How to prepare and survive a sudden early retirement

More than half of all retirees found that their retirement began sooner than they expected. I should know. I was retired, six years ago.

I'm using that passive past tense on purpose. I didn't retire. I was retired. Many people talk about financial independence retire early, or FIRE. But, I’m not talking about FIRE. I’m talking about fired. I was called to an HR meeting at 4 p.m. on a Thursday and fired, one month before I turned 59.

Yet, I’ve discovered that may have been the best decision I never made.

As I approached 65 in 2021, I decided look back at my unexpected retirement and share lessons learned with others who might be on a similar flight path, with an emergency landing of a retirement plan, well short of the runway.

How many are there out there who might be on a similar flight path? Allianz Life does an annual Retirement Risk Readiness Study. In 2021, more than two-thirds of retirees, 68 percent, said they retired earlier than expected. The top two reasons were health care issues, at 33 percent, and unexpected job loss, at 22 percent. In 2020, the survey found half of all retirees said they retired sooner than expected, with 34 percent due to job loss and 25 percent due to health concerns.

Keep in mind, that was before the COVID pandemic began. I expect 2022 numbers in a month will continue this trend, as the Great Resignation continues.

There are three tips to prepare if you are worried about an unexpected retirement, as well as three tips to take, if you find that you're suddenly retired.

Before I begin, I should explain that I am not a financial professional. I don't have any special certificates or initials after my name. So take this as entertaining ideas from one educated consumer to another. Always do your own due diligence, and seek out a professional if you need one.

Let’s begin with three tips that you could take to make your retirement plan more resilient:

1. Create an emergency cash fund.

As you approach retirement years, you should have at least one to three years’ worth of expenses safely stored in the bank or cash-like investments. You will be able to tap these funds before any of your long-term retirement assets. In my case, our two children were exiting their college years and I had already put away money to make sure tuition was paid each semester. So, I was able transition those dollars to an emergency cash buffer.

I know one to three years is a lot of cash to put aside. But, you should recognize that a job loss will last longer as you get older, so that cash cushion will be important whether you are beginning a forced early retirement or surviving until your next job.

Start slow. Build up six months’ worth of expenses, and then a year, and then two years, and then three years. Build up that cash cushion, in case a sudden retirement looms.

2. Pay down debt.

We began that process soon after we were married, when we decided credit cards would be paid each month. In fact, I had to pay down my credit cards before I could get married. My wife said she was going to marry me and not my debt.

We passed that lesson on to our children, who know to pay the bill at the end of each month, to avoid running up a balance. By the way, credit cards are safer than ATM/debit cards, given the added consumer protections with a credit card.

We also paid down debt in our house, which is the largest debt most of us incur. When we bought our first house, we took a 30-year mortgage. But, we made a schedule to pay the mortgage company twice a month. The extra payment went to principal and that helped us build up equity. At first, the goal was to help remove the private mortgage insurance (PMI) premium added on many starter mortgages. Eventually, we built up enough equity to refinance to a 15-year mortgage. We continued to make extra payments, until we retired the mortgage in my early 50s. That allowed us to use the free cash flow for added retirement savings.

3. Max out retirement savings.

Early in our careers, we are taught to contribute at least 6 percent to earn your 3 percent employer match, or whatever the math is in your retirement savings program. After all, that’s free money. However, you should not stop at that percentage. Every time you get a raise, every time you get a bonus, look for opportunities to increase the percentage of your salary that you are putting away toward retirement. Most 401k plans now even offer an option to increase your contribution by a percentage a year, up to a set limit.

By the time you are nearing retirement age, you should be up near the maximums allowed by the IRS. In 2022, that will be $20,500 for those below the age of 50, plus another $6,500 for those over 50.

If you can contribute the maximum allowed, think about the difference that could make.

Consider two savers, both 35 years old, earned $45,000 in 1990 and retired at age 67 in 2021. For both our savers, I assumed same investment returns, same modest net expense ratio, and same inflation rate. I used 2 percent for this experiment, which despite recent readings, is close to the actual inflation trend.

Minnie Saver just contributed 6 percent to earn her employer’s 3 percent match. Her colleague, no relation, Max Saver, contributed the maximum allowed each year. I looked up the maximum limits allowed by the IRS for Max. To keep this simple, I’ve assumed salaries went up with inflation, so I’m not including raises or bonuses. See the spreadsheet here.

