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Should you consider retiring early during the pandemic? Thumbnail

Should you consider retiring early during the pandemic?


Should you consider retiring early during the pandemic?

The pandemic has added a new dimension to the question of “when to retire?” The thought of retiring early during the pandemic has certainly crossed many people’s minds. If you are 5 to 10 years away from retirement and could conceivably retire now, does it make sense to go back into the office and grapple with the uncertainties of returning to the workplace in a pandemic? For those who are considering retiring early during the pandemic, the key things to consider are financial readiness, what your lifestyle will be like after retiring and how to plan your estate. 

What is the ideal age to retire? There’s no set “retirement age.” The age at which you are first eligible for Social Security benefits is 62. As many people depend on Social Security to fund their living expenses in retirement, this has become the time when many people start to think about retiring.

Should 62 be your retirement age? Not necessarily. 

Before we get into a discussion of retiring early during the pandemic, let’s take a moment to define what being financially ready to retire really means. This is a highly personal choice that involves many factors, both emotional and financial. We will begin our discussion with an overview of the major financial questions that you should be asking yourself.

Are you financially ready to retire early during the pandemic?

A thorough review of your finances and a scenario analysis of your future wealth will give a sense for how ready you are. The following are likely to be your major sources of income in retirement: 

  • Personally held investments
  • Employer retirement benefits
  • Real estate
  • Social Security
  • Insurance

Let’s review each in depth.

Personal Investments

Assets that you hold on your own (as opposed to in an employer sponsored plan, which we’ll discuss next) are likely to play a part in your plan for retiring early during the pandemic. Review what you hold in the following types of accounts:

Individual Brokerage Accounts

Individual accounts are held by one person. There are no tax benefits for investing in these accounts, but there are also no restrictions on the amount of money that one may contribute. You can withdraw freely from an individual brokerage account and there is no required age for starting distributions. You will need to think about taxes when withdrawing from this type of account, since you will most likely have capital gains on your holdings. These can be significant and should be considered as part of your planning for retiring early.

Joint Brokerage Accounts

You also may hold assets jointly with another person such as a spouse or business partner. There are several types of joint accounts with varying legal aspects to them. 

IRA 

IRA stands for Individual Retirement Account. There are two major types: Roth IRA and Traditional IRA. In both cases, any contributions grow tax-deferred, but there are limits on the amounts you can contribute annually. The tax treatment of the contributions and distributions from these two types of accounts vary quite significantly, so if you are using these vehicles to save for retirement it is important to consult with a tax or financial professional prior to doing so. You are mandated to begin withdrawing from your Traditional IRA accounts at age 72. If not, you will have to pay penalty fees. Note that this was changed in the SECURE ACT from age 70½  to age 72, for those who will reach the age of 70½ after January 1st, 2020. 

Employer Sponsored Retirement Benefits

Employer sponsored plans, such as pensions, defined benefit, 401k and 403b plans, are a significant source of retirement savings for many individuals. It’s important to make sure that all past plans are reviewed and potentially consolidated. You may be able to roll them into your current plan, or transfer them to an IRA (IRA rollover). 

Employer sponsored retirement accounts can play a major role in planning for early retirement, they should be reviewed periodically. 

Real Estate

Real estate plays a part in the decision to retire early during the pandemic. When considering what to do with your current home(s), consider the following questions:

  • Do you still have a mortgage?
  • If so, would you be able to sell your home for more than what you owe? Consider asking if you should downsize and use the excess cash to help fund your retirement?
  • Does it make sense to try to pay down your mortgage before retiring?
  • When was the last time your home was appraised?
  • What are the costs of maintaining your home or homes?
  • If you are considering downsizing, are you really going to be happy living in a smaller house or are you too accustomed to having more space?

You may want to consider downsizing your home if you truly feel you have more space than you need and the financial circumstances are right. This may be a good time to consider selling your home in favor of a smaller residence. Many suburban housing markets are very active at the moment. According to Bloomberg news, suburban New Jersey homes are showing the biggest price increase in nearly a decade. The pandemic has caused many to seek houses with yards and room for office space.

