A good financial plan revolves around a single number: The date when your client plans to retire. But the number isn’t set in stone. Almost half of current retirees say they quit work earlier than planned, the result of job loss or health problems, or simply because they could afford to quit, according to the Employee Benefit Research Institute .
When a client retires unexpectedly, plan reassessment is a must. How will the change affect retirement income from Social Security, savings or pensions? Should spending plans be adjusted?
“I always re-run the plan with a worst-case scenario of no further work and no further income,” says Lisa Hatcher of Hatcher Byles Financial Planning in Richmond, Virginia. “What does the change do to my client’s standard of living? Even for people who have more assets, no one likes to go from spending $120,000 a year to $100,000 a year. No matter what their level of affluence, there needs to be some kind of tweaking of goals.”
Here’s a look at some key strategies and issues to consider when a client’s plan is rocked by an unplanned early retirement.
Cash: the low-hanging fruit
Meeting immediate living expenses may be a concern, especially if there isn’t a spouse who is still working.
Christine Benz, director of personal finance at Morningstar, suggests going first to the client’s most liquid assets, and avoiding accounts that generate taxes, early withdrawal penalties or borrowing costs. “The emergency fund obviously is the best choice,” she says. “From there, I’d go to longer-term taxable assets or a Roth IRA account.”
Keep an eye out for rebalancing opportunities, she adds. “Don’t be reticent to harvest winnings of the last few years. Portfolios may be out of balance or too aggressive, so it is a way to get it back on track.”
401(k) and IRA withdrawals
Traditional IRAs and 401(k)s can be tapped if no other cash options are available. Two issues should be considered here:
- Income tax. The withdrawals generate an income tax liability, which might be acceptable if overall household income falls into a lower tax bracket due to retirement. However, the withdrawals also could have an unintended side-effect: raising the cost of health insurance premiums under the Affordable Care Act (see below).
- Penalties. A 10 percent early-withdrawal penalty generally applies if your client is younger than age 59 ½ - although there are a couple exceptions.
If your client is at least 55 years old and retires, quits or is fired, she can withdraw funds from the 401(k) plan of that employer without penalty under the 72(t) section of the IRS code . This applies to people who leave jobs any time during or after the year that they turn 55. If your client still has a 401(k) at other former employers, those funds must wait to be tapped until age 59 ½.
That can be a good reason for your clients to consolidate old 401(k)s in their current employer’s plan before retirement; in most cases, it’s impossible to consolidate in a plan where employment has been terminated, notes financial planner Jim Blankenship, author of An IRA Owner's Manual . “It might be technically permissible by law, but I’ve never seen a 401(k) plan that would accept additional funds after employment has terminated.”
Early retirement is a key reason many Americans file early for Social Security - 38 percent of men, and 43 percent of women, filed for benefits  at age 62 in 2012, according to the Social Security Administration. Although it’s a tempting source of cash, most people working with financial planners have sufficient assets to consider other options that will get them to better long-range retirement outcomes. In most cases, they are better off waiting at least until full retirement age (66 for today’s boomers) to file for Social Security.
This is especially true for married couples, who can take advantage of Social Security’s valuable spousal and survivor benefit rules. Consider the example of a married couple, both age 62, who have stopped working. He retired with final income of $100,000; she earned $75,000 at retirement. I ran some numbers on this using T. Rowe Price’s handy Social Security Benefits Estimator;  if our couple both file for benefits early, at age 62, they can expect lifetime Social Security benefits of $1,125,711, assuming he dies at 83, she at 95. If the same couple pursued a maximize (i.e., file-and-suspend) strategy, they could expect $335,154 more lifetime income from Social Security - $1,460,865.
“Especially for your clients who retire early, understanding what their goal is for their Social Security benefits is an important step toward determining what their best strategy may be,” says Christine Fahlund, vice president and senior financial planner at T. Rowe Price. “Having a thoughtful conversation with your clients and educating them before they make their decision is extremely important, since several hundred thousand dollars over their joint lifetime may be at stake.”
