Early retirement: The disadvantages of retiring early

Early retirement is usually associated with financial independence and freedom from drudgery of the 9 to 5, or 8 to 4.

However, using early retirement just to free yourself of the fetters of the boring job can lead to various problems – not just financial ones – later on.

While the definition of retirement is changing somewhat, early retirement refers to situations where persons retire before the mandatory age and without alternative employment. As one can imagine, there are several disadvantages of this move.

Reduced or inaccessible state pension benefits

Pension payments that are requested earlier are typically lower since the payout period is longer. This is just the way calculations are set, so the benefit of receiving payments for a longer period is negated by the payments being significantly lower. In addition, there are certain state benefits (national insurance and Social Security) that have a minimum stipulated age (60, 62 or 65). Early retirees may have to rely on other sources of income until they can access those benefits.

Your benefits from defined contribution plans (annuities, IRAs and 401 (k)s) would be lower

Just as in the aforementioned point, younger retirees have lower “annuitization” rates. However, with defined contribution plans, the effect of compounded interest is less significant over a shorter accumulation period. The nominal value of compounded interest is much higher towards the end of the investment period compared to the initial stages of the period.

Higher longevity risk

Research by LIMRA showed that early retirees have a significantly higher life expectancy compared to retirees who opt for mandatory retirement or work well past the average retirement age. For instance, persons who stop working at age 50 can expect to live up to age 86. The downside to this is that such persons also face a longer period on a fixed income. This can create problems especially when proper planning was not undertaken. Early retirees have a greater risk of outliving their retirement savings.

Discontent

Retirement is not just about finances. Early retirees may find themselves facing social and psychological pressures in adjusting to life without work. Some might feel displaced or purposeless as opposed to those who anticipated the various challenges of retirement and prepared properly for them. Early retirees who did not plan may yearn for the drudgery of work compared to the boredom associated with an unplanned retirement.

Conclusion

Earlier retirement puts pressure on planning for retirement, since time is not in abundance. Taking early retirement does not necessarily have to be disadvantageous. The critical disadvantages of early retirement are a lack of preparation and higher longevity risk. However, the effects of these can be withstood by proper planning – particularly early retirement planning.