one knows what the future holds. It’s possible these programs will undergo changes in the future. We recommend planning for current laws but leave enough of a buffer to make adjustments if laws change. Also, Social Security and Medicare both have minimum age requirements, so you’ll have to make sure you have enough to get by until you reach those ages. Social Security benefits currently increase every year they’re deferred, so it may be ideal to wait before receiving those benefits. The benefits are also determined by the amount of Social Security taxes paid over your working years, so if you retire really early, you run the risk of drastically reducing the amount of benefit you’ll receive.

Final Thoughts

Early retirement is a big decision that requires thorough planning and a great deal of self-discipline. Very few people can just spontaneously decide to stop working and have a successful early retirement. It takes time and dedication to generate adequate savings, and thorough research to develop a budget and draw-down strategy that can sustain your desired lifestyle.

You don’t have to go it alone. Whether you’re just starting out or are already well on your way, working closely with a Financial Planner can help guide you down the path toward a successful early retirement.