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Would You Be Prepared for an Unplanned Early Retirement?

Most of us would prefer not to think about an unexpected (and unwelcome) early retirement, but it does happen frequently. In fact, nearly half of current retirees retired earlier than planned, and of that group, more than 60% did so due to changes at their company or a hardship, such as disability.1 For that reason, it’s a good idea to take certain steps now to help prepare for the unexpected.

What you can do now

Save as much as possible in tax-advantaged accounts. 

If you’re forced to retire earlier than planned, your work-sponsored retirement plans, IRAs, and health savings accounts (HSAs) could become critical resources. HSA assets can be used tax-free to pay for qualified medical expenses at any time, and you can generally tap your retirement plan and IRA assets after age 59½ without penalty. Although ordinary income taxes apply to distributions from pre-tax accounts, qualified withdrawals from Roth accounts are tax-free.2

In addition, the IRS has identified several situations in which retirement account holders may be able to take penalty-free early withdrawals. These include disability, terminal illness, leaving an employer after age 55 (work-based plans only),3 to pay for unreimbursed medical expenses that exceed 7.5% of your adjusted gross income, and to pay for health insurance premiums after a job loss (IRAs only). 

Pay down debt. 

Generally, it’s wise to enter retirement (especially when unexpected) with as little debt as possible. Ensuring that your financial plan includes a strategy for paying down student loans, credit card debt, auto loans, and mortgages can help you minimize your income needs later in life. 

Know your bare-bones budget. 

Another way to help cushion the shock of an unexpected early retirement is knowing exactly how much you spend each month on your basic necessities, including housing, food, utilities, transportation, and health care. Maintaining a written budget throughout life’s ups and downs will help you quickly identify how much income you’d need over the short term while you work on a longer-term income-replacement strategy.

Maintain adequate levels of disability insurance. Your employer may offer group coverage at reduced rates; however, you lose those benefits if your employment is terminated. Private disability income insurance can help you secure coverage specific to your needs, and since the premiums are typically paid with after-tax dollars, any benefits would generally be tax-free (unlike work-sponsored coverage that is paid with pre-tax dollars).

Understand Social Security benefits. 

If you stop working due to disability, you may qualify for Social Security Disability Insurance benefits if you meet certain requirements. You must have earned a certain number of work credits in a job covered by Social Security and have a physical or mental impairment that has lasted or is expected to last at least 12 months or result in death. If you remain eligible, benefits may continue up to age 65 and then convert to Social Security retirement benefits.

If you need to retire earlier than planned for reasons unrelated to disability and are eligible for Social Security retirement benefits, you can apply as early as age 62. However, starting payments prior to your full retirement age (66 or 67, depending on year of birth) will result in a permanently reduced monthly benefit.

For more information on Social Security disability and retirement benefits, visit the Social Security Administration’s website at ssa.gov.

Consider your health insurance options. 

Terminating employment prior to age 65 could leave you without health insurance. You may opt to continue your employer-sponsored health coverage for a limited period (permitted through COBRA, the Consolidated Omnibus Reconciliation Act), although this can be quite expensive. If you’re married and your spouse works, you may get coverage under their plan. You may also seek coverage through the federal or a state-based health insurance marketplace. If you receive Social Security disability benefits, you’d automatically qualify for Medicare after 24 months.

Why 49% of Retirees Retired Earlier Than Planned

Source: Employee Benefit Research Institute, 2024

Don’t be caught off guard

Don’t wait for an unwelcome surprise. Take steps now to help ensure your overall financial plan considers the “what-if” of an unexpected early retirement.

1) Employee Benefit Research Institute, 2024

2) Qualified Roth withdrawals are those made after a five-year holding period and after the account owner dies, becomes disabled, or reaches age 59½. The penalty for early retirement account distributions and nonqualified withdrawals from Roth accounts is 10%. Nonqualified withdrawals from HSAs will be subject to ordinary income tax and a 20% penalty. After age 65, individuals can take money out of HSAs penalty-free, but regular income taxes will apply to funds not used for qualified medical purposes.

3) Age 50 or after 25 years of service for public safety officers

IMPORTANT DISCLOSURES

The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

Securities and investment advice offered through Investment Planners, Inc. (Member FINRA/SIPC) and IPI Wealth Management, Inc., 226 W. Eldorado Street, Decatur, IL 62522. 217-425-6340.

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New Retirement Saving Options in 2024

While some provisions were effective in 2023, many important changes did not take effect until 2024.

The SECURE 2.0 Act, passed in December 2022, made wide-ranging changes to U.S. tax laws related to retirement savings. While some provisions were effective in 2023, others did not take effect until 2024. Here is an overview of some important changes for this year.

