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Gaby Deimeke
When I turned 35 last year, I decided that the No. 1 financial goal I wanted to focus on was retiring early. After looking over my finances, I realized that I wasn't in a good position to reach that goal in 15 years or less. While I didn't have any debt and I was funding my retirement plan on a monthly basis, I wasn't following a strategy, and other areas of my finances weren't set up for success.
In an effort to get on track, I chatted with certified public accountant and certified financial planner Ryan Nelson about the most common mistakes people make when they attempt to retire early. We talked about how to avoid these mishaps by planning ahead.
When we think about retirement planning, we often think about how to save and invest our money so it grows. But Nelson said a mistake he commonly sees are people who aren't strategically thinking about their tax planning.
One way to do this is by income recognition optimization, which is the practice of voluntarily recognizing income from retirement accounts in the first few years of retirement when your income might be lower because you are no longer working.
"Through this strategy, a person can convert money in pre-tax accounts to a Roth IRA over time in a tax-efficient manner," he said. "Doing this lets them pay taxes on the converted amount at a lower tax rate and then lets the money grow tax-free in the Roth IRA."
Nelson said that the biggest benefit of this strategy is that it reduces the eventual minimum distribution a retiree will have to take from their pre-tax retirement account at a certain age and gives the retiree optionality within their retirement income plan since Roth IRAs do not have required minimum distributions.
Since a lot of people get discounted health insurance rates through their employers or their spouse's employer, Nelson said a big mistake that people make is not planning ahead for the cost of insurance once they have to pay for the entire policy on their own.
"Before retiring, have a good idea of how much health insurance will cost once you no longer have it subsidized through an employer," he said.
He advised people to proactively calculate the cost of health insurance during early retirement before reaching Medicare age, which is currently 65.
"Since these costs can be quite high, it's helpful to factor into your monthly cost of living when you retire," he said. "Look into private marketplace options, whether individual health insurance plans, health sharing ministries, or short-term health insurance plans to see how much these could cost."
For those planning to retire early, Nelson also recommend that they maximize their health savings account contributions.
For 2024, you can contribute up to $4,150 for individuals and $8,300 for families into your HSA.
"Unlike a flexible spending account, HSA funds roll over every year and you can invest this money for potential growth," he said. "The biggest benefits to doing this is that contributions are tax-deductible and they grow tax-free. Plus, you can withdraw the money when you retire, tax-free, if you use it for medical expenses."
If you're planning to retire early, Nelson pointed out that funds in IRA and 401(k) retirement accounts are typically inaccessible until you hit the age of 59½, unless you want to pay a penalty.
"So, if you want to retire early, it's important to build out a liquidity strategy that will pay for your cost of living until you're able to access retirement funds," he said.
To do this, Nelson recommended redirected savings and bonuses to taxable brokerage accounts.
"That way, you have access to cash and investments to support your living expenses up to the point where it starts to make sense to consider withdrawing from retirement accounts."
In order for a person to quit their job and retire early, they need to be able to have the money available to cover their cost of living. But Nelson said that determining what that yearly amount is might not be so obvious.
"I've noticed that an early retiree's spending is usually more than they planned for," he said. "That's because they want to enjoy their financial independence which typically pushes them to spend on activities that bring them joy like travel, eating out, and participating in other high-cost activities."
Nelson said this number is often even higher for those retiring at a young age because they are usually healthier and have the energy to maximize their financial independence.
"A smart way to plan for this uptick is to map out what the first five to 10 years of retirement look like in terms of anticipated cash outflows," he said. "That will help you determine if you have enough, or if a course correction is necessary in advance of a major life decision."
