6 Steps to Help Clients Plan for an Early Retirement

Identifying a client's goals, income sources and anticipated expenses is essential to developing a financial plan.

Some of your clients may want to retire early. This is certainly a great aspiration, but like any financial goal, achieving early retirement takes planning.

Here are six steps to help your clients achieve their goal of an early retirement.

1. What’s driving the decision?

When clients express a desire to retire early, be sure to have a conversation with them to help you understand what is driving this decision. Perhaps a parent died at an early age and never got to enjoy their retirement. Perhaps they feel they have accumulated a sufficient level of wealth through all of the work you’ve done for them and they feel comfortable taking the leap.

For clients within 10 years or so of their normal retirement age, many companies might offer them a buyout to entice them to retire early.

Whatever their situation, understanding the client’s motivation is important to the planning work you will be doing to help them make their early retirement dreams a reality.

2. Define ‘early retirement.’

Early retirement can mean different things to different people. It can mean retiring “cold turkey” from any sort of paid work. It can also mean phasing out of a position, perhaps scaling back to part-time work with an employer for a few years prior to moving to full retirement.

Some clients may decide to retire early to pursue their passion. This might mean starting a business or perhaps doing consulting work in their area of expertise.

Defining what early retirement means to a client will help drive your financial planning recommendations to help them achieve their goal.

3. Review current retirement savings and investments.

Part of the planning process is to review all retirement accounts and other investments that could be used to fund an early retirement. You will want to take an inventory of all accounts and other sources of retirement income. These will typically include items like:

Each client’s situation is different and may well include other retirement resources beyond these.

For a client retiring around their normal retirement age, all of these potential sources of income can easily be tapped when they retire or soon after. Clients planning an early retirement, however, will have fewer options at the outset.

One issue for early retirees is the taxes and penalties that may come with accessing retirement accounts early. One consideration is to try and accumulate a sufficient amount of assets in taxable accounts to tide your client over until they reach age 59 ½ and can access assets in retirement accounts without incurring penalties.

There are some exceptions to this, such as taking a Series of Substantially Equal Periodic Payments, or SOSEPP. These are allowed under IRS rule 72(t). Distributions can be taken penalty-free from an IRA or other retirement plan prior to age 59 ½ as long as certain rules are followed.

The main rule is that the distributions must continue for five years or until your client reaches age 59 ½, whichever is longer. While there are no penalties, these distributions would be subject to income taxes.

Another option is to withdraw contributions made to a Roth IRA without taxes or penalties at any time. Earnings, however, cannot be withdrawn without penalties or taxes prior to age 59 ½, though there are other exceptions, such as in the event of a disability.

Clients leaving their employer at age 55 or older can utilize the rule of 55 to withdraw funds from their current 401(k) or 403(b) penalty-free, but not tax-free. The plan must have elected to offer this option to participants. This can only be done for your client’s current plan at the time they leave the employer; retirement plans at prior employers or IRAs are not eligible. Some public safety workers may be able to take advantage of this option as early as age 50.

SOSEPPs, withdrawing Roth contributions and the rule of 55 all have the advantages of eliminating penalties (and taxes, in the case of the Roth withdrawals) prior to age 59 ½. The downside that has to be weighed is that your client is reducing the value of their retirement accounts for the latter part of their retirement.

4. Plan for health care costs in retirement.

Covering the cost of health care in retirement is a major issue for those who retire at 65 or a more “normal” retirement age. Older adults generally have the benefit of being able to enroll in Medicare when they retire or soon after.

In the case of early retirement, it’s important to be sure that your client has health insurance coverage in place to tide them over until they are Medicare-eligible. If they are leaving an employer early, they need to check into whether there is some sort of retiree medical plan they can utilize.

Some employers may offer extended medical coverage as part of a buyout incentive, if this is applicable to your client. COBRA is also an option, but this is expensive and only lasts for up to 36 months.

If the client is married and their spouse continues to work, coverage under the spouse’s plan is also an option.

For most early retirees, purchasing health insurance on their state’s insurance marketplace is going to be their best bet. In terms of budgeting for the cost of the policy, it’s important to keep in mind that while the costs of this plan will be lower than with COBRA, they should expect higher premiums and perhaps higher deductible limits than with their former employer’s plan.

If your client is planning to work for an employer on some type of part-time or consulting basis, they may be able to negotiate being included on the employer’s health insurance plan as part of their compensation, which could save them some money.

An excellent planning tool for clients contemplating early retirement is to fund a health savings account (HSA) if they can. HSAs allow for pretax contributions, and the money can be used to cover the cost of health insurance continuation coverage such as COBRA, as well as other eligible medical expenses, during the client’s early-retirement period until they are eligible for Medicare. For those who are eligible, HSAs can be used to reimburse clients for Medicare premiums for Parts B ad D.

5. Create a retirement spending plan.

As with a client retiring at their normal retirement age, it is critical to formulate a retirement spending plan. What will it take to support their early retirement lifestyle? There are a number of issues to consider here, including:

It’s also critical to formulate a retirement withdrawal strategy for their early retirement years with considerations for what might change further down the road. Which accounts will be tapped, and in what order to help your client meet their spending needs? How might this evolve over the course of their retirement years?

This second question is multi-faceted and must take into account the client’s tax situation, any employment or self-employment income, the timing of Social Security and pensions, among other considerations.

6. Weigh the impact of early retirement on the client’s overall retirement planning.

Early retirement is a valid option for your clients to aspire to. However, as their advisor, you need to review their situation to be sure that by retiring early they are not putting themselves at risk of outliving their assets over the course of their lifetime.

This can help your client formulate what their early retirement will look like and to make decisions as to a full early retirement or perhaps a partial one where they do some sort of work or self-employment for a period of time before totally retiring from work.

Beyond this initial analysis, you will want to run a retirement projection periodically to determine where they stand for the longer term and to see if any adjustments need to be made to their investing plan or their retirement withdrawal strategy.

 (Image: Adobe Stock) 

Roger Wohlner is a financial writer with over 20 years of industry experience as a financial advisor.

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