These same questions come up whether you're on the path to FIRE or traditional retirement.
A few years ago, I left my career as a physical therapist at age 41. I decided to pursue a completely different financially independent, retired early lifestyle. Around the same time, my parents asked me to go over their finances with them. They were preparing for traditional retirement in their 60s.
Dealing with uncertainty The biggest challenge to retirement planning is dealing with uncertainty. Financial markets, interest rates and inflation are all difficult to predict and completely out of our control. Health-care costs are a massive unknown. We all have unique personal situations that will affect our tolerance for risk and need for security. And none of us know how long we’ll live.
A clear advantage to retiring sooner is reclaiming younger, and presumably healthier, years of life to do the things you desire. But there is a trade-off. From a planning perspective, retiring earlier creates more uncertainty. We can perform Roth IRA conversions in years when earnings are lower in early retirement. In traditional retirement years, we can withdraw the money directly from the tax deferred accounts. In either case, we anticipate taking the money from the tax deferred accounts at lower tax rates than we would have paid during peak earning years.Tax planning for early retirement Our initial thinking was that we would have little to no earned income in early retirement.
Second, we have determined that health-care-sharing ministries are not a viable option for our family. We’ll most likely use Affordable Care Act subsidies to reduce our insurance premiums once we can no longer qualify for employer-sponsored coverage.Generating more taxable income by performing Roth conversions could decrease ACA subsides, effectively increasing insurance premiums. This may diminish the benefit of doing Roth IRA conversions.
Taking larger withdrawals or performing Roth conversions at traditional retirement age can have additional adverse financial impacts. Increasing taxable income can affect how much of their Social Security income is taxed. If you are required to take larger distributions from tax-deferred accounts, this income may also affect your Medicare premiums.
The overlay of the ACA subsidies on the tax code until Medicare eligibility complicates tax planning during early retirement or semi-retirement years. Spreading tax-deferred income over these years using Roth conversions may be challenging. I first started thinking about this issue when I was still working as a physical therapist. I recall a consultation with a recently retired physician who was coming to see me as a new patient. Our paths had crossed several times previously when he was practicing. He was a jovial guy.
I talked to my dad, who at the time was in the process of transitioning out of the small photography business he had spent nearly 30 years building, about my interaction with the doctor. My dad related to the doctor’s feelings. She was a stay-at-home mom for a period. Later, she became the primary caregiver for both of her parents as well as a few of my dad’s aging relatives in their later years. She then stepped in and played a huge role in my daughter’s formative years.
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