After a year of human hardship, with no travel and endless zoom calls, it’s no wonder many baby boomers are thinking of retiring early to make the most of the remaining time. Data from the Pew Research Center suggests 3.2 million more people retired last year than the year before. A survey by the New York Fed also shows that Americans are trying to get out of the job market earlier than originally planned.
It’s not just pandemic fatigue that is driving people into retirement. The stock market has risen nearly 30% since early 2020. So if you had a number on your mind, an account balance to hit before you retired – maybe $ 200,000, $ 500,000, or $ 1,000,000 – rising markets mean you got there sooner than you thought.
But wait. In fact, you may not have as much money as you think because your balance isn’t the only number to worry about. If you don’t consider these other factors, early retirement could be one of the biggest financial mistakes you will ever make.
First of all, you need to consider the risk. People who are about to retire usually have around 40% of their retirement assets on the stock exchange. This is great when the market is rising, but you will lose more when the market falls. Chances are the stock market will see a significant decline at some point during the 20 or 30 years that you are retired – perhaps more than once.
Second, you have to spend money in retirement. If you have a special number on your mind for your golden years, it should be how much you can spend each year. And funding these expenses brings with it many new risks.
First, consider health expenses like Medicare premiums, long term care, and prescription co-payments. A recent report estimates that a retired couple can spend more than $ 200,000 on healthcare expenses! And remember that this estimate is very different. Some people need a lot less, some a lot more; a couple needs more than $ 300,000 to make sure they can pay for all of their healthcare bills.
In 2019, the median household savers aged 60 to 65 had total assets of just $ 250,000. You may have seen a guideline that says you can spend 4% of your savings every year. But the amount you can spend depends on interest rates and inflation, and with the current low interest rates protecting you from inflation that has even gone negative, your money won’t get that far.
You need to worry about the prospect of rising inflation because, unlike people who are still employed, you have a steady income. The risk of inflation increases, but you can address that by valuing your future expenses with inflation-linked bonds.
There are few hard and fast rules when it comes to retirement funding, but one is this: if you want to see how much you can spend each year, divide your wealth by 32. That’s the current pension factor, a number that breaks down based on inflation. Adjusted rates to help you figure out how much $ 1 of expenses will be over an expected 30 year retirement.
Real interest rates that protect you from inflation have decreased in recent years, which has made it more expensive to fund future expenses – with negative interest rates today, it costs $ 1.01 today to make sure you can spend $ 1 in 30 years. This change in real interest rates has also increased the annuity factor by 13% since January 2020.
Think of it this way: suppose you had $ 500,000 in January 2020 when the pension factor was 28. That meant you could afford to spend $ 17,500 a year in retirement. By May 2021, if you put all your money in the stock market, you would have $ 646,000, which is a 30% increase. But your spending capacity only increased 14% to $ 20,000 because the pension factor increased to 32.
If I just shattered your early retirement dreams, I have little good news. You have some control over your social security income. Deferring payments until you are older can increase your monthly check significantly without the risks of the stock market. For example, if you were making the average income for most of your career, you would be starting at $ 63 today). That’s a 42% increase in four years, and way more than you would likely get in a volatile market!
And if the new spending figure you now have on your mind isn’t what you expected, you may have more work options to help keep your finances firmer. In a post-pandemic world, employers may be more willing to accept partial retirement, where you work fewer days for less income while getting sick pay until you’re eligible for Medicare at 65. And maybe your employer would be willing to take the part-time scheme after joining Medicare. That would make for a much safer retirement and save you from the potentially costly mistake of retiring too early.