Retiring early can be tricky, even if you have considerable home equity.

Say for example that you’re married with $1.4 million in your IRAs and a home worth $750,000. Retiring early could well be within reach, but you may face be a few big challenges. Retiring at age 60 means having to wait several years to become eligible for Social Security and Medicare, potentially leaving you overly dependent on portfolio income. Turning your home equity into cash, meanwhile, can pad your nest egg, but it may increase your housing costs going forward.

Potential Issues With an Early Retirement

While everyone’s situation is different, early retirement raises a few key challenges: the years-long delay before Social Security and Medicare kick in, as well as an early reliance on portfolio withdrawals.

Social Security Delay

First, retiring before age 62 means you won’t have immediate access to Social Security.

While 62 is the minimum age to begin taking Social Security benefits, doing so means taking a 30% reduction in benefits for the rest of your life. However, you won’t receive your “full” benefit unless you wait until full retirement age (67 for most). Waiting until age 70 to file for Social Security can increase your benefits by at least 24%, but it will mean relying on other income sources until you turn 70.

By retiring at 60, for example, there would be at least a two-year gap before you could collect Social Security. If you already expect to be living on a tight budget in retirement, not having these benefits may put significant strain on your finances.

Medicare Delay

Retiring early will also mean budgeting for health insurance.

Medicare coverage begins at age 65, at which point you will receive significant (but not comprehensive) health insurance through the government. You may also want to budget for supplemental coverage such as gap and long-term care insurance. However, by retiring at age 60, you would also need to replace any health insurance you received through your employer.  

If you already pay for health insurance out of pocket, keep that line-item in your budget. If not, price out individual coverage plans and account for those premiums in your retirement budget.

Reliance on Portfolio Income

Finally, retiring early means that you’ll transition from the accumulation phase to the withdrawal phase sooner than other people. While your portfolio will continue to generate returns in retirement, most households withdraw money faster than their portfolios accrue it.

If you retire at age 60 instead of 67, you would need to rely more heavily on your portfolio for seven more years. As with Social Security, make sure you have enough money to support a comfortable lifestyle for these extra years. If not, early retirement may not be wise. And if you help assistance evaluating how long your assets may last, a financial advisor can help.

Income and Budgeting for Early Retirement

A couple that retired at age 60 enjoys a fall day together.

In a sense, retiring early is no different than at any other time. It all comes down to income vs. spending. If you have enough benefits and assets to cover your lifestyle for a foreseeable life span, you may be able afford to retire. If not, then something needs to change.

In the hypothetical scenario from above, you and your spouse are 58 with $1.4 million in your IRA and a paid-off home that’s worth $750,000. Could you afford to retire at 60?  

Assuming your IRA balances grow at, say 5% per year, over the next two years, you would end up with approximately $1.54 million. Using the 4% rule for withdrawals, you and your spouse could potentially afford to withdraw $61,600 from a balanced portfolio (50% stock, 50% bonds) in your first year of retirement and then adjust your withdrawals by the rate of inflation in subsequent years. While the 4% rule is a static approach that doesn’t account for your changing spending needs, it’s designed to make a retirement portfolio last up to 30 years. However, since the money is in a pre-tax account, you’ll have to account for the taxes that you’ll owe on the withdrawals, as well.

Whether your IRA and Social Security benefits (when they start) would be enough to support your lifestyle for the rest of your life depends not only on how long you will live, but how much you expect to spend.

There are some ways to boost this income, but all have their own risks and benefits. For example, you could invest in a guaranteed lifetime annuity. A representative annuity purchased for $1.4 million might pay $8,041 per month or $96,492 per year. While an annuity may deliver more annual income than the 4% rule would – at least initially – annuities typically aren’t indexed for inflation. At standard rates the purchasing power of this income would be worth about half its original value in 30 years. 

On the other hand, say you and your spouse delay retirement. If your IRAs were to grow at 5% per year between ages 60 and 67, you could retire with more than $2.17 million. At that point, withdrawing 4% in your first year of retirement would produce $86,800 before taxes. You also would have seven fewer years of retirement to fund. But if you need help building an income plan for retirement, consider working with a financial advisor.

Using Home Equity to Fund an Early Retirement

A couple looks at home listings on a tablet to determine if downsizing makes financial sense.

Then there’s the house. Many retirees anticipate their home being a significant, if not primary, source of wealth in retirement.

In theory, selling your $750,000 home in two years and adding the proceeds to your retirement nest egg would bring your total assets to $2.29 million before taxes. Again, this assumes your IRAs grow at 5% per year over the next two years. Withdrawing 4% from that cumulative pot of money would produce an income of $91,600 in your first year of retirement.

But home equity isn’t a full-value financial asset, because you will still need somewhere to live. If you buy a new home, you can only invest whatever’s left over. Taking a mortgage would cost even more because of interest, and leave you with a new monthly expense.

Renting involves lower stakes but will increase your monthly budget indefinitely. Particularly if you live in an expensive city, you would trade the low costs of a paid-off home (insurance and taxes) for monthly rent that will likely increase with inflation.

These are all things to think about as you consider tapping your home equity in retirement. But if you need an expert’s perspective, speak with a financial advisor.

Bottom Line

Retiring early is an ambitious, and spectacular goal. If you plan on retiring before 65, it’s important to account for moving pieces like Social Security, Medicare and the extra years of portfolio withdrawals ahead. Early retirement is possible, but make sure you’ve got enough reliable money on hand before making the leap. 

Retirement Planning Tips

  • A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • One option we did not discuss is the reverse mortgage, a financial product designed to let retirees get the value of their home’s equity without having to sell the property. These loans can be valuable and risky, and it’s worth thinking carefully about whether a reverse mortgage is right for you.

Photo credit: ©iStock.com/Ridofranz, ©iStock.com/kali9, ©iStock.com/Paperkites

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