The topic of early retirement is a serious favorite among personal-finance blogs. While I believe that it?s a worthy goal, there are challenges with early retirement that are rarely discussed. I came up with seven that I think that if you are not prepared for, they can be a serious threat to the whole concept of early retirement.
1. Health Insurance Before Turning 65
As big an issue as health insurance is right now, we have to assume that its absence from early retirement discussions is probably intentional. After all, the high cost of health insurance has the potential to throw the whole notion of early retirement into doubt.
Before even planning for early retirement, you must confront the health insurance question. If you are currently employed, you probably have an employer subsidized health insurance plan. But once you retire, that will be gone, and you’ll be too young to get on Medicare.
You can go to Healthcare.Gov’s health insurance plans & prices web page to get a projection of what your health insurance premium will be when you retire. For example, if you?re 35 and plan to retire at 50, go to the website and get quotes for a policy for a 50-year-old, as well as your spouse if you?re married.
Warning: it’s sobering.
Though health insurance companies can no longer charge higher premiums for health conditions, they can do so for age. That $400 per month payroll deduction to cover the employer-sponsored plan that you?re now complaining about will suddenly look like a bargain.
I ran an example through the site, assuming a married couple each 50 years old. I came up with a Silver Plan, with a monthly premium of $808. That was with an annual deductible of $6,000, and an annual out-of-pocket maximum of $10,000.
That means that you will need to budget nearly $10,000 per year for health insurance premiums. And you may have to budget $20,000 in order to be prepared for a worst-case scenario in any given year.
Also rest assured that the premiums will steadily increase until you?re 65 and eligible for Medicare.
There are two potential workarounds to the health insurance exchanges. The first is getting health insurance through your spouse, if he or she plans to continue working and the employer provides coverage. The second is to find and keep a part-time job with health insurance. They are available – my wife and I are on such a plan now – but it will also mean that you will not be fully retired.
That may be a trade-off you will have to make. That is, unless your retirement income can handle $10,000 per year or more just for health coverage.
2. The Periodic Need for More Income
No matter how well you plan your early retirement, there will be years in which your expenses will exceed your income. You will need to be prepared for that, otherwise you may be forced to dip into your retirement savings. And that has the potential to jeopardize your continued retirement.
Being able to deal with the periodic need for more income is probably going to come down to the continued ability to earn a living in some capacity. There are various ways to do this, including taking a temporary job, maintaining a part-time business, or developing passive income sources.
Whatever the method, you’ll need to have a retirement back-up plan in place for those times when you will need extra money. It could be higher medical costs, relocation costs, money to replace a major asset such as a car, or helping out your children.
3. The Temptation to Borrow to Cover What Your Income Won’t Cover
The World War II generation largely understood the need to become debt-free before retirement, and to stay that way. But more recent generations have a very different attitude toward debt. If you’ve come up in life having a benign view of debt, you may not recognize the true threat that it represents to the whole concept of retirement.
It’s possible that during those times when you have higher expenses, you may turn to debt as a solution, and without much hesitation. But debt creates ongoing obligations, that will impair the cash flow from your retirement investments.
Your best chance of achieving early retirement, and staying retired, will depend heavily on your ability to avoid debt. That means not only retiring in a debt-free position, but also maintaining the practice of paying cash-on-the-barrel for any major purchases. That also means that you will need to continue saving money for contingency outlays even after you retire.
4. Making Your Investments Last for Decades
This is one of the biggest challenges of early retirement. If you retire at say, 50, you will likely need to make your retirement assets last for at least 40 years. That’s not as easy as it sounds. It will require that you live beneath your means. A significant amount of your investment income will need to be reinvested to produce future income.
The main reason for this is inflation. If you believe the Consumer Price Index (CPI) put out by the Bureau of Labor Statistics, then the rate of inflation is something less than 2% per year. That being the case, you have to allocate 2% of the return on your retirement portfolio for reinvestment. That’s not to get ahead, but just to stay even.
My own personal feeling however is that the CPI is largely a bogus number. It’s suppressed, because that works better in running government finances and general economic policy. But if you believe the real rate of inflation is higher, then that’s the number you should use. I believe that the real rate of inflation is likely closer to 5%. If you plan to early retire, your success will largely be based on your ability to estimate and invest for the real rate of inflation.
Basically you will have to divide your annual investment rate of return between the amount that you will need to live, and the amount that you’ll need to reinvest for inflation. The best convention on that is to use the safe withdrawal rate. You can set a withdrawal rate of 4% to cover living expenses, and then reinvest the difference to cover inflation.
That means that if you believe that the true rate of inflation is say, 3% per year, you will have to earn at least 7% per year on your retirement portfolio. 4% will go for living expenses, and 3% to cover inflation.
If you can be successful in that strategy over the long run, then you will avoid the prospect of outliving your money.
5. The Decline of Income Generating Skills
Returning to work should be one of the strategies to deal with a time of high expenses. But this can be problematic. If you?re twenty-something or thirty-something, and you take a sabbatical for one or two years, it may not be difficult to find a job afterwards. But if you retire at 50, and then start looking for a job five years later, the employment world won?t be so welcoming.
Part of that problem is age discrimination, and it’s very common despite the fact that it’s also totally illegal. But the other issue is deteriorating job skills. If you haven?t worked in your field for several years, you’re unlikely to be “cutting edge”, which is what most employers demand today.
For that reason, you may want to have a strategy to keep your work skills current. That may require that you lower your sites, and instead choose some form of semi-retirement. That can involve part-time or temporary employment, or maintaining a business on a part-time basis. It can cover long gaps on a resume, and keep your skills up-to-date.
