The “Too Young” Conundrum

Early retirement gives you an opportunity to get away from the corporate world and pursue your interests. But people who retire in their 50s suffer from what I call the “too young” conundrum: they are too young to qualify for government benefits and could face penalties if they try to draw from retirement accounts. Furthermore, an early retirement also makes it more difficult to make your savings last. Here are some common complications of early retirement.

Too young for Social Security. Most people can't claim Social Security benefits until age 62, and you'll need to wait until age 66 or 67 in order to get the full payment you are entitled to. If you retire before age 62 you typically won't have a Social Security check coming in to help pay part of your bills. Early retirement could also negatively impact the Social Security payment you will eventually receive. Social Security payments are calculated based on 35 years of earnings. If you don't work for 35 years, zeros will be averaged into your Social Security calculation and result in a lower payout in retirement. Since most often your highest income years are later in your career, retiring early could have a negative impact on the total amount that you would be eligible to receive in Social Security payments in the future.

You won't qualify for Medicare. Retirees can sign up for Medicare beginning at age 65. If you retire at a younger age you will need to set up health insurance from another source. Likely you will have to go out and seek your own independent coverage, and it is without a doubt more expensive. Early retirees can currently buy health insurance through their state's health insurance exchange and might even qualify for subsidies to help pay for it. Some people are also eligible for retiree health insurance through a former employer or coverage under a working spouse's plan or a group plan through membership in an organization.

The 401(k) and IRA early withdrawal penalty. Don't count on being able to withdraw from your retirement accounts if you retire early. IRAs and 401(k)s have an early withdrawal penalty that is typically applied to distributions taken before age 59 1/2. However, there are a couple of ways around the early withdrawal penalty. If you leave your job at age 55 or later, you can take penalty-free distributions from the 401(k) associated with that company (if allowed by the plan). However, if you roll your 401(k) over to an IRA, you will need to wait until age 59 1/2 to avoid the penalty. IRAs provide different exceptions to the early withdrawal penalty if you use the money for specific purposes, such as college costs, large medical bills, health insurance after a layoff or part of a first home purchase. Retirement accounts also allow penalty-free early withdrawals if they are taken as a series of equal payments set up using an IRS-approved distribution method. In all of these cases, income tax will be due on each traditional retirement account withdrawal.

Friends still working. Not everyone can manage to save enough for an early retirement. Some early retirees leave their jobs, only to find that their friends and neighbors are too busy with work and family life to socialize. Before leaving your job in your 50s, develop a plan for how you will spend your time. It's really important to try to retire to something instead of just from your job.

Making your money last. If you retire at age 65 and live until age 95, you will need to pay for 30 years of retirement. Your retirement will be a decade longer if you retire in your 50s, which is even more years to finance. As a result, you do have to save even more in your working career in order to cover those extra years in retirement.

Despite the conundrum retiring “too young” presents, it can be (and has been) done! But it takes a lot of forethought and preparation before you do so to make sure your finances are set up to overcome the pitfalls mentioned above. If your ideal retirement means leaving the workforce before your 60s, make sure your plan can bridge those early years.