Retirement is a huge step for everyone, one that's full of potential hurdles and pitfalls. With a little planning up-front, your transition into retirement will be a lot smoother. Here's how to prepare for retirement, whether it's coming early or not.
1. Understand Health Insurance and Subsidies
For the last several decades, access to affordable health insurance proved the sole barrier to early retirement for many. Times have changed.
With the passage of the Affordable Care Act (ACA, also called “Obamacare”), the health insurance marketplace changed dramatically for the better for those seeking to retire early (before age 65).
Under the ACA, you can receive subsidies to help with insurance premiums if you make less than 400% of the federal poverty level. For example, a married couple earning less than $63,720 (four times the federal poverty level) will receive subsidies to reduce the cost of their insurance premiums. At the most, the couple will pay around $500 per month for mid-range health insurance coverage, and possibly much less than that depending on their income level.
In addition to subsidies to help offset the cost of health insurance premiums, another huge benefit of the ACA is the elimination of pre-existing condition exclusions and denials. Before passage of the ACA, generally healthy people in their 40s and 50s with a previous illness in their medical past could find it difficult or impossible to get health insurance coverage.
Even if coverage was available, it might come with sky-high premiums and exclusions. Today, you can no longer be denied coverage or have parts of care excluded from coverage if you previously experienced a medical issue. What this means for the aspiring early retiree is that no matter your health history, you are guaranteed a health insurance policy.
To add a second layer of coverage for medical costs in retirement, check to see whether your employer offers a Health Savings Account. The Health Savings Account can be a highly tax-efficient way to save for retirement medical expenses because your contributions made while working go into the HSA completely tax-free (even free from payroll taxes!), and any amounts spent on medical care come back out of the account completely tax-free.
Some HSA accounts permit investments in mutual funds and ETFs, which would allow the opportunity for significant long-term growth.
2. Don't Rely on One Source of Income
For some, a hefty portfolio spitting out dividends will be enough in the early years, to be supplemented by Social Security payments in the later years. Others might have only a small pension and a small investment portfolio and need some additional income sources to carry them through retirement.
Pensions, Social Security, and income from an investment portfolio are all at risk of declining or fluctuating over the years. It pays to have other income sources to support your living expenses during retirement.
Consider starting a side hustle. Maybe it's a part-time job doing something fun, a work-from-home small business or a profitable hobby. Some retirees find a second calling as a flipper on eBay or as an artist on Etsy. Others enjoy the social interaction that comes from working a couple of shifts per week in retail.
Another class of side hustle is the part-time job with big perks, like being an usher at a concert venue. Free admission to top-notch concerts, anyone? Sometimes the job perks are worth just as much as the paycheck itself.
If working part time isn't for you (it is retirement, after all), consider other sources of income, such as rental real estate. Though there are still some elements of work, you're essentially running your own small business by keeping your rental units in good shape, screening tenants and addressing maintenance issues as they arise.
Much of this work can be outsourced to a management company and contractors, letting you be more of a hands-off investor. Returns from rental real estate can still fluctuate, but they often zig while your stock market investments zag.
By relying on multiple streams of income, you can sleep better at night knowing your retirement isn't at risk of blowing up if one source of income gets cut.
3. Know What You'll Do in Retirement
Switching from full-time work to full-time retirement is a huge step. Some retirees struggle with getting the right mix of challenges, hobbies and activities in retirement to stave off boredom and mental atrophy.
In the years leading up to retirement, focus on what brings you joy and make plans to keep active in those pastimes and activities. In a recent article here on Investor Junkie, I shared a day in the life of what I do in early retirement. Some retirees love to travel, while others enjoy exploring their surrounding city and state. It's all about figuring out your passions and indulging in them during retirement.
Think about how you'll get social interaction in retirement. Your work buddies will be busy at work, so you'll probably ease into a new social network. Establishing those new social contacts before jumping into retirement means you'll avoid that feeling of isolation that comes from losing your daily water-cooler chat sessions in the office.
Plan Ahead for Retirement Success
By understanding and planning for health insurance in retirement and securing multiple income streams, you'll improve your financial stability during retirement. To make sure you are on track to reach your goals, consider using personal finance software like CountAbout to track your investments against your monthly spending habits.
But finances aren't everything, as many retirees learn. Facing the daunting question of “What will you do all day?” is just as important.
For recent retirees accustomed to spending most of their waking hours in the office, it's a strange notion to be responsible for your own entertainment all day. Nailing down the social and psychological elements of retirement are just as important as the financial aspects.