Technically speaking, leaving the workforce between the ages of 61 and 65 is considered to be early retirement. However, according to the Life Insurance and Market Research Association, about 51% of Americans retire between the ages of 61 and 65. The average retirement age in the U.S. is now 64, so retiring just one year earlier than that is not a particularly unusual course of action. Even still, you may want to approach things carefully, as you’ll need to account for things like healthcare and a smaller Social Security check.
Consider working with a financial advisor as you plan out your retirement goals.
Evaluating Your Retirement Resources
There are three steps required for any retirement plan, including one that entails leaving the workforce at 63. The first one is assessing your retirement resources; the second is estimating your needs and wants; and the third one is taking action to close any gap between your retirement resources and retirement needs and wants.
Early retirement can affect your Social Security benefits. If you retire at 63, you can start drawing your Social Security benefits even though they will be around 25% to 30% lower than if you wait until after your full retirement year. Retiring later rather than earlier may benefit you in other ways. If you start drawing benefits after your full retirement age, you earn delayed retirement credits, which are additions to your benefits because you have waited until later to retire. In other words, retiring at 63 doesn’t necessitate beginning to take Social Security at that time. If possible, it’s wise to delay taking Social Security to increase those monthly benefits.
If you are part of a married couple, consider your Social Security benefits in the context of both of you instead of one of you. This is important because it takes spousal and survivor benefits into account to maximize your Social Security income. When both of you draw Social Security benefits, the highest earner over 35 years will draw more. If the highest earner files early for benefits, that will permanently reduce their benefits. If the highest earner dies first, their benefit becomes the other spouse’s survivor benefit. The net effect is it will permanently reduce the survivor benefit if the highest-earning spouse file for benefits before full retirement age. If you and your spouse want to retire at 63, both of you don’t have to start to draw Social Security benefits at that time. The higher-earning spouse could, theoretically, wait until later.
If you plan on working after retirement, you will have to pass an earnings test until you reach your full retirement age. Social Security limits the amount of money you can make until you reach your full retirement age. If you exceed that amount, then you are taxed on your earnings as well as on your Social Security earnings. Although your benefits will be recalculated at full retirement age, it may take many years to make up that difference.
Tax-Advantaged Retirement Plans
A defined-contribution plan is an employer-sponsored plan that allows you to take pre-tax dollars and invest them in capital market securities. Examples of such tax-advantaged plans are 401(k), Roth 401(k), 403(b) and 457. Your contribution may or may not be matched by your employer. Unlike defined benefit plans, defined contribution plans offer no guarantees about your future benefit. They rise and fall with the market. If you plan to retire at 63, but you have a few years left before retirement, the best strategy is to max out your plan every year.
In 2022, the maximum you can contribute per year to a 401(k) is $20,500. If you’re 50 years of age or older, then you can deposit up to another $6,500 during the year. If your employer matches your contributions, the combined limit is $61,000 for 2022, but only if you are 49 or younger. Once you turn 50, that limit increases to $67,500 for 2022. If your employer matches any of your contributions, that is a significant employee benefit and can really impact your retirement savings.
Be sure to keep income taxes in mind with these plans. Unless your company’s 401(k) is a Roth account, you will likely be subject to taxes when you withdraw money. So if you retire at 63, you will be subject to taxes but not penalties.
Individual retirement accounts (IRAs), which also come in traditional and Roth variations, may also be part of your retirement plan. These plans essentially work the same once you reach retirement as their 401(k) counterparts. With a traditional IRA, you’ll need to pay income taxes on your withdrawals. On the flip side, qualified withdrawals from a Roth IRA can be taken tax-free.
Defined benefit pension plans provide employees with a fixed, pre-determined benefit at retirement. They are fairly rare, but some government units still offer them. According to the Bureau of Labor Statistics (BLS), in 2019 26% of civilian workers had access to defined benefit plans, including 16% of private industry workers and 86% of state and local government workers.
On top of Social Security, tax-advantaged plans and pensions, be sure to factor in any brokerage and savings accounts you may have.
Finally, you should have an emergency fund that is equal to at least six months of your monthly income. If you have an adequate emergency fund, you can take care of the emergency while hanging on to your retirement savings. The best place to keep your emergency fund is either a high-yield savings account or a money market account or fund.
