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3 Ways Retiring Early Can Hurt Your Finances

Early retirement isn’t the norm for most workers, but with some careful planning, it’s possible to quit the 9-to-5 grind 10, 15 or even 20 years ahead of schedule. Whether you plan to spend your golden years sunning on the beach or traveling the world, it’s important to be prepared for how leaving the workforce early will impact your finances. Aside from not having enough money saved to last for the long haul, there are a few other issues that could negatively affect your bottom line.

Find out now: How much do I need to save for retirement?

1. Your Social Security Benefits May Take a Hit

Timing is everything when it comes to taking your Social Security benefits and retiring early can potentially reduce your benefit amount. For workers born after 1960, full retirement age is 67 but you can start taking benefits at age 62. If you do, however, you’ll only get about 70 percent of the monthly benefit amount you’re eligible for. If you were to wait until age 65, that amount goes up to 86.7 percent.

The only way to get 100 percent of your Social Security payout is to wait until full retirement age to apply for benefits. If you were to wait even longer before taking Social Security, you’d see a slight increase in your benefits each year until you turned 70. At that point, your payments would level off.

If you think you’re going to rely on Social Security benefits at some point down the road, it’s a good idea to consider how early retirement is going to alter your long-term financial outlook. Knocking a few hundred dollars off your benefits each month may not seem like much, but that extra cash could come in handy if your nest egg begins to shrink faster than you anticipated later on in life.

Of course, you can retire from work and also hold off on applying for Social Security benefits.

Find out now: Calculate Your Social Security Income

2. You Might Have to Cover the Health Insurance Gap

3 Ways Retiring Early Can Hurt Your Finances

Health insurance coverage is mandatory but you won’t be able to sign up for Medicare coverage until your 65th birthday. If you’re planning to retire well before that, you’ll need to make sure you’ve got insurance in the meantime to avoid a tax penalty.

Purchasing coverage through the health insurance marketplace can be a good option since it might make you eligible for a premium tax credit. This policy could still put a strain on your budget. While you can find individual coverage for just a few hundred dollars a month, you can expect to pay a lot more if you’re married or you still have kids at home.

It’s especially important to weigh the cost of health care if someone in your family has a serious health issue that requires ongoing treatment. If your previous employer’s plan covered most of your medical bills, you may be in for a rude awakening when working out your post-retirement budget.

3. You May Have to Pay Extra Taxes

3 Ways Retiring Early Can Hurt Your Finances

Having multiple income streams is a must if you’re retiring early from a tax perspective. If you’ve got all your money tied up in tax-deferred accounts, such as a 401(k) or a traditional IRA, you might not be able to take it out before a certain age without paying a 10 percent early withdrawal penalty. That’s on top of the regular income tax you’ll owe on the distribution.

Check out our 401(k) calculator.

You can get around the extra penalty by selling off long-term investments first, since you’ll only get hit with a capital gains tax on the sale. If you don’t have investments outside your retirement accounts, you’re probably going to need to have a pretty penny set aside in a savings account at the very least. Otherwise, you’re potentially looking at adding to your tax burden to cover the cost of retiring early.

Photo credit: ©iStock.com/PeopleImages, ©iStock.com/BraunS, ©iStock.com/fstop123

Rebecca Lake Rebecca Lake has been writing about the nuts and bolts of personal finance for nearly a decade. She is an expert in investing, retirement and home buying topics. Her work has been featured on The Huffington Post, Business Insider, CBS News, U.S. News & World Report and Investopedia. As a homeschooling mom of two, she's always looking for ways to make the most of every dollar.
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