Minnie retired with $735,026 in savings in 2021. Her 6 percent steady contributions added $119,413, her employer contributed $59,706, and investment returns added $555,592. Expenses at 0.25% took $19,685 in fees.

Max retired with $1,845,747. That’s more than double what Minnie had. Max got the same employer match, $59,706. But he maxed out his contributions, starting with $7,979 in 1990, and rose to $19,500 last year. He also made the catch-up contributions starting at age 50. So his total contributions were $535,656. Earnings on investments added $1,275,759, with fees subtracting $45,194.

More importantly, consider the balances at age 60. If Minnie or Max faced a sudden early retirement, what would they have? Minnie would have had $458,785. Max would have had $1,104,089, or 241 percent of Minnie’s balance. By maxing out his savings, Max would have been more more prepared for a sudden retirement.

There are three more tips I’ve learned to manage a sudden unexpected retirement.

1. Get a budget.

In my case, I had been tracking expenses, but not that carefully. When I paid credit cards, I often stuck the whole payment in “miscellaneous” in my Quicken register. When I looked back at spending in 2015, the year I was retired, I discovered “miscellaneous” was 35 percent of spending. Trust me, “miscellaneous” should not be one of your biggest pie slices.

I have since connected credit cards to Quicken and automatically assign categories for each transaction. In 2021, “miscellaneous” was 3 percent of total expenses.

That kind of detail allows you to build a bottom-up estimate of spending. Many financial planners recommend that you start with an estimate of 85 percent of your pre-retirement salary. But that’s a very rough rule of thumb. Why base your estimate on any percentage of what you used to earn, or what you used to spend before retirement? A detailed bottom-up budget will be a lot more accurate.

2. Consider your health care costs.

If you are retiring prior to Medicare, you need to consider your options for health care. We started by switching from group insurance to COBRA coverage. In most cases, you are eligible to continue group coverage for up to 18 months. We elected to do that because all four of us were on the group plan. However, it was an expensive option. COBRA requires you to pay your share, your employer’s share, plus an administrative fee, adding up to 102 percent of the total costs. Eventually both children got full-time jobs with benefits and my wife and I could seek coverage under the Affordable Care Act (ACA).

Take a look at what you could get through the ACA Marketplace. Loss of group coverage is one reason for a special enrollment period. Take a look at your modified adjusted gross income (MAGI), including any income taken from your 401k or retirement savings, because that'll count as ordinary income. With that expected MAGI, and the number of folks in your family who need insurance, see what kind of premium tax credits you could get on the ACA Marketplace.

3. Prepare a retirement withdrawal strategy.

The final tip if you suddenly retired is to consider how you will take money from your retirement plans. First, make sure you are counting all of your available assets. If you are 55 and older when your sudden retirement begins, you need to keep the Rule of 55 in mind. You are allowed to tap your last employer’s retirement savings plan without a 10 percent penalty. Other retirement savings from former employers or your own IRAs will be subject to the 10 percent penalty, if you withdrawal funds before the age of 59-1/2.

Once you look at all of the available assets, including any assets available under the Rule of 55, consider how you will withdraw funds. Some people use a simple 4 percent rule to decide how much they should withdraw. Take all of our savings and multiply by 4 percent, and that is what you can withdrawal in the first year.

I recommend using your bottom-up estimate of expenses and then build a strategic withdrawal plan to cover expenses. You may find that you need to go over 4 percent in early years to meet expenses, especially if you are delaying pension and Social Security payments. You also may need to take out more in early years to cover health care prior to Medicare. That will be okay, as long as it's mapped out strategically in falls back to a sustainable rate in later years.

Part of your retirement withdrawal strategy is when to begin a pension and Social Security. If you are one of the lucky few with a private pension, find out the age you will get your maximum benefit. You may qualify for a reduced benefit before age 65, but a maximum benefit at 65.

For Social Security, I will reach my full retirement age in about a year, but I am waiting until 70 for the maximum Social Security benefit. For those born 1960 and later, the full retirement age is 67 but you will earn 8 percent a year up to the age of 70. If you can afford to wait, it is the best longevity insurance you can buy.

Conclusion

My experience tells me there are steps you can take before you face a sudden retirement to make your retirement plans more resilient. If you are in your 40s and 50s, consider these steps now. Perhaps you will never need to rely on them.

But if you do retire suddenly, there are other steps you can take to quickly transition to a sound retirement.