Are You Ready to Retire Early? Ask Yourself These Questions First

The pandemic has nudged lots of folks to rethink their priorities, both in and out of the workplace. And for some, that has included the possibility of retiring earlier than expected, whether to pursue new passions or to simply create more time for doing the things you love, with the people you love.

In fact, in the 2022 Northwestern Mutual Great Realization survey, which polled 1,000 Americans ages 26 to 57 across the country, 11 percent said they want to retire early.

But as with any big life event, retiring early can have a major impact on your finances and the life you may be hoping to lead, both now and in your later retirement years. If you’ve been contemplating early retirement, here are some questions to ask yourself to determine if you’re ready.

1. What will your overall expenses look like?

“The first thing you’d want to do is think about how much you’d be spending if you weren’t working anymore,” says Andrew Weber, CFP®, senior director of Planning Philosophy, Research and Guidance at Northwestern Mutual. “That’s going to determine a lot of the financial viability of your plan.”

Weber suggests creating a retirement budget to make sure you know what you want to spend. Start by thinking about all your monthly expenses — from housing to discretionary spending to health care expenses. Now factor in non-monthly expenses. This may include vacations and holiday spending. When taken together, how much do you anticipate spending per year in retirement?

Keep in mind as well that health care costs can add up to a big expense in retirement —especially if you’re too young to enroll in Medicare — and will likely only get higher as you grow older. “If you stop getting coverage through work, you need to think about how you’re going to be paying for health insurance going forward,” Weber says. For context, an eHealth report found that the average monthly premium in 2021 for consumers 55 to 64 who bought insurance on the marketplace was $771.

2. Are your income streams sufficient?

Now look at all your retirement income sources. That may encompass:

• Cash savings: Setting aside two years’ worth of expenses is typically recommended in retirement. This can protect your income during bouts of market volatility.

• Social Security: While you can technically begin taking your Social Security benefit at age 62, you’ll receive more monthly if you hold out until your full retirement age.

• Your investment portfolio: This may include a 401(k), IRA, or regular brokerage account. You may also have alternative investments in the mix.

• Income annuities: These can provide steady retirement income month after month, typically for life.

• Whole life insurance: Though not conventionally thought of as an income stream, the accumulated cash value within a whole life insurance policy can provide supplemental retirement income if needed.

“Compare the income you would have coming in with your retirement spending needs,” Weber says. “That will give you a rough amount that you’d have to come up with to retire comfortably.”

One common guideline called the 4 percent rule suggests saving 25 times your total annual expenses to have enough for a retirement that lasts 30 years. However, the 4 percent rule has been rethought in recent times and is more of a starting point than the entirety of a retirement plan. Plus, your age is another important factor. If you retire early at 60, you might be living off your nest egg for more than three decades.

If you don’t have quite enough saved for early retirement, one option could be to opt for part-time work or consulting to cover the income gap.

3. Have you drawn up a withdrawal strategy?

Weber says that if you find you have a gap between how much you want to spend and your income streams, you will likely have to sell your investments to create the cash to spend in retirement. So you will want to have a plan for when you can increase your income or when you may want to decrease spending in a year when the market drops. If you have sufficient income streams, you are less reliant on the market to deliver returns for your spending.

“Plus, people are living longer nowadays so you should be comfortable that your spending plan is reasonable,” Weber says. “But research has shown that a retiree can increase spending by 10 percent per year through an effective withdrawal strategy.”

Working with a financial advisor to build your retirement plan can help ensure you have a diverse range of financial options will allow you to map out the best withdrawal strategy for your situation.

4. Have you reviewed your investment portfolio?

If you’re contemplating early retirement, the hope is that your investments are growing in a way that will ultimately outpace inflation. It’s also important to understand the tax consequences of drawing on your investment portfolio in retirement. Distributions from tax-deferred accounts like 401(k)s and traditional IRAs will be taxed as ordinary income. There’s also a 10-percent early withdrawal penalty if you’re younger than 59½.

“If you’re thinking about early retirement, it’s a good time to review your investment allocation to support your plan for how you’re going to withdraw your money,” Weber says. “Are you going to hold some money in cash in case the market goes down? Or are you going to liquidate from your investment accounts to create income? Those are two different approaches, and either one can affect the way you invest your money.”

Working with a financial advisor can help you determine how to draw down from your assets in a tax-efficient way. They can look at your entire retirement portfolio and help you come up with a drawdown strategy that takes you goals, taxes and certain retirement risks into account.

5. How do you envision spending your time?

“What will you be doing now that you have time freedom?” Weber asks. “Are you going to be doing more traveling, which could increase spending? Or are you going to be doing craft projects at home that don’t require a lot of money?”

Of course, this isn’t just a financial decision. Your emotional well-being comes into play, too. Even if you have new plans or passions that you expect to take up your time, don’t underplay the impact that work had on your life and identity. Work life often creates built-in opportunities for friendships, adult conversations and social activities. How will you fill this need if you’re no longer going into the workplace every day?

“Maybe it’s dinner with friends, spending more time with family, joining a tennis league or volunteering,” Weber says. “You want to have something where you feel connected to other people during retirement.”

All investments carry some level of risk including the potential loss of all money invested.

The primary purpose of permanent life insurance is to provide a death benefit. Using permanent life insurance accumulated value to supplement retirement income will reduce the death benefit and may affect other aspects of the policy.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™ and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.