Early retirement planning considerations.Making early retirement a positive experience requires knowledge of a wide range of financial areas. The effects of early retirement on Social Security benefits, employee pension benefits, health insurance coverage, and current investments and savings should be carefully reviewed prior to making the decision to retire. While U.S. workers continue to follow their desires to retire early, the statistics available from the Social Security Administration (1) and private research studies on retirement planning Retirement financial planning refers to a collection of systems, methods, and processes which, in their aggregate, support a family unit's (client's) desire to achieve a state of financial independence, such that the need to be gainfully employed is optional. (2) indicate that the majority of U.S. workers are not financially prepared for retirement. People are living longer and, at the same time, more and more workers opt for early retirement without the resources needed to generate sufficient retirement income. This article explores some basic financial planning Financial planning
Evaluating the investing and financing options available to a firm. Planning includes attempting to make optimal decisions, projecting the consequences of these decisions for the firm in the form of a financial plan, and then comparing future performance against considerations for early retirement.
Meeting Retirement Income Needs
Early retirement, or retirement at any age, may be less than an enjoyable experience without sufficient income. Generally, financial planners Financial Planner
A qualified investment professional who assists individuals and corporations meet their long-term financial objectives by analyzing the client's status and setting a program to achieve these goals. recommend that an individual should strive to maintain 70 percent to 80 percent of his or her final working year's income during retirement and have made provisions to increase income in retirement to keep up with inflation. A small but growing number of financial planners recommend that individuals should strive for 100 percent or more income replacement during retirement years. (3) The logic behind this recommendation is that individuals tend to spend more money when they have time to do what they would like to do. In planning for retirement at any age, the first task is to determine the income desired in retirement and examine how those income goals will be met. The exact amount of income that an individual needs in retirement is specific to each individual's financial circumstances CIRCUMSTANCES, evidence. The particulars which accompany a fact.
2. The facts proved are either possible or impossible, ordinary and probable, or extraordinary and improbable, recent or ancient; they may have happened near us, or afar off; they are public or and goals. For example, an individual or couple with a home that is paid for would li kely spend less on housing in retirement than an individual or couple who are still paying off their home or renting.
Financial planners generally suggest that an individual's retirement plan include at least three important sources of retirement income. These sources usually include Social Security benefits, personal savings/investments, and employer/employee retirement accounts, such as defined benefit plans Defined benefit plan
A pension plan obliging the sponsor to make specified dollar payments to qualifying employees at retirement. The pension obligations are effectively the debt obligation of the plan sponsor. Related: Defined contribution plan , 401(k)s, 403(b)s, and IRAs. Of the aggregate income received by retired Americans, Social Security benefits consist of 42.5 percent; individual savings and investments generate 36 percent; and employer/employee retirement benefits make up 21.5 percent of retirement income. (4) The anticipated income from each of these sources should be carefully examined prior to making the decision to retire.
Social Security Retirement Income
According to according to
1. As stated or indicated by; on the authority of: according to historians.
2. In keeping with: according to instructions.
3. the Social Security Administration, 60 percent of U.S. workers elect to begin Social Security retirement benefits at the youngest eligible age, 62. Up until the year 2000, opting for early retirement at age 62 meant a 20 percent reduction from the amount received for full Social Security retirement at age 65. The full retirement age began to gradually increase in the year 2000; it will reach age 67 in the year 2027. The earliest retirement age for Social Security remains at 62, but the reduction in benefits for early retirement will gradually increase to 30 percent by the year 2022. (5)
If U.S. workers continue to retire early, aggressive retirement planning is even more essential in light of the scheduled reduction in benefits from Social Security for early retirement. Table 1 lists the scheduled Social Security early retirement reduction. Once an individual elects to begin receiving Social Security early retirement benefits, the reduction in benefits is permanent.
Another aspect of Social Security to consider is the retirement benefits for the retiree's spouse spouse A legal marriage partner as defined by state law . Spousal benefits spousal benefits Social medicine Benefits, including health and life insurance, provided to a spouse–ie, husband or wife–of an employee; in socially advanced nations and in the US, SBs may be extended to unmarried–including same sex–partners are typically calculated as a percentage of the primary wage earner's benefits. The spousal spou·sal
1. Of or relating to marriage; nuptial.
2. Of or relating to a spouse.
Marriage; nuptials. Often used in the plural. benefit for a spouse age 62 would be 37.5 percent of the primary earner's full benefits. At full retirement age, the spousal benefit is 50 percent of the primary earner's benefits. A spouse may receive Social Security retirement benefits based upon the greater of his or her own employment record or the spousal benefit. Similar to the situation with a covered worker, a spouse's benefits are permanently reduced by a percentage based on the number of months before he or she reaches full retirement age. (6) For many married retirees, the combined reductions for early retirement may be significant.
