In theory, early retirement sounds like an absolute dream. Save enough money, quit your job in your 50’s or even your early 60’s, and everything should be golden, right?
Unfortunately, there are a few disadvantages of early retirement that can be detrimental to your early retirement ambitions if not adequately planned for.
Today we’re covering the top 7 disadvantages of early retirement, with some tips for overcoming those obstacles. The downsides to early retirement certainly aren’t insurmountable, but they’re essential to consider and plan for before you take the plunge.
1. Healthcare is Expensive
If your early retirement dream involves leaving a career with employer-sponsored health insurance, you need to consider how you’ll pay for private health insurance after you retire. You won’t be able to enroll in Medicare until age 65, so budgeting for private health insurance between your retirement date and your 65th birthday is essential.
In 2020, the average cost of private health insurance premiums for families was $1,152 per month, which isn’t much less than many people’s mortgage payments, depending on what part of the country you’re in. That average doesn’t include costs incurred by patients for deductibles and out-of-pocket maximums. And because the rising costs of healthcare and health insurance continue to outpace inflation, this average will likely only increase in the coming years.
The high costs of health insurance don’t always mean that early retirement is just a pipe dream. They do mean, however, that your anticipated expenses in early retirement may be higher than you originally counted on. Your financial plan for early retirement must account for the high price of health insurance premiums, deductibles, and out-of-pocket maximums.
2. Social Security Considerations
Like Medicare, you won’t be able to rely on Social Security benefits in retirement until you reach a certain age. Most people won’t be eligible to receive Social Security benefits until age 62, and if you do start taking benefits that early, you’ll receive reduced payments for your entire lifetime. Each year you wait to take Social Security, your benefitsincrease by about 8% until age 70.
When you decide to start taking Social Security benefits is dependent on a variety of factors, including your life expectancy, your tax situation, and your other sources of income. But keep in mind that the desire to retire early should not be a reason to take benefits early. Until you reach the age of 62 or higher, don’t count on Social Security to supplement your retirement income.
3. Early Withdrawal Penalties
Additionally, you can’t rely on savings in retirement accounts to fund your early retirement years unless you retire at or after the age of 59 ½. If you withdraw from any of your retirement accounts before 59 ½, you’ll have to pay steep penalties to the IRS, which can significantly diminish your nest egg in a short amount of time. We always recommend against this.
Therefore, you’ll have to fund your early retirement with income from other sources. For some people, this looks like savings in non-tax-advantaged investment accounts. For others, this means passive income in the form of rental payments from real estate properties. There are many ways to fund an early retirement lifestyle, but savings in tax-advantaged retirement accounts are typically not one of them.
4. You Lose the Power of Compound Interest
When you decide to retire early, you’re shortening your savings years and sacrificing your opportunity to benefit from the power of compound interest. This means that what you do save during your savings years needs to be substantial.
Here’s a simplified example. Let’s say that starting at age 20, you invest $1,000 a month into an investment account that earns a 6% interest rate compounded annually for 45 years (until you reach age 65). On your 65th birthday, you would have accumulated $2,552,922.17. If you wanted to accumulate $2.5M in just 30 years, you would need to save over $2,600 a month.
Again, this disadvantage of early retirement doesn’t mean that early retirement isn’t possible. But it does mean that you have to strategize how you’ll make up for that lost time with the time and resources you do have.
5. You Lose Employer Retirement Contributions
Another opportunity cost to consider is that of employer retirement contributions. If your employer provides matching contributions to your retirement savings, this is a great way to increase the value of your nest egg without having to sacrifice anything from your monthly budget. Of course, the opportunity cost of employer contributions is too great for people who are miserable in their careers.
However, losing this money means you’ll need to strategize ways to make up for that loss. You can either increase your own retirement contributions with other income sources, or you can find ways to cut your monthly expenses both now and in the future. Whatever you do, you’ll need to develop alternative strategies to account for the loss of this money.
6. Cost of Living Expenses May Remain High
Having more free time on your hands means you have more opportunities to spend money. Instead of spending the majority of your day earning money, you may now be looking for things to do that cost money instead. And unfortunately, a lot of the activities people most enjoy in retirement (think traveling, playing golf, taking ceramics classes, etc.) cost money.
In fact, one study found that most retirees experience a “spending surge” in the two years leading up to retirement and the first three years post-retirement. This spending surge is likely due to the enormous emotional and lifestyle transition new retirees experience.
And if you plan to use your newfound freedom to enjoy activities like traveling, your expenses in retirement might actually increase.
When planning for early retirement, be realistic about the lifestyle you’ll live. If you’re having trouble cutting expenses from your budget now, know that cutting expenses in retirement isn’t any easier for most people. Be honest with yourself and create a plan for an early retirement lifestyle that is realistic for you and your family.
7. Unexpected Emotional and Lifestyle Changes
Finally, many would-be early retirees fail to consider the enormous emotional and lifestyle changes they’ll experience. In the US, our work and careers are a huge part of our identity. Many retirees end up grieving the loss of one of their most important identities after retiring from their career.
Finding purpose outside of work can be challenging, even for retirees who are prepared for this emotional transition. Although early retirement may end up being good for your physical and mental health, you should be aware of and plan for possible health concerns as well before making this drastic change.
Create a Plan to Overcome the Disadvantages of Early Retirement with Caviness Wealth Management
At Caviness Wealth Management, we want to see you retire early with confidence. We understand that your desire to retire early may be an important goal in your life, and we know there are significant disadvantages to retiring early that may be difficult to spot in the moment.
To see if we can help you develop appropriate, custom strategies to overcome the disadvantages of early retirement, click here to schedule a conversation.
Content in this material is for general information only and is not intended to provide specific advice or recommendations for any individual.
