How to Prepare for Early Retirement

WDC NEWS 6 STAFF February 25, 2025

179 11 minutes read

Retiring early gives you more time to enjoy life while you’re younger and healthier, but it also has some complications: You’ll pay a penalty if you withdraw money from most retirement savings plans before age 59-½. You’ll need to find health insurance to cover you until you’re eligible for Medicare at 65. Your retirement savings may need to last through a period almost as long as your working years, and figuring out whether you have enough can be difficult.

“The key is proper planning,” says Jaime Eckels, partner with Plante Moran Financial Advisors in Auburn Hills, Mich. “Sometimes that means sacrificing — saving more than you normally would and spending less.” But it can also mean that following some conventional strategies for saving for retirement, such as stashing away the maximum in a 401(k), may not be in your best interest. Instead, it may be helpful to direct some money toward a taxable account that’s accessible without penalty at any age, even if it doesn’t have the benefit of tax deferral.

And that assumes you have time to plan ahead. If you lose your job in your fifties and are thrust into early retirement before you’ve had time to build up other savings, it’s important to understand special rules that let you tap your 401(k) before age 59-½ without an early-withdrawal penalty.

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Here’s what you can do to prepare for early retirement, as well as a rundown of your options if you suddenly find yourself out of work.

Saving for early retirement

Figuring out whether you’ve saved enough to retire early is the first step. Then you need to make sure you have enough money that’s accessible before age 59-½.

Fritz Gilbert spent more than 30 years working in the aluminum business, rising from sales to plant manager to global management, and he saved in his employer’s 401(k) the entire time. He and his wife, Jackie, saved “diligently,” Fritz says, “and we avoided lifestyle inflation by automatically increasing our savings rate with every pay raise.” Whenever he received a raise, he added two-thirds of it to his 401(k) before he had a chance to spend the money on anything else.

When he turned 50, he started using retirement calculators to estimate when he could stop working. He had saved enough money to retire at 54, but it was all in his 401(k), and he’d have to pay a 10% early-withdrawal penalty to get it out. So instead of contributing the maximum to his 401(k) for the last few years before retirement, he reduced his contributions to 6% of his income, which enabled him to get the full employer match, and used the extra money to build up a taxable account he could tap at any age. “We recognized that we had to beef up the after-tax savings to bridge to 59-½,” he says.

He also adjusted his target retirement date from 54 to 55 so he’d have one more year of peak earnings, which would increase his safe withdrawal rate. “I had an uncle who told me 10 years before I retired that once you retire, you’ll never make the money you’re making in your peak earning years,” he says. And leaving his job at 55 also made him eligible to tap his employer’s 401(k) without penalty before age 59-½.

Now 61 years old, he’s happy with the results. “Generally, on the financial side, we’re very pleased with the way we planned it,” Fritz says. The biggest surprise was on the psychological side — “your loss of identity, your loss of purpose,” he says. Documenting his retirement progress on his blog, The Retirement Manifesto, has helped. Meanwhile, Jackie started a charity, Freedom for Fido, which builds fences for low-income dog owners so they don’t have to tie up their dogs on chains. “That’s turned into a huge part of our retirement,” he says.

The following steps can help you prepare to fund an early retirement:

Build up savings in accessible accounts
The Gilberts added to their savings when they sold their 4,000-square-foot home in suburban Atlanta three years before Fritz retired and moved to a cabin in less-expensive Blue Ridge, Ga. They reduced their expenses by using some of the home-sale profits to pay off the mortgage on the cabin, which they had purchased several years earlier and had been renting out occasionally. They added some of the proceeds from the sale to the taxable account they could tap penalty-free before age 59-½. Moving to an area with a lower cost of living also helps them keep their regular expenses low.

Consider other flexible sources of savings you can tap early, too. For example, you can withdraw Roth IRA contributions at any age without taxes or penalties, and the first withdrawals from a Roth IRA are considered to be from contributions. Investment earnings withdrawn from a Roth before age 59-½ are generally taxable and subject to a 10% early-withdrawal penalty, but they are penalty-free and tax-free after that age, as long as you’ve had a Roth for at least five years.

You can contribute up to $7,000 to a Roth IRA for 2025 ($8,000 if you’re 50 or older) if your modified adjusted gross income is less than $150,000 for those with a tax-filing status of single or $236,000 for joint filers. The contribution phases out entirely at $165,000 for single filers and $246,000 for joint filers. You can’t contribute more than your earned income for the year, but even part-time or consulting work can count.