Matching student loan payments

Employees who make student loan repayments may receive matching employer contributions to a workplace retirement plan as if the repayments were employee contributions to the plan. This applies to 401(k), 403(b), and government 457(b) plans and SIMPLE IRAs. Employers are not required to make matching contributions in any situation, but this provision allows them to offer student loan repayment matching as an additional benefit to help address the fact that people paying off student loans may struggle to save for retirement.

New early withdrawal exceptions

Withdrawals before age 591⁄2 from tax-deferred accounts, such as IRAs and 401(k) plans, may be subject to a 10% early distribution penalty on top of ordinary income tax. There is a long list of exceptions to this penalty, including two new ones for 2024.

Emergency expenses — one penalty-free distribution of up to $1,000 is allowed in a calendar year for personal or family emergency expenses; no further emergency distributions are allowed during a three-year period unless funds are repaid or new contributions are made that are at least equal to the withdrawal.

Domestic abuse — a penalty-free withdrawal equal to the lesser of $10,000 (indexed for inflation) or 50% of the account value is allowed for an account holder who certifies that he or she has been the victim of domestic abuse during the preceding one-year period.

Emergency savings accounts

Employers can create an emergency savings account linked to a workplace retirement plan for non-highly compensated employees. Employee contributions are after-tax and can be no more than 3% of salary, up to an account cap of $2,500 (or lower as set by the employer). Employers can match contributions up to the cap, but any matching funds go into the employee’s workplace retirement account.

Clarification for RMD ages

SECURE 2.0 raised the initial age for required minimum distributions (RMDs) from traditional IRAs and most workplace plans from 72 to 73 beginning in 2023 and 75 beginning in 2033. However, the language of the law was confusing. Congress has clarified that age 73 initial RMDs apply to those born from 1951 to 1959, and age 75 applies to those born in 1960 or later. This clarification will be made official in a law correcting a number of technical errors, expected to be passed in early 2024.

No more RMDs from Roth workplace accounts

Under previous law, RMDs did not apply to original owners of Roth IRAs, but they were required from designated Roth accounts in workplace retirement plans. This requirement is eliminated beginning in 2024.

Transfers from a 529 college savings account to a Roth IRA

Beneficiaries of 529 college savings accounts are sometimes “stuck” with excess funds that they did not use for qualified education expenses. Beginning in 2024, a beneficiary can execute a direct trustee-to-trustee transfer from any 529 account in the beneficiary’s name to a Roth IRA, up to a lifetime limit of $35,000. The 529 account must have been open for more than 15 years. These transfers are subject to Roth IRA annual contribution limits, so it would require multiple transfers to use the $35,000 limit.

Increased limits for SIMPLE plans

Employers with SIMPLE IRA or SIMPLE 401(k) plans can now make additional nonelective contributions up to the lesser of $5,000 or 10% of an employee’s compensation, provided the contributions are made to each eligible employee in a uniform manner. The limits for elective deferrals and catch-up contributions, which are $16,000 and $3,500 respectively in 2024, may be increased an additional 10% for a plan offered by an employer with no more than 25 employees. An employer with 26 to 100 employees may allow higher limits as long as it provides either a 4% match or a 3% nonelective contribution.

Inflation indexing for QCDs

Qualified charitable distributions (QCDs) allow a taxpayer who is age 701⁄2 or older to distribute up to $100,000 annually from a traditional IRA to a qualified public charity. Such a distribution is not taxable and can be used in lieu of all or part of an RMD. Beginning in 2024, the QCD amount is indexed for inflation, and the 2024 limit is $105,000.

SECURE 2.0 created an opportunity (effective 2023) to use up to $50,000 of one year’s QCD (i.e., one time only) to fund a charitable gift annuity or charitable remainder trust. This amount is also indexed to inflation beginning in 2024, and the limit is $53,000.

Catch-up contributions: indexing, delay, and correction

Beginning in 2024, the limit for catch-up contributions to an IRA for people ages 50 and older will be indexed to inflation, which could provide additional saving opportunities in future years. However, the limit did not change for 2024 and remains $1,000. (The catch-up contribution limit for 401(k)s and similar employer plans was already indexed and is $7,500 in 2024.)

The SECURE 2.0 Act includes a provision — originally effective in 2024 — requiring that catch-up contributions to workplace plans for employees earning more than $145,000 annually must be made on a Roth basis. In August 2023, the IRS announced a two-year “administrative transition period” that effectively delays this provision until 2026. In the same announcement, the IRS affirmed that catch-up contributions in general will be allowed in 2024, despite a change related to this provision that could be interpreted to disallow such contributions. The error will be corrected in the 2024 technical legislation.

IMPORTANT DISCLOSURES

The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

Securities and investment advice offered through Investment Planners, Inc. (Member FINRA/SIPC) and IPI Wealth Management, Inc., 226 W. Eldorado Street, Decatur, IL 62522. 217-425-6340.