Citi Personal Wealth Management

How to Prepare Your Finances
for Early Retirement

HomeFinancial GuidanceRetirement

The following information can be complex and you should consult an expert about this topic.

For some, careful planning and diligent saving can lead to excitement over an early retirement. For others, early retirement may be as a result of being forced into it, either by ill-health or being laid off before you were ready to quit the workforce.

Whatever the circumstances, you may be overwhelmed with all the changes and choices coming your way. After all, if you retire at a younger age, you will have less time to get financially prepared for your potentially longer retirement, and you may be faced with the need to buy your own health insurance until you become eligible for Medicare at age 65.

With that in mind, here are some steps you might take if you are considering entering an early retirement.

Estimating Income

Whether you're opting for early retirement or forced into it, start by estimating your likely retirement income, including:

Totaling up your savings and considering how much income they could generate. Financial experts often suggest estimating a 4 percent withdrawal rate based upon your beginning portfolio value, adjusted for inflation each year. That means that, for every $1 million you have saved when you first retire, you might be able to spend $40,000 per year, adjusted each year for inflation. However, everyone's situation is different and your spending might be higher or lower. You may want to consider consulting a financial advisor to better understand your income sources in retirement and how much you can spend throughout your years.

Finding out how much you can expect from Social Security. Use Social Security's Retirement Estimator to get an initial projection of your Social Security income. Keep in mind that retiring and claiming Social Security are two separate decisions—and there can be good arguments for delaying benefits even if you're no longer working. For instance, you might delay Social Security to get a larger monthly check because you're in good health and expect to receive that larger check for many years. Delaying might also make sense if you were the family's main breadwinner and your spouse will likely receive your benefit as a survivor's benefit.

Asking about monthly payments from any defined-benefit pension plan. Some plans allow early pension payments at a reduced amount. Ask for a pension estimate at different ages. If your plan requires waiting until age 65 and you retired earlier, you may need to use your other income sources.

Exploring part-time work. Let's say you could earn $12,000 a year. That might be comparable to having a nest egg that's $300,000 larger, based on the 4 percent withdrawal rate mentioned earlier. Working part-time may also delay withdrawals from your retirement assets, allowing more time for potential growth.

Prepping Your Finances

As your last day on the job approaches, your biggest questions will likely be: How much you will spend each month, where the retirement income will come from to cover those expenses and how you will handle health-care costs.

Your expenses could be slightly different in retirement and if you find you need to reduce expenses:

Take a close look at housing costs, which could be your largest monthly expense. You may be able to cut costs, and simultaneously free up home equity that can then be spent, by either trading down to a smaller place or moving to a part of the country where home prices are cheaper.

Aim to get any car loans, credit-card balances and other debts paid off before you quit the workforce. See if you may benefit from refinancing your mortgage at a lower rate. Apply to refinance your mortgage (if you intend to keep it) to a lower rate while you still have a paycheck coming in, so it will be easier to qualify. As part of the refinancing, you might borrow a little extra to pay off other debts that you have.

If you're in your 50s, getting cash from your portfolio may mean paying the 10 percent tax penalty that's often assessed on retirement-account withdrawals before age 59 and a half. As an alternative, you may wish to consider:

Building up your regular taxable account, even as you continue to sock away money in retirement accounts.

To take withdrawals from your IRA account without penalty before age 59 and a half, certain exceptions apply (e.g., disability, qualified higher education, etc.), but you should consult with your tax advisor first. With careful planning and help from your tax advisor, you may consider other withdrawal strategies.

If you have a Roth , you could also withdraw your original annual contributions. Generally, that can be done at any time, with no taxes or penalties owed. Another possibility: If you are 55 or older and have left your job, you may be able to take at least one distribution from your 401(k) without penalty, assuming the plan allows it, but please contact your tax advisor first.

What about health care? You may be eligible for your employer's retiree medical program, which is generally designed to cover eligible employees until they reach Medicare eligibility age, or you may be able to continue your employer's health coverage under the Consolidated Omnibus Budget Reconciliation Act(“COBRA”). This insurance isn't cheap; the cost is generally 102% of your employer's premium. You can generally keep the coverage for up to 18 months for you and your family, including coverage for pre-existing conditions. After COBRA runs out, you will need to buy coverage on your own. Your state's health department may have information on how to purchase individual insurance coverage. You may wish to price all options, including Medicare costs when you reach eligibility age (currently 65).

To get a quick initial projection on your medical costs during your retirement, try out the Citi Personal Wealth Management healthcare planning tool.