It’s not an uncommon question from clients looking to retire: Is there a way to do it a bit more gradually? More as a lifestyle than a life-stage decision? While many of our clients are delighted to retire in their 50s instead of their 60s, another part of that cohort often envisions more of a second act to their career than an outright transition out of work. We’ve been asked about everything from teaching to starting a consultancy as a “post-career” sort of “hobby job”, albeit any teacher or business owner knows it’s a bit harder than it appears! This week, we’re talking about two of the common pitfalls and hazards that can pop up along the gradual transition road to retirement, and what you can plan to do about them.
Healthcare Before Medicare
Probably the most common pre-retirement hazard we encounter in the retirement planning conversation is the cost of healthcare. Whether you’re fully retiring or simply planning to take a new position between your lifelong career and retirement, the loss of employer-provided or employer-subsidized healthcare is often a major concern. And it’s no surprise: Many people spend their careers paying little to nothing for health insurance provided by their employers. So when they go looking at the public marketplace and find that it might set them back anywhere from a thousand to three thousand dollars a month just to cover themselves and their spouse, it can be a system shock to imagine spending so much on what seemingly used to cost so little.
Yet, for those who have adequately prepared for retirement such that retiring in their late 40s or early 50s is possible, upon an analysis of the impacts of paying for healthcare for few years or to a decade or so, we often find that while it adds up to tens or hundreds of thousands over the pre-65 period, it’s often a rounding error in the overall scheme of their retirement plan. Now, for those with less liquid retirements, such as those who have primarily saved for retirement through state or other employer pensions, this can represent a bigger hurdle, as there may not be much in the way of liquid savings to fund the expense. Worse, many pension plans are punitively restrictive on just how much income you can receive if you plan your pension earlier than the anticipated 60+ age range.
A couple of strategies present themselves in solving for healthcare expenses for those pursuing a second act job between retiring from their primary career field and reaching full retirement. First and most obvious, if the second act position provides health insurance or can subsidize it, that materially reduces the out-of-pocket costs of paying for individual ACA-compliant insurance. Second, for those who consider something like contracting or consulting as their second act, health insurance can be treated as a deductible business expense depending on your business structure and the degree of coverage; and for those with a still-working spouse, of course, the option can present itself to simply stay under their family coverage through their employer.
But for those without the possibility that another employer will pick up the tab, the best strategy is sometimes simply to face the expense head-on. For those healthy individuals or couples in this situation and with ample liquid savings, simply choosing the lowest cost bronze tier plans can present a more affordable route, particularly if the costs are subsidized by either ACA subsidies directly or, at the very least, by using HSA contributions to reduce the net-of-tax expense of healthcare. For those with chronic conditions or greater healthcare cost concerns, the ACA Gold plans still present the best net-of-premium-and-net-of-expenses option, albeit this can sometimes set a household back by as much as thirty or forty thousand dollars. For this potential eventuality, availing yourself of healthcare premium extensions under your prior employer’s COBRA plan can be a strong option.
The last option that presents itself is non-ACA-compliant plans, such as healthcare ministries and healthcare sharing programs. While these can be substantially cheaper than traditional health insurance, keep in mind that there is no free lunch. There is an endless list of cases where real medical needs were denied, delayed, or under-funded by such organizations, well beyond even the poor reputation of healthcare reimbursements by actual ACA-compliant insurance carriers. So, for the most budget-conscious, these can present an option, but you should otherwise be mindful of Hearn’s Law: You will pay for what you get, and if you’re lucky, you will get what you pay for.
Claiming Social Security While Still Working
Given the decades-long concerns that social security is going to fail (I’ve been reliably told that it’s going to collapse next year; for the past ten years.) It is not an uncommon question from those who’ve reached the blessed hurdle of age 62 as to whether they should claim social security early. For many people, the answer is a resounding “maybe.” It depends on the size of your benefit, your eligibility for coverage under a spouse’s greater benefit, your age, their age, the composition of your other retirement savings and assets, etc. etc. All of this to say, the core question we’re going to talk about here is the early claiming earned wages penalty.
For those still working, social security caps your potential early retirement claim (claiming before “full retirement age” as defined by your birth year) at a certain earnings limitation. Until the year you turn your full retirement age, this is limited by an annual wage limit ($23,400 in 2025), or $62,160 in 2025 if you’ll turn your full retirement age in 2025. If you exceed the earnings limit before your full retirement age year, then you’ll have your income reduced by $1 for every $2 you earn over the limit. So, if your benefit for social security was $10,000 and you earn $33,400, you’ll end up only getting $5,000 from social security, not $10,000. In the year you reach full retirement age, the ratio drops to a $1 reduction for every $3 earned, and the month you reach full retirement age the penalty evaporates entirely.
So, for someone who wants to claim early but is earning more than the $23,400 or $62,160 limits in 2025, what’s a solution? Well, unfortunately, if you tell your employer that you just don’t want to be paid or want to be paid less than you’ve earned, you’re not really solving the problem. Earned income and its taxable nature is triggered by two conditions: Constructive receipt, which is the principle that once income is earned it is subject to taxation, even if not literally received in the form of a check, transfer, or cash. The second condition, which can head this off, is a substantial risk of forfeiture. So, if you ask an employer not to pay you, that’s not sufficient to avoid constructive receipt or create a substantial risk of forfeiture. Enter in the deferred compensation plan.
A deferred compensation plan is typically reserved for senior staff or executives of employers that have highly paid employees. For those that offer such a benefit, the employer can offer a number of formats for deferred compensation that allow employees to “defer their income” (compensation, get it?) for tax purposes. However, the formats all come with their own terms and risks:
- Unfunded promise to pay: Essentially, the employer gives the employee an IOU to pay them later. This creates a substantial risk of forfeiture because no money is being put aside to assure the employee of the security of their deferred income, and the employer will pay it out of future revenue or assets. This means that the deferred wages are also at risk of being taken away by creditors of the company in a lawsuit.
- Irrevocable Trusts: There are two formats, termed “Rabbi” and “Secular” trusts, but each is a form of trust that is either subject or not subject to the creditors of the company. By extension, then, the money is more or less secure, but importantly, each can use a vesting schedule to create some “requirements” to re-earn the deferred compensation put into the plan, maintaining the substantial risk of forfeiture. In turn, these come with their own unique tax and financial implications, but that’s beyond the scope of what we’re discussing today.
Are Healthcare and Income the Only Issues?
No, but they’re probably two of the most common problems we encounter when helping clients plan for an early retirement. Be mindful that there are myriad other issues, such as portfolio allocation and asset location, tax planning considerations, and impacts to things such as your children’s financial aid when applying to college. Remember, we always like to say that money is permission, so keep in mind that while financial planning occasionally does unearth challenges, it’s important to keep your vision for your best life in mind while navigating said challenges. Don’t let the health insurance or taxes tail wag the lifestyle dog.