If you have an eligible health insurance policy with a deductible of at least $1,650 for single coverage or $3,300 for family coverage in 2025, you can contribute to a health savings account, which provides tax-free money for qualifying medical expenses, such as deductibles, co-payments and other out-of-pocket costs. You can withdraw money from the HSA without taxes or penalties at any time to reimburse yourself for eligible expenses — even years after you incur them — as long as you keep the receipts.

Start filling your retirement buckets
After Fritz Gilbert got a handle on his yearly retirement expenses, he divided his savings into three “buckets” based on his time frame.

He keeps enough to cover at least three years’ worth of expenses in the first bucket, which is in cash in his taxable account. That way, he doesn’t need to sell stocks for a loss in a market downturn to pay the bills. He filled that bucket with the money he needed from ages 55 to 59-½ before he retired.

The second bucket, which is for money Fritz will need in five to eight years, is invested primarily in bonds. The third bucket is invested mostly in stocks to provide long-term growth to keep up with inflation. He reviews the buckets every quarter and refills them several times a year.

Continue to increase income and reduce expenses
The greater your income and the smaller your expenses, the less money you’ll have to withdraw from your savings. Doing any work after retiring early, even for just a fraction of your previous income, can make a big difference in your long-term financial security.

Mark Whitaker, a certified financial planner and founder of Retirement Advice, in Provo, Utah, specializes in helping early retirees. He says the majority of his clients end up working again after a year or two of early retirement — but with much more flexibility than they had with their full-time job. Some engineers return as part-time contractors in their former field, he says, and retired nurses pick up a few shifts when they have time. Other clients have started a business or work at a fish and game store. It’s less about money, he says, and more about their social life and sense of self-worth. “As humans, we like to work — but on our terms,” he says.

Brian Lewis, one of Whitaker’s clients, originally planned to retire in his mid-fifties, after a 21-year career as an aircrew member in the Air Force working primarily on airborne communications and 12 years at defense contractor Northrop Grumman. But his experience in information-technology project and program management was in high demand, and he ended up returning to work to help with short-term projects for several major corporations, including Lowe’s, L.L.Bean and Bank of America. Because he had Tricare health coverage as a military retiree, he could afford to take assignments that didn’t offer health benefits. But his earnings, although smaller than his previous income, helped increase his retirement savings.

Now age 64, he has been totally retired for about a year, and he uses withdrawals from his cash account, as well as his Air Force retirement pay, to cover monthly expenses. He’s not planning on taking on any new jobs, unless they’re short-term projects he can do remotely. He and his wife, Brandelyne, enjoy traveling across the country in their Airstream Trade Wind trailer, volunteering as weather spotters for the National Weather Service. Brandelyne works remotely as an executive administrative assistant, connecting to work via satellite internet service Starlink when they’re on the road.

The Lewises also saved money by moving to a less-expensive area after retirement. They compared state income tax rates, property taxes, housing costs and cost of living before deciding to settle in a rural area in northwest Tennessee, about 10 miles from the Kentucky border.

Early retirement and redundancy

If you lose your job in your mid-fifties, you may not have time to plan for early retirement — and that scenario is not unusual. Whitaker recently worked with a 55-year-old software engineer whose company was in the midst of downsizing. He hadn’t planned to retire early, but when faced with the prospect of starting over again at a new company, he asked Whitaker to review his finances. They determined he could afford to retire but needed to figure out how to access his savings at his age.

There are strategies you can use to take penalty-free withdrawals from your 401(k) or traditional IRAs before age 59-½, but they may not be your best options if you have other funds available, says Marla Skeffington, a CFP and financial consultant with Fidelity Investments in Hingham, Mass. They’re primarily appropriate for individuals who were laid off in their fifties and have most of their savings locked up in tax-deferred accounts, she says.

The rule of 55
If you leave your employer in the year you turn age 55 or older, you can withdraw money from your 401(k) or other employer-provided retirement plan without an early-withdrawal penalty. This applies only to the plan from the job you left at 55 or older, not plans with former employers. This option also vanishes if you roll over your 401(k) to an IRA, which many people do after leaving their jobs, says Tim Steffen, director of advanced planning for Baird in Milwaukee. “But if you’re 55 or older, you probably want to leave it in your 401(k) because now you can access those dollars penalty-free,” he says.

The withdrawal is taxable, even though you’ll avoid the penalty, so you may not want to rush to tap your 401(k) if you have other savings. Even though Gilbert could access his 401(k) early because he retired at 55, he kept the money growing in the account to benefit from the tax-deferred growth for the future.

