Atmospheric retrievals are widely used to constrain exoplanet properties from observed spectra. We investigate how the common nonphysical retrieval assumptions of vertically constant molecule abundances and cloud-free atmospheres affect our characterization of an exo-Earth (an Earth-twin orbiting a Sun-like star). Specifically, we use a state-of-the-art retrieval framework to explore how assumptions for the H2O profile and clouds affect retrievals. In the first step, we validate different retrieval models on a low-noise simulated 1D mid-infrared (MIR) spectrum of Earth. Thereafter, we study how these assumptions affect the characterization of Earth with the Large Interferometer For Exoplanets (LIFE). We run retrievals on LIFE mock observations based on real disk-integrated MIR Earth spectra. The performance of different retrieval models is benchmarked against ground truths derived from remote sensing data. We show that assumptions for the H2O abundance and clouds directly affect our characterization. Overall, retrievals that use physically motivated models for the H2O profile and clouds perform better on the empirical Earth data. For observations of Earth with LIFE, they yield accurate estimates for the radius, pressure–temperature structure, and the abundances of CO2, H2O, and O3. Further, at R = 100, a reliable and bias-free detection of the biosignature CH4 becomes feasible. We conclude that the community must use a diverse range of models for temperate exoplanet atmospheres to build an understanding of how different retrieval assumptions can affect the interpretation of exoplanet spectra. This will enable the characterization of distant habitable worlds and the search for life with future space-based instruments.