Ask Real Deal Retirement

I’m 54 and have two daughters, 10 and 6. My wife and I have heard that you can retire early as long as annual expenses are less than 3% of investable assets. I have $2.7 million saved. So what do you think—can I retire at 54?

—B.J., Atlanta, Georgia

At first glance, it appears you should be able to pull off early retirement quite nicely.

After all, if you’re really able to cover your annual living expenses by drawing roughly 3% ($81,000 in your case) from your nest egg and then increasing that amount each year by the inflation rate to maintain purchasing power, there’s a high likelihood your nest egg will be able to support you for upwards of 40 years.

Besides, I assume you and your wife will also eventually qualify for Social Security benefits, which will give you an extra margin of safety.

That said, retiring early could also turn out to be more of a challenge than you think. And in any case, it’s not a decision you should make based solely on the rule of thumb you mention.

Why? Well for one thing, if your nest egg were to take a 2008-style hit soon after you retire, the combination of investment losses and withdrawals could so deplete its value that you could run through your savings early in retirement.

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Your expenses after leaving the workforce could also be much higher than you project. One potential wild card is health care. Even though the Affordable Care Act has made it easier for early retirees to find affordable health coverage until they qualify for Medicare, the cost for insurance and health-care services can still eat up a lot of your budget. And even after Medicare kicks in at age 65, medical expenses can still be quite daunting as AARP’s Health Care Cost Calculator shows.

And let’s not forget that retired or not, you’ve still got those two daughters to raise. You may be surprised at what sort of havoc children can wreak on a budget, especially when they move into their teen years. No wonder the U.S. Department of Agriculture recently estimated the average cost of raising a child at $245,000.

To the extent you’ll be relying on money in tax-advantaged accounts like 401(k)s and IRAs for spending cash, early retirement presents another challenge: Can you tap those accounts without shelling out an extra 10% tax for early distributions?

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There are ways to do that. The “72(t)” annuity exemption allows you to dodge the early withdrawal tax by taking “substantially equal periodic payments” based on life expectancy. IRS Publication 590 points out a few other exceptions to the tax on early withdrawals from IRAs. If you retire at 55 or later, you can pull money from your employer’s 401(k) plan without penalty. And if you have money in Roth accounts—or even after-tax contributions in your 401(k)—you may be able to tap at least some of those funds early tax-free. Doing so can be tricky, however, so you’ll definitely want to check the distribution rules beforehand at a site like Fairmark.com.

Given all these issues, I strongly recommend you do a thorough assessment of your retirement prospects before you leave your job.

Start by completing a retirement expenses worksheet. No spending estimate is going to be totally precise, but try to be as meticulous and realistic as you can,  especially when it comes to health-care expenses, which you can estimate using the AARP and Health View health-care cost calculators.

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Next, turn to Social Security. By leaving the workforce in your mid-50s, you’ll almost certainly qualify for a smaller benefit than had you stayed on the job longer. Your check will be reduced even more if you and your wife begin taking benefits before full retirement age (67 in your case). You can get an estimate of the benefits you’ll receive at different ages by going to Social Security’s Retirement Estimator.

Do some “lifestyle planning” as well. Among the issues you’ll want to examine: Do you want to stay in your current home or relocate? How will you fill the hours of each day once you no longer have the routine of a job to provide structure? Do you have a network of friends who can provide companionship and support? The “Ready-2-Retire” tool can help you address these questions.

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Once you’ve got a handle on income and expenses, plug this information, as well as details like your nest egg’s value and how your savings are invested, into a good retirement income calculator. You’ll come away with an estimate of the probability that your resources will be able to generate the income you’ll need for the rest of your life. Then run the analysis again, assuming a smaller savings balance and higher-than-expected expenses. This will give you a sense of how much wiggle room you’ll have should your nest egg takes a hit or you end up spending more than you anticipate.

If you feel that this sort of evaluation is more than you can handle on your own, you can always consult an adviser. But if you really want to know whether early retirement is a real possibility for you and your family, this is what you need to do. And you need to do it before you exit the workforce. Otherwise, you may find you’ve taken retirement not early, but too early.   (1/19/15)

Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at walter@realdealretirement.com.