Can You Afford to Retire Early?

Here’s one result of the five-year rally in stocks: Investors who once wondered when they would be able to retire comfortably can now at least ponder the possibility of making the leap early. The temptation is understandable. But don’t jump to conclusions. Deciding whether to kick up your feet a few years ahead of schedule is more complicated than adding up account balances to see if they have reached a magic number.

Have You Saved Enough?

Retiring during a bull market may be easier on the nerves. But it can also make the math more complicated. The S&P 500 dove in 2008, but it has generated a positive return every year since. An investor who had $500,000 in the index when it hit the financial-crisis low in March 2009 would have $1,599,581 as of Thursday, including dividends—a cumulative return of 220%. But stocks routinely give up some gains, and a selloff that starts just after you stop drawing a paycheck could do serious damage if you are forced to sell off assets at low prices to cover living expenses.

Take the example of a man with $1 million in savings and monthly expenses of about $4,600. If he is 66 and retires soon, he could turn the savings into an annuity that would pay him and his 62-year-old wife $4,620 a month for as long as either of them lives, according to ImmediateAnnuities.com, an online annuity brokerage. The annuity payments would not grow with inflation. If he is 63 instead, and his wife is 59, the same savings could buy only $4,390 in monthly income, and the couple would have to find some way to make up the roughly $2,500 annual shortfall or pare back their lifestyle.

Can You Live on a Budget?

Controlling spending is crucial to making savings last. That is harder than it sounds. Darrow Kirkpatrick, a former software engineer now living in New Mexico, retired in 2011 at age 50. He says he began thinking about leaving the working world in his late 30s, and started carefully tracking household spending and saving more. He now blogs about his experiences at CanIRetireYet.com. Mr. Kirkpatrick suggests looking at each recurring expense—the monthly cable bill, for example—and multiplying it by 300, which represents 12 monthly payments a year, times 25. A $50 monthly cable bill would translate to $15,000, without adjusting for inflation.

Which Money Will You Spend First?

Not all income sources are the same. That is particularly true for early retirees. For one thing, it is often a smart move to postpone taking Social Security benefits until age 70. Delaying from 62, the youngest age of eligibility, until 70 can increase the monthly payout by 76% or more. But that means early retirees have more years during which they have to cover living expenses in other ways. Ms. Schnaubelt recommends making a list of all potential sources of retirement income, including tax-deferred 401(k)-style plans, individual retirement accounts and taxable brokerage accounts. Then come up with a strategy for drawing on them in the order that will make the money last the longest.

Withdrawing some money from a taxable account and some from a tax-deferred account can often be a smart approach for an early retiree. Taxable accounts are useful because long-term investments and dividends are taxed at the rate for capital gains, which can be as low as 0% or as high as 24%. By contrast, money withdrawn from an IRA or a 401(k) is taxed as ordinary income, which could be taxed at a higher rate. In addition, withdrawals before age 59½ often come with penalties. Roth IRAs offer greater flexibility than other types of accounts, as there are no mandatory payouts and withdrawals can usually be tax-free.

How Will You Pay for Health Care?

Getting older can be hard on the body and the wallet—particularly if you call it quits before age 65, when federal Medicare benefits kick in. The Kaiser Family Foundation says that as of last year, 28% of companies with more than 200 employees offered health benefits to retired workers, and only 5% of smaller companies did.

That means early retirees often need to find another way to fill the gap. Many companies with more than 20 employees offer departing workers Cobra coverage, which typically allows them to keep the coverage they had while working for at least 18 months. But that isn’t cheap—the average monthly cost is $500 for an individual and $1,390 for a family, according to AARP.

Insurance exchanges that sprung up as a result of the Affordable Care Act also offer plans. The bad news: Coverage can also be costly, though premiums can vary by state. For example, the average monthly premium for mid-level insurance coverage for a 62-year-old in Dallas is $612 before tax credits, while similar coverage in Cleveland would cost $558 before tax credits, according to government figures.

Do You Have a Backup Plan?

Retirement seems like a dream come true for many people. But it is worth giving some thought to nightmare scenarios. Poor health, unanticipated expenses or a downturn in the financial markets could wreak havoc on the most careful retirement planning.

If something does go wrong, think about whether you could cut expenses or return to work. Early and recent retirees may be able to generate new income more easily than people who have been out of the workforce for a decade or more, but reversing course is still likely to be difficult in many cases.

What if You Don’t Enjoy It?

Of all the nightmare scenarios, the possibility that retirement won’t be fun may seem the least likely. But retirement isn’t for everyone. Affluent individuals are more than twice as likely as other people to keep working in retirement. Some 33% of retirees with $1 million to $5 million in assets are working, as are 29% of those with more than $5 million. Most say they do so because they want to, not because they have to, according to the survey. Half of affluent working retirees have shifted to a different line of work, most often because of greater flexibility of scheduling, the opportunity to experience new things, and the pursuit of a passion or interest, the survey found.

The results show how important it is to consider what you will do with your time and to think hard about whether that will be satisfying.