Retire Early?

Early retirement, or financial independence, is a dream for many. In fact, one of the most popular questions our new clients tend to ask me in our first meeting is how early can I safely retire? As many of you know, I’m a big believer that people should retire as early as they can, assuming they have a plan in place and a good understanding of what they want to do in the next chapter of their life. But this is a subject for a different newsletter.

Today, I wanted to talk about one of the most common omissions when it comes to retirement planning that is hiding in plain sight. I’m talking about high, in many cases much higher, medical expenses in the early part of your retirement, or specifically until age 65 when you qualify for Medicare. If you don’t think of this issue ahead of time, you will likely experience some major headaches. In the worst-case scenario, lack of planning for health care expenses in early retirement can significantly derail your overall plan.

Just to make sure we are on the same page, if you are at 60 and retire, just as an example, your employer will likely offer COBRA health care coverage to you. This coverage usually lasts for 12 to 18 months but can be prohibitively expensive since your employer will no longer cover any of the premium.

Earlier this year, I reviewed a COBRA plan with a good level of coverage that would cost our clients over $2,200/m. It can be even higher than this if you have multiple dependents.

Up until you turn 65 and switch to Medicare, you are essentially on your own, so planning ahead is crucial.

Now, not to make things overly bleak, you will have access to the Affordable Care Act (ACA) plans, commonly known as Obama Care. Depending on where you live, you will have access to a variety of different plans to choose from, depending on how much you want to spend and what coverage you need. Here is the biggest issue. Your ACA health insurance premium will be based on your income. Unless you run the numbers ahead of time, you may be up for an unpleasant surprise.

Just to give you an example, with $100K income in Maryland, a mid-tier plan for a family of two will cost $700/m.

If you are single with $200,000 in income, your premium for the same type of plan will be around $850/m.

To be clear, you will also be responsible for the deductible and co-pays depending on the plan you pick. In my experience, anywhere between $5,000 to $10,000 a year is a reasonable estimate but can be higher.

So what can you do about it?

Consider working until age 65 to stay on your employer’s insurance. Sure, this can at least partially prevent you from retiring early but it’s one option. Depending on what you do, you can have a flexible arrangement with your employer where you continue to receive health insurance but don’t work full time.

If you are married, perhaps one of the spouses would be comfortable working so that the family has employer-provided coverage.

I understand this may not be ideal but still one of the options.

If you are all set on retiring prior to the Medicare age, you should certainly plan your income going forward. Ideally, you would want as much of your portfolio income to come out of your brokerage accounts which are usually only partially taxed and at a lower rate. Even better, when possible, try to raise more cash in low-income or low-tax years so that you don’t generate too much taxable income in the years when you need ACA coverage.

As an example, if you need $50,000 from your taxable accounts and you purchased funds for $30,000, only $20,000 will be taxable to you and reportable for ACA premium purposes. If you take out $50,000 out of your IRA, the entire amount will generally be taxable and included for the purposes of calculating your ACA premium.

As a rule of thumb, I usually suggest that our clients who want to retire early maintain approximately 1/3 of their portfolio in taxable accounts and 2/3 in tax-deferred such as IRA, 401k, etc. If you have time, let’s say 7 to 10 years prior to your projected early retirement date, consider adjusting your savings and adding more to your brokerage account. This approach will give you much more flexibility.

Should you use your Roth IRA accounts early in your retirement to reduce health care premium costs?

Potentially. We usually discuss this option but it tends to be less than ideal since the benefit of having a Roth IRA comes from keeping them for longer. If you use up some or even most of your Roth funds in your early retirement, it may negatively impact you in the later years of your retirement.

So I would think twice before you take the Roth approach.

Should you begin your Social Security benefits as early as 62 to have more flexibility for medical expenses?

Potentially, but keep in mind this approach would permanently reduce your Social Security benefits for the rest of your retirement.

We frequently discuss this option with our clients, but I rarely end up recommending it.

What does this mean to you?

Early retirement or financial independence is a great and achievable goal as long as you take a comprehensive approach to planning for your next chapter.

Think of your retirement in stages, each with unique challenges and opportunities rather than one long period that requires some fixed amount of spending.

The more thoughtful and detailed you are, the fewer mistakes you will make which can significantly increase your happiness and enjoyment in retirement!