The True Cost of Retiring Two Years Ahead of Schedule

Walking away from work early sounds like the ultimate dream: endless travel, afternoon golf, lazy days by the beach. But for your bank account, an early exit could be anything but relaxing.

Even shaving just two years off your planned retirement date might cost you far more than you'd expect. Before you put in your notice ahead of schedule, here's what retiring two years early could really do to your retirement plan and your long-term savings.

The definition of retiring early

What does it mean to retire early? Traditionally, 65 has been considered the age when people retire. Of course, many people retire before that, and many others continue to work beyond that landmark year.

In the modern age, 67 might be a more accurate traditional retirement age. Not only are people living longer, but for anyone born after 1960, full retirement age is 67, the age when you qualify to collect your full Social Security benefit.

To keep things simple, we will say that anyone who retires before the age of 67 is retiring "early." Thus, retiring two years early would put you at age 65.

Why people think about retiring early

There are many reasons to retire early. Countless workers either dislike their jobs or are burned out and can't wait for their golden years.

Others may retire for health reasons or to take care of aging family members.

Of course, another reason to retire early is because you simply want to enjoy your life. For some, this might mean engaging in hobbies that they love. Others may want to spend time traveling with a spouse or partner.

In short, there are countless reasons why people retire early. In fact, 58% of workers retire earlier than expected, according to research from the Transamerica Center for Retirement Studies in collaboration with Transamerica Institute.

Can you even afford to retire two years early?

While many workers want or need to retire early, the decision to do so often comes at a painful financial price.

When you stop working, it can have effects that ripple across many aspects of your finances. Some of these impacts may be less obvious than you imagine.

If you have a solid nest egg, this might not be a big issue. Fidelity urges you to have eight times your income saved up by age 60, and 10 times your income by age 67. If you are not near these figures, it's possible that retiring early could be a big risk.

Here are some ways that retiring early can hurt you financially.

It can reduce pension income

If you are fortunate enough to have a pension at work but decide to retire early, it could reduce your overall pension income. Pensions are typically based on the years of service you give to a company, so if you quit a couple of years early, it could reduce your payout.

Taking your payout early could mean you will receive pension checks for a slightly longer period, which may also lower your monthly payout.

The rules vary by company, of course, so it's important to talk to your human resources representative to find out exactly how much retiring early might hurt your pocketbook.

It can impact your Social Security distributions

Taking Social Security before your full retirement age will result in a permanently smaller monthly benefit.

For instance, if you were born in 1962, you would be 64 in 2026. Taking your benefit this year would result in a monthly payout that is approximately 86.7% of your primary insurance amount, which, according to the Social Security Administration (SSA), is the full monthly Social Security benefit a person receives at their full retirement age.

It's important to note that Social Security benefits are designed to be actuarially neutral. That means that taking benefits early should not really cost you money over your retirement lifetime. But it will indeed reduce the size of your monthly check, which makes a difference for many retirees' day-to-day expenses.

It could impact your health care costs

Most workers get their health insurance through a plan that their employer provides. The cost of such coverage typically is much lower than what you would pay if you purchased a plan on the open market.

If you retire two years early, this might not be an issue. We are using the benchmark of age 65 in our examples, and that is the same year people qualify for Medicare coverage.

However, if you retire earlier than 65, health care costs can be a big challenge. You might end up having to pay $1,000 or more each month for a policy.

If you're in this boat, know that there are ways to structure your income that might help you to qualify for federal subsidies that can significantly reduce your costs. Be sure to talk to a financial advisor or retirement consultant to figure out your best options.

It could impact your overall nest egg

Retiring early often means having to dip into your nest egg early. This can have a significant impact on whether you can stretch your retirement savings further in retirement. 

Beginning retirement withdrawals two years early robs you of extra time for your investments to compound more interest. This can be a big deal, especially if the stock market booms during that period.

For example, say you have a nest egg of $1 million that is invested 100% in stocks. If the stock market booms and averages a 15% return for each of those years, your nest egg would swell to $1.3 million in two years.

But if you're withdrawing money from your nest egg regularly during those two years, you would not enjoy this growth. Even worse, you would have to pay taxes on withdrawals if they're coming from a traditional IRA or 401(k) account.

If the stock market sinks during those two years, the situation becomes even more dire. You would be forced to make withdrawals from a shrinking pool of funds. And because you would be spending the money, the loss would be permanent.

Bottom line

Retiring early is a dream for millions of workers. If you have a strong financial foundation, it is possible to turn this vision into reality, but there is often a big price to pay for beginning your golden years a little early.

Just make sure you do your homework first to see if you can retire early without jeopardizing your financial future.