The Risks and Costs of Early Retirement

By Darrell Victor

Given that there are risks of retirement in general, it is no surprise that there are risks associated with early retirement in particular. However, early retirement is typically far riskier than retirement at the full retirement age. In some cases, early retirement is involuntary or even ideal. It is clear that those who retire earlier than the full or normal retirement age bear burdens that are peculiar to early retirees.

Increased longevity risk

All retirees bear the risk of outliving retirement savings, especially if they do not plan for retirement properly. However, early retirees typically face a longer retirement period with lower retirement income. The other risks of retirement tend to compound longevity risk as well. Those who retire between 62 and 65 may have a retirement period of 18-25 years (on average). However, the earliest retirees might live up to 36 years on average!

Opportunity cost

Opportunity cost is the cost of a decision in terms of what you forego by making that particular decision. The earlier you retire, the higher your opportunity cost of early retirement is going to be. You might forego the income you would have enjoyed from working longer and higher retirement benefits, for example. Increased longevity makes opportunity cost even higher for early retirees; this is one reason for many baby boomers' decision to work longer.

Loss of employer-sponsored benefits

While working, you may enjoy employer-sponsored benefits such as health benefits and savings plans. Some employers offer coverage for retirees as well, but this is not often the case. When you take the decision to retire early, you should factor in these benefits as part of your decision. At best, you should have a suitable alternative to benefits lost, especially health coverage and income, when you retire early.

Debt-servicing risks

Many retirees find themselves entering the retirement phase in debt, whether the debt is a mortgage or consumer loans. Since retirement income is normally fixed, the burden of the debt increases over time and refinancing options become far less attractive. While some retirees might seek to pay the balance of debt with lump sums and gratuity benefits received, even that may not be a wise move, since they forego the benefits of investing that lump sum wisely and deplete their retirement savings - without knowing if they might need it sooner than later.

Retirement income risk

Since early retirees have an increasingly higher life expectancy, much can happen to their retirement income in that period. The combination of inflation and taxation significantly erodes retirement savings and income. This suggests that earlier retirees' income may not keep pace with living expenses in the latter stages of retirement, which increases the income risk significantly.

Inaccessible state/retirement benefits

When you retire before the full or normal retirement age, some retirement benefits may not be available. Even if they were, you would receive a lower nominal benefit because your life expectancy is longer. Age is a significant factor in the retirement decision, since it can affect your defined benefit, tax burden and even your annuity benefits- to name a few. The relatively low availability of replacement income for early retirees is a surmountable problem, but a critical early retirement issue nonetheless.

Tax risks of taking Social Security benefits earlier

Early retirees who receive retirement income from sources other than Social Security have a higher tax liability arising out of existing tax legislation. Since this fact exposes early retirees to additional taxation before the full retirement age, it is better to delay taking Social Security benefits, until the full retirement age. The distribution of retirement income has a clear tax implication. While the tendency of early retirees is to grab all their retirement income available, this can augment their tax burden significantly.

Social and psychological risks

Those who dream of early retirement sometimes base their dream on push factors. The major push factors are that their job is too stressful or they do not want to work for too long. Relying on push factors can create a void in that such retirees may not properly plan for taking retirement early. They do not know how they would fill the gap in a meaningful way. This can lead to an aimless, sedentary lifestyle, particularly when funds are limited and the retirement reality comes to bear. Retirees must be able to cope properly with being out of the workforce. Many retirees enjoy working or switching jobs to a part-time endeavour that they truly enjoy to avoid socio-psychological retirement issues.

The good news is that while the risks of retirement are more burdensome to early retirees, they are not necessarily insurmountable obstacles to a happy and secure early retirement.

Darrell Victor is a freelance writer and former insurance advisor. To read related articles visit http://www.helium.com/users/338815/show_articles?channel=6

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