Social Security provides a smaller percentage of income replacement in retirement for higher salaried workers. As can be seen in Table 2, Social Security retirement benefits, as a percentage of earnings, are less as a person's income rises. In order to maintain the desired income replacement percentage in retirement, other substantial sources of retirement income become more critical.
Employer/Employee Retirement Benefits
Another important consideration before opting for early retirement is the amount of money that will be provided by any employer/employee retirement plans. Most individuals are eligible to participate in several different tax sheltered tax shelter: see tax exemption. retirement plans. The current trend in pension plans to give the employee more flexibility creates more uncertainty re a precise determination of future retirement benefits. With most pension plans today, retirement income is based on the performance of the investments selected by the employee. In recent years, the Years, The
the seven decades of Eleanor Pargiter’s life. [Br. Lit.: Benét, 1109]
See : Time down stock markets have altered many early retirement dreams. However, even in down markets, it is important to keep in mind the advantages of investing in employee/employer retirement plans.
Individuals who participate in employer-sponsored tax-deferred retirement plans Tax-deferred retirement plans
Employer-sponsored and other plans that allow contributions and earnings to be made and accumulate tax-free until they are paid out as benefits. have the opportunity to deduct de·duct
v. de·duct·ed, de·duct·ing, de·ducts
1. To take away (a quantity) from another; subtract.
2. To derive by deduction; deduce.
v.intr. their annual contributions from gross income before taxes. The earnings accumulate Accumulate
Broker/analyst recommendation that could mean slightly different things depending on the broker/analyst. In general, it means to increase the number of shares of a particular security over the near term, but not to liquidate other parts of the portfolio to buy a security tax deferred and the income received from the account in retirement is taxable in the year received. The federal legal annual contribution ceiling on 401(k) and 403(b) plans is $11,000 for the year 2002. Recent tax law changes increase the annual employee contribution limit for 401(k) and 403(b) plans by $1,000 in each subsequent year until it reaches $15,000 in 2006. After 2006, the annual contribution limit will be indexed for inflation.
Under the new tax laws, individuals who are at least 50 years old are eligible to make additional contributions above the annual limits. In 2002, the additional amount is $1,000 and will increase by $1,000 per year in each subsequent year until it reaches $5,000 in 2006. As a result, beginning in 2006, individual employees over age 50 will be able to contribute up to $20,000 per year into their 401(k) or 403(b) plans. Also, effective in 2002, the new tax law allows an employee to contribute up to 100 percent of his or her compensation into a 401(k) or 403(b) plan up to these new limits. The scheduled increases in the legal annual contribution ceiling enhance the opportunity for individuals to invest for retirement.
Many employer-sponsored plans employer-sponsored plan,
n a program supported totally or in part by an employer or group of employers to provide dental benefits for employees. The plan may be administered directly by the employer or another person or group under a contractual contain provisions for the employer to provide matching funds Noun 1. matching funds - funds that will be supplied in an amount matching the funds available from other sources
cash in hand, finances, funds, monetary resource, pecuniary resource - assets in the form of money . An employer's matching contributions Matching Contribution
A type of contribution an employer chooses to make to his or her employee's employer-sponsored retirement plan. The contribution is based on elective deferral contributions made by the employee. increase the amount that an individual has invested annually into his or her retirement account and will magnify mag·ni·fy
To increase the apparent size of, especially with a lens. the sum available in retirement. Eighty-two percent of 40 1(k) plans offer a company match. The most common match is 50cents for each $1 of worker contribution up to 6 percent of the employee's wages. (7)
Where matching funds are involved, individuals generally should maximize employer-sponsored plan contributions before considering other tax-sheltered options. When an individual is considering retirement, the company's human resources The fancy word for "people." The human resources department within an organization, years ago known as the "personnel department," manages the administrative aspects of the employees. office or pension fund administrator should be able to give an accurate estimate of the monthly income available in retirement under different options.
There is no simple equation or rule of thumb that financial planners use to calculate the amount of money needed to produce a comfortable income in retirement. A recent Wall Street Journal survey of website retirement planning calculators reported that the amount of money that the various calculators say an individual needs for retirement varies widely. (8)
A number of factors can influence the amount of income that personal savings and investments generate in retirement. The most important factor is the amount of personal savings and investments that an individual is able to accumulate during working years to supplement other sources of retirement income. Financial planners generally recommend systematic savings programs, such as payroll deductions. These are automatic, allow for investment dollar cost averaging and, once established, can help to maintain the savings habit.