The higher lifetime income pays off as a hedge against longevity risk - an especially important issue for women, who tend to outlive men - and the household portfolio. “If you’re worried about clients running out money, Social Security is the perfect answer to that problem,” says Mike Piper , a CPA and author of several books about retirement planning.
A delayed filing also can boost portfolio life  significantly over the long haul, even if your client must draw down larger sums in the early years to meet living expenses. That's because the big boost in Social Security income reduces pressure to use portfolio assets for living expenses.
Manage income for health care subsidies
Two features of the Affordable Care Act (ACA) are invaluable for retirees not yet old enough to enroll in Medicare. First, insurers can’t turn down enrollees due to preexisting conditions. Second, the overall cost of insurance will be held down  for many by cost-sharing subsidies and advanceable, refundable tax credits on premiums.
This year the subsidies are available for individuals with annual income between $11,490 and $45,960, and from $23,550 to $94,320 for a family of four. The definition of income is modified adjusted gross income (MAGI), which includes wages, salary, foreign income, interest, dividends and Social Security benefits.
The subsidies create incentives for households to carefully manage income  to stay within premium assistance brackets. “It’s a strange thing,” Piper says. “Literally $1 in income can cost you a subsidy worth thousands of dollars. It’s possible to make some really big mistakes.”
If your client works part-time, or a spouse is employed, income from wages should be considered here, along with retirement account decisions. For example, Piper notes that contributions to tax deferred accounts can become more valuable in light of the ACA subsidies, and that taking distributions from those accounts could bump households into higher-cost health insurance.
“If you can hold off on deferred account distributions until the client reaches Medicare age, that can help a lot to keep income lower,” he notes.
If your early retiree is fortunate enough to have a defined benefit (DB) pension, the natural inclination may be to file for benefits immediately. Not all DB plans allow early retirees to file for a benefit before full retirement age, but if it does, check on how taking a pension early will affect payouts for the beneficiary and for a surviving spouse. The Pension Rights Center also advises early retirees to check the plan’s rules in the event your client decides to return to work after benefits start. Some plans require that benefits be suspended under certain circumstances; failure to navigate those rules properly could result in recoupment claims down the line.
A growing number of plan sponsors now offer lump sum distributions  from DB plans - another possible temptation for an early retiree. Lump sums can make sense for clients with low longevity odds, or for those who have other reliable sources of regular income – for example, a spouse with a defined benefit pension -- and might benefit from the flexibility of access to the lump sum. But as a rule of thumb, lifetime income streams will be more beneficial. The Pension Rights Center offers this lump sum fact sheet .
Re-think spending plans
Be sure to work with your client to scrub expense assumptions. Recent Morningstar research  finds that the typical rule-of-thumb on pre-retirement income replacement is off the mark, and that actual needed replacement rates vary from under 54 percent to over 87 percent. A key finding: spending actually falls over the course of retirement, especially for wealthier households, which have more discretionary pre-retirement spending, and thus have more flexibility in retirement to cut back if funds aren’t available. This is especially true as people reach advanced ages, when their interest and ability to spend on travel, entertainment and clothes declines.
If the plan looks precarious, talk with your client about possible ways to cut spending or boost income in retirement. “I’m telling a lot of my 40-something clients to keep up their skills so they do some kind of consulting in retirement,” says Hatcher. “Are they willing to downsize or move to a less expensive location? Take on a boarder, or rent a spare room to a college student?”
Address psychological needs
Hatcher also warns advisers not to miss the human side of unplanned retirement. “On the one hand, the message is ‘things aren’t looking as we thought, so we need to regroup.’ But it’s also important to acknowledge the grief that comes with this, and to empathize.”
Mark Miller is a journalist and author who writes about trends in retirement and aging. He is a columnist for Reuters and also contributes to Morningstar and the AARP Magazine. Mark is the author of The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work and Living(John Wiley & Sons, 2010). He edits RetirementRevised.com. Twitter: @retirerevised