Social Security

You are entitled to partial Social Security benefits as early as age 62, but you will want to consider the costs and benefits of doing so.  The biggest question people tend to have about Social Security is when to begin taking your benefits. This question is best answered by a thorough breakeven analysis.  You should also consider your own personal health situation and life expectancy when making this decision.

For example, consider the table below. In this scenario, delaying starting your social security benefits from age 62 to age 70 would result in your collecting more total benefits after you reach age 78. After this point, you would continue to collect a higher monthly benefit. This is a simplified example and should not be used to make individual decisions.  

If you are married, widowed or disabled, there are additional strategies to explore when considering when to start taking benefits. While beyond the scope of this article, they are well worth evaluating.  

Already started taking social security benefits? You may still have options to suspend or withdraw your application for benefits.

Insurance

While certain types of insurance, such as term insurance, are geared towards protecting the insured, other types of insurance, such as whole life insurance contracts, may provide a guaranteed stream of income in retirement. Insurance contracts should be reviewed periodically to ensure that they remain relevant and are not in danger of lapsing. 

It is also wise to make sure that you maintain sufficient life insurance in the case that you have joint obligations, such as a mortgage or child care expenses. The cost of insurance tends to increase with age, so it may be better to address any insurance shortfalls sooner rather than later.

Investing considerations for retiring early during the pandemic

Now that we’ve talked about the major types of investment accounts, let’s talk about some investing basics. Regardless of how you hold them, your investments should be prudently managed by either yourself or by a qualified investment professional. 

Investments are managed according to risk and return parameters that are set when you begin investing and monitored periodically. In concert with your investments, you should have a financial plan that spells out a strategy for meeting your cash flow needs in all likely scenarios.

Estate Planning

If you are considering retiring early during the pandemic, it’s important to review and update your estate plan. We’ll start with some estate planning basics and then discuss some of the more advanced aspects of estate planning that may apply to individuals with significant wealth.

What is an estate plan? Every family has different assets, needs, and goals. An attorney can create a set of legal documents that comprise your estate plan. The basic parts are:

  • A will
  • Power of attorney 
  • Healthcare directives
  • A trust or trusts
  • Other related legal documents

There are some technical terms that may be new, so we’ll briefly define them.

Will 

A will is a legal document that establishes what you wish to happen with your assets and the care of any minor children. In a will there are guardians appointed who would care for the children in case something were to happen to the parents. It also specifies which assets are to be distributed to specific heirs or others.

Power of Attorney

A power of attorney is a legal agreement that allows someone to act on your behalf. Powers of attorney can have many uses. One such use is to have someone step in in case you were to become incapacitated.

Healthcare Directive

This is a legal document that grants another party the authority to make healthcare decisions for you in the case that you are unable to make them yourself. It can also inform others of your wishes regarding your healthcare. 

Trust

A trust is a fiduciary arrangement in which one party, known as a grantor gives another party, the trustee, the right to hold title to property or assets for the benefit of a third party, the beneficiary or beneficiaries. Trusts can take many forms and may be used to specify exactly how and when the assets pass to the beneficiaries. They can also save time and avoid public disclosures by helping to avoid probate at death. Trusts can also help to avoid or reduce estate taxes. 

When looking to retire, it’s important to have all this documentation in place. The estate planning needs of each family can vary. Some families have more complex needs, which call for more advanced planning.

Advanced estate planning

With larger estates, concentrated holdings in single stocks and in the age of blended families and second marriages, things can become more involved. If matters such as these were straightforward, there would be no need for more advanced estate planning. These types of situations can be managed with advanced estate planning techniques. We’ll cover two examples: QTIP Trusts and Charitable Remainder Trusts or CRTs.

Charitable Remainder Trust (CRT)

A CRT is an estate planning tool that is created to minimize the tax impact of a highly appreciated asset while also achieving philanthropic goals. The donor places assets inside a CRT and receives distributions from this trust. The remaining funds at the end of the term of the trust are given to a designated charity. 