Estimating Your Retirement Expenditures
Whether you will have enough retirement savings plus Social Security benefits at 63 is completely individual. It is often recommended that, if you are 60, you should have eight times your salary saved for retirement. If you earn $50,000 per year, that is $400,000 – not counting your Social Security benefit, which tends to average around $1,500 per month. Most advise counting on needing approximately 80% of your pre-retirement income.
If you retire at 63, you will no longer have health insurance coverage with the company you retired from unless that company falls under the Consolidated Omnibus Budget Reconciliation Act (COBRA). You won’t be able to get on Medicare until you are 65. If you can get COBRA, you can stay on your employer’s health insurance for up to 18 months after retirement. You, however, have to pay the full premium, your part as well as the company’s part. This is why COBRA can often be expensive. In some cases, companies may let you stay on their healthcare at their expense for a period of time.
Other options include going onto your spouse’s health insurance plan, which may be the most affordable option. The last option is to buy your own health insurance plan through the Health Care Marketplace where you can obtain quotes. Evaluate the plan based on your deductible, premiums, coverage and copays. You have 60 days to choose this option or lose your discounts. If you choose a plan that has a deductible of more than $1,350 for single individuals and $2,700 for joint couples, you will be eligible to open a health savings account (HSA). Make sure the fees for your health insurance are on the list of your retirement expenses.
Finally, consider buying long-term care insurance. It’s costly but, depending on your health and resources, it may be important to consider this.
Taxes and Other Costs
You also must consider the tax liability on your Social Security benefits in comparison to the tax liability on other retirement income. Because Social Security benefits are taxable on up to 85% of your earnings, they can be more valuable than your benefits from taking withdrawals from an IRA since the tax liability is lower on an IRA depending on the size of that IRA.
Unless you have a Roth IRA or Roth 401(k), you will pay taxes on your pension income. Taxes will further reduce it at your marginal tax rate. For example, if you are in the 22% tax bracket, for every $1,000 you withdraw, you will net $780. If you work during retirement, it may be reduced further by taxation on your Social Security benefit if you retire and start working at 63 which is before your full retirement age.
Don’t forget yearly property taxes and such items as homeowner insurance bills plus the monthly cost of utilities.
Differentiating Between “Needs” vs. “Wants”
During retirement, you may actually have expenditures that increase or that are new. Travel is an example. You may want to travel more than during your working years. If you want to have more “fun money” in retirement, concentrate on cutting out any unnecessary non-essential expenditures like subscriptions you don’t use, too many visits to Starbucks and opt for stylish, but less expensive clothes. Check your bank balance at the end of every day to be sure you are staying on track with your budget and so you will know no fraud has occurred.
You may also have expenses that will decrease. Commuting expenses, professional clothing and saving for retirement are such expenses.
Following a Retirement Budget
You should make a personalized budget based on your current expenditures. You don’t need a complex spreadsheet or budgeting app. Instead, you can use pen and paper and follow your check register or any app on which you keep track of your expenditures. Add up expenditures for a reasonably typical month. Mark the expenditures as essential or non-essential. You can list every expense in one year on a month-by-month basis. This will help you get a total expenditure tally by month and by year.
Taking Appropriate Remedial Action
The third step, after determining your resources and estimating your expenses, is taking action to close any gap that your analyses have revealed. Here are some possible courses of action:
- If you aren’t contributing the maximum to your 401(k), start doing that by cutting your non-essential expenses, particularly luxury items.
- Consider starting an IRA if you don’t have one. You can either start a traditional IRA, which requires you to pay taxes when you make withdrawals at possibly a lower, post-retirement tax rate or start a Roth IRA. You have no penalty if you start making withdrawals after age 59.5. In 2022, you can contribute a maximum of $7,000 per year if you are over 50.
- Consider purchasing an annuity from a reputable insurance company.
- Embrace a more prudent lifestyle to enhance your ability to save.
Any retirement plan, including one that has you leaving the workforce at 63, requires a clear-eyed look at your retirement resources, your retirement expenses and a willingness to take any remedial action. Such action may involved turning a hobby into a part-time second career. Push back your retirement date closer to your full retirement age. Set up an IRA and try to contribute the full allowable amount each tax year until you retire.
Retirement Planning Tips
- Consider working with a financial advisor as you create or update a retirement plan.
Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Check out SmartAsset’s 401(k) calculator which will help you decide how much to contribute to your 401(k). In addition, take advantage of SmartAsset’s Social Security calculator to help you determine your benefits.
Photo credit: ©iStock.com/g-stockstudio, ©iStock.com/Inside Creative House, ©iStock.com/tumsasedgars