Are you considering retiring earlier than planned but worried about the potential costs and downsides? If so, this article is for you. Today, we are exploring the cost-of-living adjustments (COLA) and the implications of retiring early. We’ll also provide strategies to help you plan effectively for a financially secure retirement.
The Pros and Cons of Retiring Early
The obvious advantage is that you retire early and gain flexibility. This means you can enjoy more free time, pursue another career or hobby, spend time with family, travel, or serve in your community. Most of the benefits here are non-financial, focusing on lifestyle goals that are difficult to quantify. For many, early retirement’s emotional and psychological benefits are well worth the effort it takes to plan for it.
However, retiring before age 62 has financial drawbacks for federal employees. Specifically, you won’t receive COLA adjustments on your annuity until you turn 62, which can significantly impact your purchasing power over time. Additionally, early retirement could mean dipping into your savings earlier, which might limit your long-term financial flexibility.
For example, you might need to withdraw from your Thrift Savings Plan (TSP) sooner than anticipated. This could result in higher taxes or penalties if withdrawals aren’t managed carefully. You may also miss out on the growth your investments could achieve if left untouched for a few more years.
The Retirement Income Timeline
Let’s break it down with an example. If you retire at 57 and are eligible for an immediate retirement at your Minimum Retirement Age (MRA) with at least 30 years of service, you will receive the FERS supplement until you turn 62.
At age 62, the FERS supplement ends, and your annuity continues without COLA adjustments until then. For example, if COLAs average 2% annually, retiring at 57 means missing out on a cumulative 10% increase in purchasing power by the time you turn 62.
Consider this timeline as a way to evaluate how your income sources will align with your expenses. If your expenses rise due to inflation, but your income remains stagnant, this gap can become a significant burden over time.
Analyzing the Financial Impact
Gross Pension Example
- Gross Pension: $2,000 per month
Deductions
- Survivor Benefits: $200 per month
- Taxes: Variable
- Life Insurance: Variable
- Health Insurance: Increases annually
If your pension remains flat at $2,000 while your deductions increase every year, your net retirement income will decrease over time. This highlights the importance of planning for inflation and rising costs.
Additional Costs to Consider
- Healthcare Expenses: Medicare eligibility starts at age 65, meaning you may need to bridge the gap with private insurance if you retire earlier. Premiums for private health insurance can be substantial.
- Housing Costs: If you’re still paying a mortgage or considering downsizing, ensure these decisions align with your broader financial goals.
- Long-term Care: Early retirement gives you more time to plan for potential long-term care needs, but it’s vital to address how these costs will be covered.
Planning Your Retirement
To make an informed decision, assess all your retirement income sources and how they align with inflation. Here are some key considerations:
- FERS Pension: No COLA until age 62. After age 62, COLA adjustments are reduced compared to inflation.
- Social Security: Plan when to start benefits. Social Security benefits increase by 6% per year between age 62 and Full Retirement Age (FRA) and 8% per year from FRA to age 70. Social Security does include a COLA, which helps offset inflation.
- Thrift Savings Plan (TSP): Know how to access and manage it. TSP investments can help combat inflation if managed wisely. Consider strategies like diversifying your portfolio or opting for income-focused funds.
- IRAs and Roth IRAs: Incorporate these accounts into your broader retirement strategy. Roth IRAs offer tax-free growth and withdrawals, which can be a valuable resource during retirement.
- Emergency Fund: Keep a liquid reserve for unexpected expenses. This can reduce the need to dip into your long-term savings prematurely.
Budgeting for Success
Create a detailed budget that accounts for your expected income and expenses. Be conservative in your estimates to ensure you have a cushion for unforeseen costs. Use tools like retirement calculators to project your financial needs accurately.
Consulting Experts
Consider working with a financial advisor who specializes in federal retirement benefits. They can help you optimize your plan, navigate complex rules, and avoid costly mistakes.
The Psychological Aspect of Early Retirement
Retiring early can bring immense joy, but it’s essential to prepare for the psychological shift. Many retirees report feeling a loss of purpose after leaving the workforce. To avoid this, create a plan for how you’ll spend your time. Whether it’s volunteering, starting a business, or pursuing a long-neglected hobby, having a clear sense of purpose can make early retirement more fulfilling.
Conclusion
Retiring early doesn’t necessarily mean you shouldn’t proceed, but it does require understanding the implications. Consider the potential decrease in net income due to the lack of COLA adjustments and increasing deductions. Evaluate your retirement income timeline to ensure all your financial bases are covered. By planning comprehensively and seeking expert guidance, you can maximize your retirement benefits and maintain financial Security.
Ultimately, early retirement is a personal decision that requires careful thought and preparation. With the right strategies in place, you can enjoy the freedom of early retirement while protecting your financial future.
Happy planning!
Micah Shilanski, CFP®, helps federal employees confidently navigate their benefits and retirement planning. As the founder of Plan-Your-Federal-Retirement.com and a key advisor at Shilanski & Associates, he simplifies complex federal systems, empowering employees to maximize benefits, avoid mistakes, and retire on their terms.
Content provided by Shilanski & Associates, Inc., an investment advisory firm. Shilanski & Associates, Inc., is not employed by the federal government and does not represent the federal government. All strategies and ideas presented should be discussed with an advisor prior to implementation.
