Is retiring early too risky?

/Home/b. Planning for Retirement in Texas/Early Retirement

Is retiring early too risky?

All you have to do is bet wrong on your funds, bet wrong on inflation, bet wrong on your expenses. Here are the questions you need to ask yourself as you start planning.


By Philipp Harper
If you watch television at all, you've seen him. He's fit, at least 50, and improbably good-looking. He wants to chuck it all and teach inner-city kids the meaning of life, or race his Shelby Cobra at the Sears Point Raceway in California, or...

There are different variations on the theme, but all lead to the same life destination: early retirement.

The thought of quitting work while still vigorous in mind and body is much more than a carrot dangled enticingly by Madison Avenue. For many Americans, it's the modern equivalent of the Holy Grail; when time becomes precious, it seems, how it is spent becomes urgently important.

The fellow in the TV commercial succeeds, we are told, because he picked his investment adviser wisely. That's certainly part of the equation, but it's not the whole story.

Rat-race escapees need to plan
Anyone contemplating an early exit from the rat race faces as many risks as he does rewards. The most obvious challenge: A longer retirement means more non-working time to pay for. It also means more time to fill in some meaningful way. It seems fair to say that the younger the retiree, the greater the amount of forethought and planning required.

Despite the challenges and risks, early retirement -- or at least earlier retirement -- has been the choice of an increasing percentage of Americans since World War II.

Social Security Administration research shows the median age of retirement falling from age 68 or 69 to 62 between 1950 and 1985. Though the trend has flattened in the last 17 years -- gaining or losing steam according to economic vicissitudes such as the tech bubble and its bust -- the baby boom's arrival at middle age figures to reinvest the issue with importance.

Though the boomers are hardly a monolithic lot, they are united in some common beliefs that are particularly relevant to any discussion of early retirement. A survey of the group's retirement attitudes by the AARP found that, compared with their parents, boomers believe:

They will need more money to live comfortably in retirement.

They are more self-indulgent.

They are healthier.

They will live longer.

The graying of the largest, longest-lived, most self-indulgent and most prolifically spending generation in U.S. history promises to make retirement -- especially the early variety -- an increasingly complex exercise. Still, by avoiding three central pitfalls, retirement wannabes from whatever generation can at least begin the process with some prospect of success.

They must begin by answering three short but encompassing questions:

Why?

How long?

How much?

The answers will go a long way toward telling them whether they can retire or even should retire early.

What do you plan to do over the next 25 years?
The motive for retiring is all important. Simply ceasing to work -- while undeniably appealing on Mondays and other bad days -- does not in itself constitute a fulfilling retirement lifestyle.

"Be sure you have something to do that occupies your time and interests and takes advantage of your talents," says Tom Gnuse, principal in HTG Investment Advisors in New Canaan, Conn.

Finding the right avocation is no less important than selecting the right vocation, Gnuse says. For more retirees, he adds, recreation -- simply having fun -- isn't enough. Workaholics may have a particularly difficult time finding their way. Asks Gnuse: "If you haven't been doing other things, do you really like other things?"

Individuals who draw a blank when they try to envision themselves as retirees may benefit from a systematic approach to retirement planning of the sort advocated by McLean, Va., planner Frederick McNair. He tells his clients to break their retirement years into three segments:

The active years. This phase is typified by "very active behavior," McNair says. "Travel, the development of hobbies -- things you were constrained from doing before. These are the opportunities that were deferred."

The legacy years. In the following period, retirees tend to be less self-indulgent and more concerned with legacy building. It is a time of "giving service to others," whether the community at large or members of one's family, the grandchildren, say.

It's also in this second phase that plans are made, logistics arranged and assets allocated for the third and final stage.

The final years. This is when, frankly, life's endgame is played out.

The money needs to last a long time
A person who retires at 50 today probably should assume a retirement lasting anywhere from 33 to 45 years, McNair says.

This gets to the issue of longevity and, even more important, morbidity, the natural tendency of health to decline as people age. A well-planned retirement recognizes not just how long a person might live, but that his or her final years very well could be characterized by ill health requiring nursing care or hospitalization.

It is difficult, but necessary, McNair says, for a 50-year-old contemplating retirement to "conceptually grasp the potential for health to decline and for finances to be depleted."

More than just recognizing the three segments, the planner has his clients create "wish lists" detailing the most favored lifestyles and circumstances for each period. In turn, the lists help determine the financial agenda, McNair says.

