How to Deal With an Unexpected Early Retirement

By Brandon Renfro

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Older couple looking at laptop, happy with their retirement plans

A key step in your retirement plan is deciding when you want to retire. For some, that is an exact age or milestone. Others may have a general idea in mind, but leave a little more flexibility in their choice.

Regardless of how you approach your retirement decision, the fact is you may not be able to control when you retire. This became apparent during the COVID-19 pandemic when some companies were forced to reduce expenses. Many turned to payroll reductions by turning to layoffs or encouraging certain employees to retire early.

If this sounds familiar to you, then you may have some things to think about. First, understand that early retirement is different from a layoff.

What Is Early Retirement?

Early retirement generally means you are making a choice to leave the workforce before you are qualified to take full advantage of retirement benefits. For example, you may not have worked for long enough to maximize your pension, or you may be faced with a penalty for withdrawing from a retirement account. A layoff, on the other hand, is forced. You do not have a choice.

Companies will sometimes try to entice older or longer-serving employees to retire early by offering incentives like early retirement packages. When they do, you may have some room to negotiate. You could ask for lump-sum cash payment, extended health benefits, or continued salary for a number of months. But, be careful. If they don’t get enough people to agree to early retirement then a round of layoffs may soon follow. You could end up without a job and without an early retirement package.

Whether you are considering early retirement on your terms, or are considering taking an early retirement offer from your employer, here are five key things to consider:

Early withdrawal penalties may apply

Retirement savings accounts offer significant tax advantages, but there are potential tax pitfalls associated with an early retirement. There are rules that define how old you must be before you can withdraw from a retirement account. Typically, you need to be at least 59 & ½ to be able to withdraw from 401ks and IRAs without incurring a 10% penalty.

However, if your specific 401k plan allows it, you may be able to avoid the 10% penalty on 401k early retirement withdrawals if you are at least 55 and retired. Check your plan document or ask HR if you think this may apply to you. IRAs do not offer the same age 55 exceptions, so take that into account before you decide to roll your 401k over into an IRA.

Social Security

If you retire early, your Social Security benefits will be affected in a few ways. First, understand that your monthly Social Security benefit is calculated from your highest 35 years of earnings. For most people, their final years are some of their highest-earning years so shaving those off will mean using smaller numbers in the calculation.

You also cannot claim your Social Security retirement benefit before age 62, which is already “early” by Social Security Administration standards. If you claim early then your benefit will be reduced. However, just because you retire early doesn’t mean you have to claim your benefit early. It may be better for you to wait and claim your benefit at your full retirement age when you can receive your full benefit, or even delay your benefit up to age 70 for an increase. There are many things you can do, such as coordinating benefits with your spouse, to maximize your Social Security benefits.

Adequate savings

Early retirement poses a two-pronged strain on your retirement savings. For every year that you retire before you had intended to, that is one less year that you are contributing to your retirement account. Not only are you not saving for each year, but you are also likely withdrawing from your savings.

This doesn’t necessarily mean that you won’t have enough to retire, but it does mean that you really need to be sure that your savings will last for as long as you need them to. If you think it won’t, you can make small adjustments to your retirement lifestyle now that could help you more than making drastic changes later in retirement when it’s too late. You can use a retirement calculator to try several different retirement scenarios and see which one makes the most sense for you.

Health care

Many Americans get health care benefits through their employer. If you retire early, that may also mean that your health care ends. Since most retirees won’t qualify for Medicare until they are 65 that means there will be a gap in your health care coverage that you will want to close.

Since the passage of the Affordable Care Act, otherwise known as Obamacare, that likely means purchasing a policy on the health care exchange.

You may be able to qualify for significant subsidies for health insurance that you purchase through the exchange. The subsidy is higher the lower your income is. Since many retirees’ income falls in retirement, this could save you a lot of money.

There is a specific modified adjusted gross income (MAGI) calculation that is used to measure your income for the subsidy. You may have some ability to influence that measure. Research it so you can plan ahead, or work with your tax preparer or a financial planner to see if you need help to get the most benefit.

Consider your life expectancy

Running out of money is one of the most often mentioned fears of retirees. The concern is obvious and understandable. If you run out of money it’s going to happen on the back end when you are much older and likely not able to return to work.

One way to combat that risk is to get a good handle on your budget. That means having a good idea of what you spend now, but also mapping out how much you can spend from your savings later in retirement based on how long you estimate you will live in retirement. While you can’t pinpoint your exact lifespan ahead of time, working that estimate into your withdrawal plan is better than having no plan at all.

If you are worried about running out of money then focus on maximizing your sources of guaranteed income like Social Security. This is one reason delaying your benefits is so helpful.

About Author
Brandon Renfro
Brandon Renfro is a Certified Financial Planner (CFP), a Retirement Income Certified Professional (RICP), and an IRS credentialed Enrolled Agent (EA). He runs his own retirement and wealth management firm and is an assistant professor of finance. Brandon is a regular contributor to MoneyRates and several other financial publications. Brandon's wealth of expertise and practical knowledge have led to him being quoted in The Wall Street Journal, Forbes, U.S. News & World Report, AARP, Business Insider, and other national publications.