6 keys to a great early retirement

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Start thinking now about how to take your pension, set up Social Security and, yes, how you'll spend your time. You'll have much more fun later on.

By Janine Latus Musick

It's every worker bee's dream -- to lie in a hammock or on a beach, to swing a nine iron or hit the open road in the ole Winnebago. Ah, to be free from the workaday world while you're still young!

Maybe for you it's not just a dream. Let's assume for a moment that your insurance policies are in order and you've got enough money socked away to trade your power suit for some baggy Bermuda shorts. That's excellent. (If you want assurance you're there or to take a reading of what you have to do to get there, check the tools on our Retirement home page.)

Before you slam that file cabinet drawer and turn in your parking pass, though, let's go over the details one more time. After all, you may live 30 years or more in this state of retired bliss, and a mistake now -- like failing to plan for emergency expenses or long-term care -- could make things a lot less blissful later.

Pension payout
Let's start with the most basic question: resources.

Somewhere in all of the paperwork you'll sign before you walk out the door may be a form that asks whether you want your accumulated pension to come to you in one big chunk or in monthly payments. Talk this over with your accountant or financial adviser, because there are a lot of things to consider.

"Annuity payments are steady, which is a positive, and they last a lifetime, but you don't know where you're going to be 15 years down the road," says Robert Doyle, a CPA with Spoor, Doyle & Associates in St. Petersburg, Fla.. "You may have a catastrophic need, and a $500-a-month annuity payment isn't going to help you if you have a $20,000 emergency medical bill. If you take a lump sum, you're in the driver's seat."

Make sure your pension plan deposits that windfall directly into an IRA, though, or you'll get hit with a 20% withholding tax.

A downside of taking a lump sum is that it may sever your relationship with the company's entire retirement plan, including any health insurance that may have been included.

As for monthly payments, there are nearly as many options as there are types of pension plans, so take the time to read the fine print and ask questions. You can take higher payments now and have payments end when you die, or take a slightly smaller amount now and have payments continue to your surviving spouse after your death. Those survivor benefits are usually only half of what you were getting, but they may be better than nothing.

Once your old pension has rolled into your new IRA, you theoretically can't touch it until you're 59 1/2 without paying a penalty and taxes. But that's not exactly true in all cases. You can take some of it out if you become disabled, or to pay certain medical expenses. You can even use it to buy a home or pay for a family member's education. Or you can use IRS Rule 72T, which allows you to set up a monthly payment plan that you commit to for a minimum of five years. It's based on your life expectancy and how much you've got in your IRA, but under the right circumstances, you actually could decide to take out, say, $1,000 a month for five years, without any penalty, as long as you committed to doing it regularly for five years. You'd pay taxes on it, of course, but you would in effect have created your own annuity. Just remember that everything you spend is not going to be available to you later in life.

Mary Melehan, 66, of Englewood, Fla., who retired from nursing at 50, drew against her retirement pension to fund her children's college educations. While she's proud of their achievements, her pension was depleted to the point that she only gets $160 a month after more than 20 years of work. Melehan, whose husband died more than 20 years ago, planned ahead by buying homes, remodeling them into apartments and then using them as investment properties. She has sold all but one of them, a five-unit place right on the beach, and has other money stashed in CDs and other investments, so she doesn't have to depend on the annuity to pay the bills. That's good, because it's more than eaten up by dental, eye and supplemental medical insurance.

Social Security
Don't retire too early. Your Social Security payment is based on the average of your best 35 years of work, adjusted for inflation, so if you retire too soon some of those 35 years will be computed as zeros. Let's say, for example, that you started work after college, at age 22. That means you won't have 35 years of earnings on the books until you're 57, and those zeros can put a big drag on your average income. So if you earned an annual average of $60,000 over your best 35 years, your benefit will be computed on that $60,000. If you only worked 30 years and then went to lie on a beach somewhere, your Social Security benefit will be computed as the average of those 30 years at $60,000 plus another five years at a whopping $0. That brings your best-35-years' average down to just over $51,000, which, depending on the age you retire, would cut significantly into your benefit.

Regardless of your retirement age, you can start collecting Social Security at age 62, although you get docked five-ninths of 1% for every month you are younger than 65. That means you'd get 20% less per month retiring at 62 than you would at 65.

(That's assuming you were born before 1938, making your full retirement age 65. Full retirement age goes up from there; those born in 1960 or later don't reach the required age until 67. That cuts into monthly benefits even more; you'll find the math on the Social Security Web site.)

Maximum Social Security benefits range from $1,422 per month for someone who retires early at age 62 to $2,111 for some who retires at age 70 -- which might argue for retiring later rather than sooner.

Inflation
Figure on 3% a year, which means the $50,000 you think you have to live on will only be worth $48,500 next year, $36,871 in 10 years and $27,189 in 20.

There's a big difference between living on $50,000 and on $27,189, and it's unlikely that your expenses will be cut in half in that time.

Lose the mortgage?
So should you pay off the mortgage, or keep making the payments? Like everything else, it depends. After all, the interest you pay on your mortgage is tax-deductible at your regular income-tax bracket, so it's probably the best debt you can have. Therefore, go by the old tried-and-true: pay off more expensive debt first, like credit cards or auto loans.

If you still have enough to pay off your mortgage, it's time to compare the after-tax cost of the debt with how much you're making on your investments, Johnson says. If your portfolio is averaging 11%, as the stock market traditionally does, and your mortgage is at 8% before your tax deduction, then leave the money in the market and keep paying the mortgage. "If your investments are sitting in low-yielding money-market accounts and your debt is at 10%, pay it off."

