Barron's had a roundup of advisor advice for people who want to retire early. I was impressed or maybe surprised that the advisors kept value judgments out of their comments and kept to just giving suggestions. Several talked about tax issues, it is important to keep tabs on how taxes might change going forward and then when they actually do change.
Yes on the taxes but without earned income and living on long term capital gains from an investment portfolio, there might be no income tax. If "passive" income from real estate or something else is part of the equation, then it can be trickier but even if taxes do go up, lower incomes are unlikely to be meaningfully impacted.
The cost of health insurance was a big concern for one of the advisors. The way things are now, the subsidies for healthcare.gov are far more generous than they used to be. That could change in the future of course but a couple making $80,000-90,000 is going to pay very little for insurance. That might not sound like much income but the context here is being retired at a young age. That much income, without Social Security or active income seems pretty good to me.
One advisor said don't own target date funds. This really is about having the right asset allocation. A balance needs to be struck between enough growth potential for a 50 or 60 year retirement and enough cash to get through the next 30 month bear market, Bear markets tend to run 18-30 months and while 2022 was shorter than that, a longer one will happen eventually.
Paying off the mortgage is a tricky question because it may not make economic sense, but it can make emotional sense. If someone has a 2.75% mortgage and collecting 5.3% in a money market or T-bill then maybe they shouldn't pay the mortgage off. It would make sense to know the after tax yield in that scenario. I lean toward the emotional security of not having a mortgage but people need to do what they think is best for themselves.
A point that I've made before that was echoed in the article was the ability to be flexible with spending. Where a portfolio invested in capital markets is part of the equation, there will be years where markets do poorly and years where just the portfolio does poorly like maybe down a little when markets are up. Having fewer fixed expenses can help with being more flexible which is an argument for paying off the mortgage.
A few more considerations from me starting with mapping out large, foreseeable expenses like when a car needs to be replaced. It is also important to understand what sorts of things could go wrong and end up being moderately expensive. I mentioned a while ago that we had an expensive plumbing issue at our house. I though the project was complete, it isn't. A while back, we replaced our roof. We have to maintain the road from our house down to the county-maintained pavement. This is getting more expensive. Parcels downhill of us are being developed and the trucks driving down there are rough on the road. If the new houses ever get finished (a whole bunch of problems our three new neighbors have been having over the course of four years) then we'll have more traffic and I can just bet the idea of concreting the road will come up. Concrete over a dirt road is a bad idea up here, it doesn't make it better for managing ice and snow and a concrete road is more inviting for looky-loos in the summer.
What about having to help family financially? That can be a tough one to think about before it happens but that is one to try hard to not be caught off guard by.
Depending on how early someone retires, they might end up with very little in Social Security when the time comes. It doesn't take too many working years to qualify but it takes a long time to get a decent payout. It is based on the highest 35 years of earnings. Any years where of zero earning income count as a zero year in the calculation. Retiring at 40 with maybe 15 years of higher earnings and a few more of very low earnings will result in a very low SS payout.
Yes there are questions about the future viability of SS. There could be cuts, yes, but it is not going away without some sort of similar replacement. If someone's full boat is $4000/mo, it could end up being less but for now it is not expected to be cut by more than 25%. All I am saying is to take this into account, there will be no meaningful SS payout for someone who retires at 40 and never has earned income again.
There was a reader comment that raised a very salient point. Always read the comments. The reader, Ben, said he is 62, has $500,000 total in his IRA and Roth but his income needs are met from a combo of small pensions, a disability payment from the military and then a larger pension when he hits 67. I don't think he'll be getting SS but if I am reading correctly, the income streams will combine to be enough for regular expenses. He has plans to build a house that will cost about $250,000 and solicited opinions about whether to take a mortgage or withdraw from the IRA accounts. There was no mention of about whether there is a current home that can be sold, his framing was a mortgage or IRA withdrawal.
He con cover most of the $250,000 out of his Roth IRA but not all. This raises an important point we've talked about before. Paying for a large, one-off expense out of a traditional IRA is very expense because of taxes. I've told this story before, a client wanted to buy a $40,000 pickup truck but only had a traditional IRA. Accounting for the taxes, the $40,000 truck cost about $50,000. When someone is taking out a regular distribution as an income stream to pay for monthly expenses, yes there are taxes but that seems more like a paycheck and we are used to paying taxes on paychecks. That might be mental accounting on my part but paying an extra 22% or 24%, maybe more maybe less depending is not ideal. If that's the only choice of accounts so be it, we need to do what we need to do, but this is an important point to understand for any retirement age.
There was no mention of Roth conversions in the article. A 40 or 45 year old who retires with a large rollover IRA and no earned income has a lot of years to slowly convert with little to no tax paid if they limit the conversion to the amount of the standard deduction or small enough where the effective tax rate is single digits.
The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.
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