After identifying the desired retirement lifestyle -- and gauging, as accurately as possible, retirement's likely duration -- it's critical that sufficient assets be amassed to pay for it. A realistic cost assessment is a necessary first step, but there's evidence that most Americans defer such calculations, and then aren't very realistic when they finally get around to them.

When the Employee Benefit Research Institute surveyed U.S. workers on retirement issues in early 2002, it found that only 32% had attempted to calculate how much they would need to save for retirement. Still, 70% expressed confidence that they would have enough.

But do pre-retirees really know how much they'll need? Only 17% of the workers surveyed anticipated needing 80% or more of pre-retirement income during retirement. The rest said they could make do with less than that, and more than 40% reckoned they could get by on less than 60% of pre-retirement earnings.

Those calculations seem like little more than wishful thinking when the experience of actual retirees is taken into account. A majority of retirees questioned in the same survey said their retirement income was at least 80% of what it had been while they were working.

The risks of not having enough
Once the cost of a retirement has been estimated, any number of analyses can be run to learn whether the prospective retiree has the resources. A common denominator seems to be an appreciation of worst-case scenarios and a recognition, as McNair says, that financial forecasting is "not an exact science." (You can do a rough estimate of your needs with MSN Money's Retirement Expense Calculator and our Retirement Income Calculator.)

Still, you should consider several obvious stumbling blocks.

Can a bad economy destroy the value of a retirement nest egg? Gnuse cautions against being lulled into a false sense of security by projections of average returns. An average doesn't take into account the possibility that there will be several years of below-average returns that could force any retiree to dip into his investment principal. Returns can "revert to the mean later on," Gnuse says, "but by then there may not be enough assets to revert."

Will inflation cut down your purchasing power? Watch out for the ravages of inflation. A portfolio can earn handsome returns, but if the cost of living increases at a faster clip, retirement can be jeopardized. So you will need assets that will grow over time and provide a hedge against inflation.

How reliable is your income? Weigh this carefully. The future viability of Social Security is an open question. And company pensions and retirement savings plans are not always the bedrock upon which a retirement can be built. So not only do you need assets that will grow, you also need assets that won't shrink -- bonds, bond funds and similar income-generating investments.

To capture "the vagaries of what the real world throws at us," the Schaumburg, Ill., firm of Balasa Dinverno Foltz & Hoffman runs what Mark Balasa calls a sophisticated "Monte Carlo" analysis for clients.

Using a Monte Carlo simulation and other modeling tools, Balasa is able to tell prospective retirees the probability -- given their assets, savings rates, and ability to generate income -- that they'll achieve the retirement they seek.

He says in cases where the probability is low -- 60%, for example -- "We say, gosh, either you need to work a few more years, go for a riskier portfolio with a higher rate of return, or you need to die sooner."

Balasa also recommends considering a number of other factors in any early retirement scenario:

The age for taking full Social Security benefits is increasing. Those born before 1938 reach full retirement age at 65; those born later have to wait longer.

Medicare benefits begin at age 65, so anyone retiring before that age may be on the hook for the cost of basic health insurance.

Avoiding a 10% penalty for early withdrawal of IRAs and pensions requires knowledgeable planning -- and the use of such things as the 72t election, which permits a fixed amount to be withdrawn at regular intervals before the age of 59 1/2.

Be aware of a portfolio's "tax efficiency." The lower an asset's cost basis, the worse the tax consequence when it is sold.

A final factor that must be taken into account is the possibility of failure. What if you retire and then, for whatever reason, can't make ends meet? How do you un-retire?

One strategy is to maintain contact with the work world by lining up part-time employment during retirement. A majority of boomers -- nearly eight in 10, according to the AARP survey -- already plan to do that, whether out of perceived economic necessity or simply for fun.

Video on MSN Money
Cover all your bases

Westhem Grant's Cory Grant explains why you need to integrate your retirement plan into your estate plan.A variety of resources exist -- private and not-for-profit -- to help retirees find work. A good place to start is AARP's Work Options home page.

Even if all of this rumination and calculation yields an unfavorable result -- a finding that early retirement simply is out of reach -- it will not necessarily have been in vain.

A substantive benefit of such exercises, McNair says, "is finding out what you need to do to get in the ballpark."

Philipp Harper writes about business, the economy and politics for national and regional publications.

© 2009 Microsoft