Considering FIRE? Pay Attention To Your Retirement Benefits

The so-called FIRE movement (Financial Independence/Retire Early) has recently gained attention for offering people a blueprint for retiring early. FIRE practitioners keep their spending as low as possible (this varies from limiting spending to extreme frugality depending on the person), pay down all their debt early, save every dollar that they don’t spend, retire as soon as they can, and fund their retirement spending with portfolio withdrawals, usually at a 4% withdrawal level.

FIRE doesn’t necessarily mean full retirement—many quit their full-time jobs but continue to work part-time, often to keep health insurance in retirement. For some, the partial/full retirement age can occur as early as their 30s.

Saving enough to support a retirement that is more than twice the typical expected retirement length is a challenging endeavor. Even if you do save enough to retire at age 40 or 45 comfortably, you would face challenges just due to the age at which you retired. Many essential government programs are set up to support the person who retires at 65 and offer little to no support for those who leave the workforce significantly earlier.

Healthcare

Typically, the person who retires at 65 immediately begins to receive health insurance coverage through Medicare, so he or she would no longer need to rely upon an employer-sponsored healthcare plan. However, Medicare eligibility is typically tied to age, not age of retirement, so retiring early does not mean that one can count on Medicare before age 65. The person who retires at the age of 50 has 15 years in which he or she would need to find an alternate source of medical insurance that would likely come at a higher cost than his or her pre-retirement plan.

Early retirees could consider private policies or extending their workplace coverage through COBRA. For now, a younger retiree may also be able to receive reasonable medical coverage thanks to the Affordable Care Act (ACA), but the future of that legislation is far from certain.

With or without the ACA, however, it’s likely that healthcare coverage costs will continue to rise, and early retirees may find that insurance premiums and healthcare expenses generally cost them significantly more than they had budgeted. These out-of-budget costs can pose a significant problem to a retirement strategy that requires careful budgeting to stretch assets for additional years.

Portfolio Withdrawals

If you’ve spent your career saving into qualified retirement plans like 401(k)s or IRAs, you may discover an additional problem: early withdrawals from these plans generally result in financial penalties. Withdrawals before age 59 1/2 will be subject to a 10% penalty and will be taxed at ordinary income rates. There are some exceptions to the rule that would allow for penalty-free withdrawals, but the early retiree who needs to withdraw money to live will almost certainly have to pay a penalty.

Ideally, an early retiree would have savings outside of qualified retirement accounts to draw on before the age of 59 ½.  Such retirees could wait to withdraw from 401(k)s or IRAs until it could be done penalty-free. But one’s ability to do this largely depends on how one has already saved. If a person holds the bulk of their savings in a 401(k) plan or other retirement plans, the early retiree may be forced to withdraw from that retirement plan early and pay significant penalties.

Social Security

As with Medicare and retirement plan withdrawals, Social Security is also set up to support retirees at a more “normal” retirement age. The earliest age that a person could begin receiving Social Security benefits is currently age 62, and taking the benefit that early reduces the amount of the potential benefit paid. An early retiree would not have this guaranteed income until later in their retirement. While a FIRE practitioner can certainly plan around this income gap, it is an important factor to reckon with when making a retirement plan.

Like health insurance under the ACA, Social Security benefits are subject to change, as well. With funding difficulties on the horizon, lawmakers may have to consider solutions that range from reducing benefits to pushing back the age of Social Security benefits to increasing the taxes that support Social Security. The sustainability of Social Security benefits is not a problem exclusively for early retirees, of course, but it is an important factor to consider if your retirement spending rate can bear very little flexibility.

Learning from FIRE Practices

While FIRE may not be a prudent retirement approach for most people, the movement does have its financial virtues. FIRE asks its practitioners to really analyze their budget, to make sure that they know the difference between their needs and their wants and to limit their spending on wants. They have to prioritize their spending and be mindful of where every dollar goes. Keeping expenses low and saving more are admirable goals for anyone who plans to retire, whether at age 35 or 65. Even those who aren’t interested in an early retirement could benefit from the careful budgeting process that is required to calculate your FIRE number. It may not be possible to retire at 40, but limiting expenses may help you retire at 60 instead of 65.

If you are considering FIRE, it will be essential to think deeply about your projected age of retirement and consider the gap between that age and when you can start to receive the benefits above. While these benefits are not necessarily make-or-break for your retirement, the lack of them could certainly complicate your early retirement and force you to spend more out of your investment portfolio than you expect.

Disclosure: This article is for informational purposes only and is not a recommendation of any investment strategy.  There are no assurances that any predicted results will actually occur.  The views are those of Adam Strauss as of the date of publication and are subject to change and to the disclaimers of Pekin Hardy Strauss Wealth Management and Appleseed Capital.