6. Lifestyle Inflation
The usual cause for lifestyle inflation is a higher income that?s offset by higher living expenses. But time can be another culprit. Once you retire, you will have plenty of it. You may choose to fill the extra hours with increased entertainment, most of which will increase your cost of living. This is not an uncommon development in the early years of retirement.
You’ll have to do your best to find ways to keep yourself entertained and occupied that won?t cost you large amounts of additional money. This will be different for every individual, but it could include greater casual activities with family and friends, low-cost fitness regimens, or more involvement in charity work.
Increasing your cost of living will directly threaten your retirement. For that reason, your new life will almost certainly require stricter adherence to a budget than your working life does now. Developing simple, low- or no-cost pleasures now is one way to make it happen.
7. Irrelevancy and Disconnectedness
It seems as if most people would like to early retire if they could. But what’s not always well understood is how our work connects us to society. You don’t hear the term “stock in trade” any more, but it has meaning nonetheless.
While each of us are complicated beings with multiple qualities, an important one is what we do for living. It’s not just about making money either. It’s also how we give back to society, through our labor and our creativity. In addition, it’s also an important indicator of our status in society. You never hear people describe themselves without indicating their occupation prominently.
But our work is also critical in our social activity. Whether it’s right or not, our status in the eyes of others is often determined by occupation. But it’s also how we relate to people on an everyday basis, given that work itself is a common denominator among the majority of people. And on a more practical level, many of our social contacts are derived through occupation.
Occupation related social benefits can disappear in retirement. It’s possible to become disconnected from the working world, and even to develop a sense of irrelevancy. After all, if you’re no longer working and contributing to society, then a major connection to it is lost.
As much as you may find the whole idea of early retirement to be appealing, it’s equally likely that you will find the end of your occupation to be at least somewhat disempowering.
That may require that you plan some sort of occupation/activity/direction that will replace your current occupation. The notion of retiring to a life of blessed nothingness is highly overrated. It’s exciting for six months or a year, and then it can start to become depressing.
We’re human beings, so it’s never all about financial security. There’s a heart, a soul and a mind in each of us, and they need to have a sense of relevancy. Maintaining that without work will be a real challenge.
Early retirement isn’t just about having a certain amount of money with an annual rate of return of X. There are challenges with early retirement that could seriously threaten the whole lifestyle. Be prepared for those challenges. Some of them might even have you rethinking the whole idea of early retirement as a goal.
What other challenges with early retirement you see?
I won’t comment on my feelings about what the Affordable Care Act (Obamacare) has done to make health insurance premiums skyrocket. No, I absolutely won’t say a word. I will comment on the unexpected need for additional income, however. We’ve been doing fine on our retirement income but it took a hit recently, when our long term care insurance premium went up approximately $350 a month for the two of us! Yikes! The reason given was the lagging stock market which didn’t provide enough earnings for the company to have enough reserves. We are able to absorb that cost, however, we now wonder about being able to save enough to pay cash for a future car purchase. The money now going for LTC insurance was being earmarked for that future need. So, what to do. We kept the LTC insurance without modifying it but are now worried about whether it will just continue to go up and up in the future.
That’s a legitimate concern Kathy. In fact, the point you made about the stock market didn’t even cross my mind. All of the current assumptions about retirement, from retirement investments, to pensions to insurance and more are based on a robust stock market performance. It’s troubling that such problems are developing despite a record high market. It makes you wonder what will happen when the stock market reverses, and it will at some point. This is why the need for an additional income source was included on the list. These dramatic increases in premiums and unexpected expenses don’t stop at retirement. Which is also why I’m a big fan of semi-retirement!
Put me down for #7. I don’t know what I would do with myself if I wasn’t working. When you spend a long time building something up, it is hard to walk away.
Hi Jim – I suspect that you’re self-employed from your comment “When you spend a long time building something up”. The self-employed never actually retire in my experience. It’s very different from saying goodbye to a job. More like, you can’t say goodbye, because you can’t “quit” on yourself. I think that’ll be me. Work is too much of an adventure to ever quit.
Kevin, great thought provoking article, per usual! For me, I’ve slotted $1500/month into our “Early Retirement” budget, and am on track to retire at Age 55 (2 years from now). We’re planning a conservative withdrawal rate of 3%, and cutting our expected Social Security income by 25% in the spreadsheets. By making conservative assumptions across the board, I’m hoping we’ll be adequately “hedged” against some of the risks you raise. Worst case, my wife and I have discussed doing seasonal work (e.g., campgrounds, National Parks), as much for the social interaction as for the $$. I’m planning on retiring once, and never having to work again. To be safe, we have a Plan B. Thanks for your great work!
Hi Fritz – I like that you’re being conservative in your planning. I have a strong sense that most people who plan for/advocate early retirement go in the opposite direction. Either way, everyone who retires needs to have a Plan B, especially early retirees. I think you and your wife have that covered.
Great list, Kevin. I believe #1 through #6 can be accounted for by retiring with More than Enough. Say 33x or 40x annual expenses, rather than the usual 25x prescribed for a 4% SWR.
#7 is an issue that money can’t solve, and should be addressed before entering an early retirement, or on-time or late retirement for that matter.
Cheers!
-PoF
True on 1 through 6. But if saving 25X necessary income will be a challenge, 33X or 40X will be that much harder. The math equations on retirement always look neat, pretty and conclusive-sounding. But the execution is where the complications come in. I’m willing to bet that most people will face a few of those complications, and will need to plan around them. It’s not as easy as simply “save more” or “invest more aggressively”.