While investment options are numerous, quality mutual funds from established investment firms are often recommended for long-term Long-term
Three or more years. In the context of accounting, more than 1 year.
1. Of or relating to a gain or loss in the value of a security that has been held over a specific length of time. Compare short-term. growth. Table 3 illustrates the importance of starting an investment/savings plan as early as possible. The accumulations in Table 3 assume long-term annual rates of return, which historically have been obtainable in quality growth mutual funds.
As can be seen in Table 3, starting a savings plan at an early age allows the time value of money (compound interest) to work for the investor. It is also important to note that a slightly higher rate of return can produce significantly greater results over time, as seen when comparing the annual rates of return.
While it is important to be aggressive in accumulating money for long-term growth, it is prudent to be conservative in estimating the income produced by a given principal. The logic here is that it is better to have too much retirement income than not enough.
If an individual wishes to pass all or part of his or her savings and investments to heirs, then living on the interest earnings is appropriate. For example, assuming an interest rate of 5 percent, when asset preservation is desired, it takes $20,000 of principal to generate $1,000 of annual income. If an additional $40,000 of annual retirement income is desired, then it takes $800,000 of personal savings and investments to generate the income. ($800,000 X .05 = $40,000).
If an individual desires to maximize retirement income with low risk and is not concerned with leaving his or her savings and investments to heirs, then a life annuity LIFE ANNUITY. An annual income to be paid during the continuance of a particular life. may be appropriate. Following a basic annuity annuity: see insurance.
Payment made at a fixed interval. A common example is the payment received by retirees from their pension plan. There are two main classes of annuities: annuities certain and contingent annuities. rule of thumb, using a single life annuity Single life annuity
An annuity covering one person. A straight life annuity provides payments until death, while a life annuity with a guaranteed period provides payments until death or continues payments to a beneficiary for a guaranteed term, such as ten years. for a male at age 65 and assuming an interest rate of 5 percent for each $1,000 of annual income in retirement, a sum of $12,500 is needed. As a result, if your goal is to have an additional $40,000 per year in retirement income from savings and investments, then an estimated $500,000 is needed in investments at age 65 ($40,000 X $ 12,500/1,000 = $500,000). Keep in mind that many factors may have an impact on the income generated and early retirement will reduce the annual annuity that a sum of money will produce.
Employment After Retirement
Many individuals continue with some type of employment after beginning retirement, and this income may be an important part of their total income. Careful attention needs to be given to early retirement considerations when continued employment is anticipated. Social Security retirement recipients between the ages of 62 and full retirement age are subject to the annual earnings limitation test that reduces Social Security benefits by $1 for every $2 earned over $11,280 in the year 2002. Retirees past full retirement age can continue employment without suffering a reduction in their Social Security retirement benefits. The income limitation is scheduled to be adjusted annually for inflation. This limitation on employment after retirement may present some serious problems for individuals who plan to retire early and supplement their retirement income with part-time part-time
For or during less than the customary or standard time: a part-time job.
Fringe Benefits fringe benefits,
n.pl the benefits, other than wages or salary, provided by an employer for employees (e.g., health insurance, vacation time, disability income). : Health Insurance and Extended Care
A person contemplating early retirement needs to consider the additional costs associated with any lost fringe benefits, such as life insurance, health insurance, and provisions for extended care. Everyone has a some-what unique set of circumstances and, therefore, no "one size fits all" plan exists for this important part of the early retirement decision. Employee benefits are usually a very good deal from the perspective of the employee. More often than not, the rates for such insurance are group rates, which are lower than those for individuals. When considering early retirement, it is important to recognize that Medicare Medicare, national health insurance program in the United States for persons aged 65 and over and the disabled. It was established in 1965 with passage of the Social Security Amendments and is now run by the Centers for Medicare and Medicaid Services. coverage is not available until age 65; the result is a potential insurance "black out" period between the date of early retirement and age 65. When an employee elects early retirement, he or she may not be able to keep group insurance coverage or may have to pay significantly higher premiums. This insurance can take a significant portion of the early retirement income.
Financial planners generally suggest 70 percent to 80 percent income replacement in retirement, with provisions for annual adjustments for inflation. The effects of early retirement on Social Security benefits, pension benefits, health insurance coverage and personal savings should be carefully reviewed prior to making the decision to retire. Once made, many of the decisions affecting retirement are irrevocable Unable to cancel or recall; that which is unalterable or irreversible.