Substantially equal periodic payments (SEPPs)
Also known as 72(t) distributions (named after the tax-code section that provides for them), SEPPs are penalty-free withdrawals you can take from your IRAs for the longer of five years or until you turn 59-½. “You’re agreeing to take a specific dollar amount out of your account every year for a period of time, and if you do that you can access the account penalty-free,” says Steffen.

There are three different ways you can calculate the SEPP: the required minimum distribution (RMD) method, the fixed amortization method and the fixed annuitization method. Your plan custodian or financial adviser should be able to explain how much you can receive under each scenario.

Once you start taking SEPP withdrawals, you’ll generally pay a penalty if you stop them, even if you don’t end up needing the money. That’s the biggest drawback, especially for the many people who end up doing some work after a year or two of retirement. Because the requirement is the longer of five years or the amount of time until you turn 59-½, you could end up having to take required withdrawals even after age 59-½ if you use this strategy when you’re in your late fifties.

“When I’ve looked into it for people, the lack of flexibility has been a barrier,” says Roger Young, a certified financial planner and thought leadership director for T. Rowe Price.

Miklos Ringbauer, a certified public accountant and principal of the Southern California–based accounting firm MiklosCPA, considers SEPP withdrawals a last resort if you have no other savings to pay your bills and otherwise would have to face the 10% early-withdrawal penalty. “Our best advice for clients is to have emergency reserves — savings that are easily accessible and available for unexpected circumstances,” he says. If you do need to take SEPP withdrawals, he recommends splitting your IRA into two IRAs: one for the SEPPs and another one that isn’t subject to the required withdrawals. The IRS has more information about SEPP rules online.

Early retirement and health insurance

Health insurance premiums and out-of-pocket costs are often a significant barrier to retiring before age 65, when Medicare kicks in. “There’s going to be sticker shock,” Steffen says. Your health care costs may jump significantly if you don’t have retiree coverage from your employer or the option to get coverage under your spouse’s employer plan.

You can usually continue your employer’s coverage through COBRA, a federal law that requires employers with 20 or more employees to continue their group coverage for employees for up to 18 months after they leave their job. That could be a good option if you’re currently going through medical treatment or will be turning 65 soon. But you’ll have to pay both the employer’s and the employee’s share of the costs. In 2024, the average total cost was $8,951, according to KFF, a health-policy research nonprofit organization formerly known as the Kaiser Family Foundation. You can estimate the cost of COBRA by looking at the amount listed for code DD on your W-2 form and adding to it a 2% administrative fee, says Michelle Morris, a certified financial planner and owner of BRIO Financial Planning in Quincy, Mass.

Alternatively, you can buy individual health insurance through HealthCare.gov or your state’s Affordable Care Act marketplace. These policies can be expensive for people in their fifties and early sixties, but thanks to enhanced subsidies first enacted in 2021, more people now qualify for extra financial help.

For example, the full price for a mid-level (silver) health plan for a 56-year-old couple in Chicago would be about $1,454 per month. But if their modified adjusted gross income for the year is $60,000, they’d qualify for $1,167 in subsidies, reducing their premiums to $287 per month. KFF offers a calculator that you can use to get premium and subsidy estimates; for specifics, go to HealthCare.gov or your state marketplace.

These enhanced subsidies are scheduled to expire at the end of 2025. If they’re not extended, premiums will increase significantly for many policyholders in 2026. KFF has a calculator that provides an illustration of how the expiration of the enhanced subsidies could affect your premiums.

After you stop working, you have more control over the income included in the subsidy calculation. “We call the period between retirement and the start of Social Security and required minimum distributions the trough period,” says Steffen. “That’s when your income is lowest — you’re not forced to take anything out of your retirement accounts, and you have complete control over how much you withdraw and the sources of your income.”

Whitaker, the Utah CFP, recently helped a couple qualify for an $1,800 subsidy by carefully selecting which accounts they should tap. Withdrawals from pretax 401(k)s and traditional IRAs boost your modified adjusted gross income. But withdrawals from Roth IRAs and Roth 401(k)s after age 59-½ don’t count toward your MAGI.

Capital gains in a taxable account can be offset by capital losses, which Whitaker usually reviews in October. He encourages clients to avoid capital gains by giving appreciated stock to charity. If you have an eligible high-deductible health insurance policy, making tax-deductible contributions to an HSA can also reduce your income for the subsidy.

Note: This item first appeared in Kiplinger Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here.

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