Remember, though, that if you're 25 years into a 30-year fixed-rate mortgage, you're paying almost nothing in deductible interest. By now, almost your entire payment is going to principal, which is not tax deductible. "Essentially, you're paying so little in mortgage interest, there's no reason to prepay it," Doyle says.

Some people, though, are just more comfortable knowing they own their home free and clear. If that's you and you choose to pay it off, it might be comforting to know that you can get money back out of your house by using a reverse mortgage, in which a lender pays you for a portion of the ownership of your home, or through a home equity line of credit. You also could sell it, of course. But as Doyle says, if you're counting on income from your house when contemplating early retirement, you probably ought to keep working for a while.

"When you retire, your house is your home," he says "Don't look at it as an investment. You can convert it if you need to, but if you're retiring because of the equity in your house, you better get back to work."

The little things
There are a lot of little things to consider when you're thinking about early retirement. Greens fees, for example, and gas for the Winnebago.

Bonnie Arnold of Columbia, Mo., a former retirement consultant at the University of Missouri staff benefits office, says you also should analyze the condition of your home and cars. If your roof is about to cave in or your car is on the blink, figure out if you can afford repairs and replacements. It's much easier to deal with such things while you're still bringing in a paycheck.

Consider, too, your family's financial health. Arnold's 45-year-old son had a stroke in January, and she spent three weeks at his bedside. "You always need to make sure that not only can you meet your normal month-to-month expenses, but emergencies, too, because they don't stop happening just because you retire."

What to do with all that free time?

Granted, some of your living costs will go down, as you quit buying work clothes, fueling up with that double espresso on the way to work and paying $7 for a turkey sandwich for lunch. Your at-home food costs can go down, too, because you'll have more time to cook and less need to rip open a package of (expensive) ready-to-eat at the end of your commute. But travel costs may go up, simply because you have more time.

Then there's the question of where to live. If you have more than one home, you need to establish permanent residency somewhere for both tax and estate planning, says Reginald Tilley, a certified financial planner in Bellevue, Wash. You may remember that there was a big to-do about the first George Bush establishing residency in Texas rather than in Maine, where he owned a substantial home, because Texas had no state income tax. Some states have no property taxes, some have no sales taxes and some have high taxes of every kind. North Carolina and Florida even have an intangibles tax, which hits the value of investments.

What to do, what to do
So now that you're free, what are you going to do with your time? Some people go back to their old jobs part-time to maintain friendships and collect a little spending money. Some head off in a whole new direction. Joe Cerullo, 60, of Columbia, Mo., retired at 54 due to a downsizing from his federal government job. He had been in the military, then worked as an aircraft ordnance supervisor teaching fighter pilots about electronic systems. He had a beeper, a radio, and a slew of employees to manage. Now he's a landscaper, and enjoying it immensely.

"I want to be held accountable, but I'm not interested in opening the shop or closing the shop, and I don't want to get into managing people," he says. "I just want something to occupy my time. I call it toy money."

If you're the type of person who has worked hard enough and saved enough to retire early, there's a good chance you haven't spent a lot of time on non-work activities, Tilley says. "If they've been so wrapped up in work to get to this point, there's a whole set of questions they're going to have to deal with," he says. "Some of these types of people have trouble going on vacation without champing at the bit."

Tilley recommends getting a psychological evaluation that tells you more about your personality and about what kinds of challenges will give you a sense of personal worth and fulfillment, even if you're not earning a paycheck from it.

For some, it's volunteering as a mentor, for others it's playing sports or working at the local hardware store for minimum wage. Quitting cold turkey is tough, he says, so it's important to segue into other activity.

Part-time work is more of an option now that you can earn Social Security while drawing a paycheck. But there are others, like journalist George Gunset of Chicago, who have no intention of working. He took retirement extra early, just to have the summer off.

"I made up my mind not to do a darn thing all summer," he says, "and I did pretty well, although my wife made sure some things got done."

Gunset is someone who will probably be successful in retirement, because he is passionate about his hobbies. He has written a family history for one branch of his family, and is working on another. He's also taking a French course so he can go to France and look for further family history, and he wants to write a novel or two, although he doesn't care if they ever get published.

"The biggest challenge for some of these people is going to be how to spend that time," says Tilley, "because if you get six months into this thing and you find that you're bored, you have no sense of purpose, there's a big void in your life, you're probably at more risk from an emotional point of view than you'll ever be from a financial point of view."

Richard Davies, 65, of Tellico Village, Tenn., isn't at risk. He retired from his job as vice president of manufacturing for Goodyear Tire & Rubber when he was 58. A brother had died of cancer, and he didn't want to spend his remaining years working. Two years later, he was diagnosed and treated for colon cancer himself. Now more than five years out, he is so healthy that he competes in basketball, track and tennis in the Senior Games.

"Being a cancer survivor, I thought that in the Senior Games I could compete with people my own age," says Davies, who was a guard on the 1964 United States Olympic basketball team. "I thought that if I did well, or more important, if I could improve each year or at least stay the same, then I must be doing OK from a physical standpoint."

Davies built an eight-bedroom home on a lake, where he boats when he isn't golfing. He even had a 17-seat theatre built into the house. It's everything he hoped retirement would be.

"I really stay busy," he says. "I often have to cancel my golf games on the weekends to go play in tennis tournaments."

Updated July 29, 2008