IRREVOCABLE. That which cannot be revoked.
2. A will may at all times be revoked by the same person who made it, he having a disposing mind; but the moment the testator is .
TABLE 1 Social Security Early Retirement Reduction EARLY REDUCTION PERCENTAGE AGE NEEDED YEAR OF RETIREMENT OF FULL BENEFITS FOR FULL BIRTH YEAR (IF RETIREMENT IS AGE 62) BENEFITS 1938 2000 20.833% * 65 and 2 mo. 1939 2001 21.666% 65 and 4 mo. 1940 2002 22.50% 65 and 6 mo. 1941 2003 23.333% 65 and 8 mo. 1942 2004 24.166% 65 and 10 mo. 1943-54 2005-2016 25.00% 66 1955 2017 25.883% 66 and 2 mo. 1956 2018 26.666% 66 and 4 mo. 1957 2019 27.50% 66 and 6 mo. 1958 2020 28.333% 66 and 8 mo. 1959 2021 29.166% 66 and 10 mo. 1960 and later 2022 and after 30.00% 67 * Source: The Social Security Administration. TABLE 2 Approximate Percentage of Social Security Retirement Income Replacement in 2002 at Full Retirement Employees' Average Annual $24,000 $48,000 $84,900 $125,000 Income Estimated Social Security $12,269 $17,360 $19,920 $19,920 Annual Retirement Benefits Social Security as a 51.1% 36.2% 23.5% 15.9% Percentage of Earnings Source: The Social Security Administration. TABLE 3 Accumulating Personal Savings and Investments; Accumulated Amount at Age 65, Investing $200 per month or $2400 per year AGE SAVINGS BEGIN AT 8% RETURN AT 10% RETURN AT 12% RETURN 25 $621,736 $1,062,222 $1,841,618 30 413,559 650,457 1,035,991 35 271,879 394,785 579,198 40 175,454 236,033 320,001 45 109,829 137,460 172,926 50 65,165 76,254 89,471 55 34,768 38,250 42,117
This article was republished with permission from Personal Financial Planning Monthly, Volume 2, Number 5, May 2002, Copyright 2002, Aspen aspen, in botany
aspen: see willow.
Aspen, city, United States
Aspen (ăs`pən), city (1990 pop. 5,049), alt. 7,850 ft (2,390 m), seat of Pitkin co., S central Colo. Publishers Inc.
(1.) Social Security Retirement Benefits Publication No. 05 - 10036, February February: see month. 1999 ICN ICN International Council of Nurses. 457500, published by the Social Security Administration.
(2.) "Financial Strategies for Approaching Retirement," American Express American Express (NYSE: AXP), sometimes known as "AmEx" or "Amex", is a diversified global financial services company, headquartered in New York City. The company is best known for its credit card, charge card and traveler's cheque businesses. Financial Advisors, Summer 1999.
(3.) "Steps to a Great Retirement," Lisa Reilly Reilly is a surname distinct from O'Reilly and Riley, and may refer to:
American poet whose collections Colors (1926) and Copper Sun (1927) established him as a leading figure of the Harlem Renaissance. , Beverly Goodman Goodman was a polite term of address, used where Mister (Mr.) would be used today. Compare Goodwife.
Goodman refers to:
(4.) See endnote See footnote. 1.
(5.) See endnote 1.
(6.) See endnote 1.
(7.) "Comparing the Roth IRA Roth IRA
An individual retirement plan that bears many similarities to the Traditional IRA. Contributions are never deductible, and qualified distributions are tax-free. A qualified distribution is one that is taken at least five years after the taxpayer established his/her first to Other Tax Sheltered Programs," Clarence C. Rose, Personal Finance, May/June 1999, pp. 27-32.
(8.) "Calculating Retirement? It's No Simple Equation," Bridget O'Brian, Wall Street Journal, February 7, 2000, p. R1.
Clarence C. Rose, PhD, is a Professor of Finance in the College of Business and Economics at Radford University Radford University is a medium-size public, state-funded university in the City of Radford, in Southwestern Virginia, founded in 1910 as a women's college and coeducational since 1972. It was granted university status by the Virginia legislature in 1979. in Radford, Virginia Radford is an independent city in Virginia, United States. The population was 15,859 at the 2000 census. The Bureau of Economic Analysis combines the city of Radford with neighboring Montgomery county for statistical purposes. .
L. Keith Larimore, PhD, is a Professor of Marketing in the College of Business and Economics at Radford University in Radford, Virginia.