This is the definition of CRTs in a nutshell. Let’s look at how this type of trust works.

A client holds a significant portion of their wealth in the stock of one company at a very low cost basis. They would like to reduce their exposure to this one company, which is a prudent goal. If the company were to lose significant value, or worse, go bankrupt, they would lose a significant portion of their assets. If they sold the stock outright, they would have a very large tax bill. After consulting with their advisor and an attorney, they decided to include a CRT as part of their overall strategy.  

When creating the CRT, they granted a portion of their company stock to the CRT. At that point, the CRT can sell the stock and invest in a diversified portfolio. The grantors then begin receiving regular payments from the trust. These payments continue until their death.  At that point, any remaining assets in the trust will go to their named charity or charities. The named charity may be changed, if the grantors change their minds. For this trust to be appropriate, the grantors need to have philanthropic goals. 

QTIP Trust

Let’s say that you and your spouse have worked for several years and have accumulated investment assets and real assets such as a house. These assets are placed in a revocable living trust. Now let’s say for the time being, both of you are in agreement that you eventually want your children to own the house. 

Sounds good?

Maybe. 

What if this is a second marriage? If one of you were to die, the ownership of the house would go to the surviving spouse. That puts a great deal of control in his or her hands. What if your spouse remarries? What if they change their mind and decide to give the house to someone other than your children? Things get more complicated as additional spouses and children from different marriages enter the equation.

There is a legal way to provide for your spouse and to protect your assets for future generations; this is called a QTIP trust.

What is a QTIP trust?

QTIP stands for Qualified Terminable Interest Property Trust. It is an estate planning tool used to exercise a degree of control over how the assets held in trust are distributed. It is a good way to ensure that the needs of your surviving spouse and your descendants are met as you intend. A QTIP trust also provides a level of flexibility when working to minimize federal taxes.  

In the scenario described above, one would create another trust that operates in conjunction with the revocable trust that you set up, a QTIP trust. Your surviving spouse may reap similar benefits to owning the house outright, such as collecting rental income; however, the house is never in the surviving spouse’s name. Upon your spouse’s passing, the house becomes the property of the children. QTIP trusts are also referred to as Marital Trusts or A-B trusts. 

Lifestyle considerations when retiring early during the pandemic

If you are thinking about retiring early during the pandemic, consider the role that lifestyle will play. This does not directly relate to investing, estate planning or taxes, but in our experience, it is critical to a successful early retirement. It can be psychologically jolting to move from one phase of life to another. Too much time on your hands can lead to boredom and be psychologically disconcerting. It’s important to craft a financial plan that considers your lifestyle in retirement.

If you want to retire early, think about the following:

  • Where you want to live
  • What activities you are counting on to occupy your time
  • Who you want to spend time with
  • Would you like to volunteer or become more involved with a charity?
  • Your plan for staying mentally and physically healthy

Here is a case study of someone who successfully made the transition. 

An entrepreneur chose early retirement after selling her firm to a Fortune 500 company. Her goal was to become financially independent so that she could enjoy life and dedicate her time to raising her children and she was advised to weigh her different lifestyle choices. It was important for her to select a new location that was more suited to her family’s activities and interests. 

Charitable giving was of high importance to her, thus, a plan was created that was coordinated with other family members and took into account the legacy of giving. It was also an ideal time to create a financial plan for both older and younger generations of the family, this included funding private education and college for her children as well as estate planning. 

If you are planning on retiring early during the pandemic, don’t do it without a plan that encompasses both your personal and financial goals.  

Summary thoughts on retiring early during the pandemic

Wanting to exit the working world during the pandemic is certainly understandable. If you are seriously considering doing it, there’s a process that should be followed. Attention must be paid to your financial resources, the status of your estate plan and your future lifestyle. Like any transition, this is one that should be well thought out. If you have questions on how to do this, please reach out to us.