Man, we love talking about FIRE (Financial Independence and Retire Early). “I am going to give the boss a giant middle finger and walk out that door when I am 45!” What we don’t spend as much time talking about is what we are going to do after we FIRE.
Specifically, what is your draw down plan? Today we will discuss one aspect of that plan, which is how to bridge the early retirement gap between when you FIRE and when you turn age 59.5. After that, you’re likely on dry land as you can now access your retirement accounts (401K/403B) from all those years of work without getting slapped with a 10% penalty for early withdrawal (though there are ways to avoid that).
Basics: What’s the problem?
When we make all of our brilliant plans for early retirement (like that trip to Europe or that trip across the country), we often fail to think about the specifics.
We have likely determined what our number is for retirement (easy ways are to multiple annual expenses by 30 to 35). For example, if you spend $90,000 post tax each year then you likely need $3,000,000. Drawing down 3% of this nest egg each year will provide you $90,000. That is likely to last a very long time based on the Trinity Study even for an early retiree.
We cannot use our 401K/403B until age 59.5 lest we receive a 10% penalty on anything we take out.
The problem is this:
How do we bridge the gap from early retirement to age 59.5?
6.5 Ways to Bridge the Gap
There are certainly ways to retire early and to have the income we need to do so, but we need to make a plan. Here are four of the best ways to have the money you need to retire early.
Number 1. Cash Reserve
A lot of early retirees advocate for having a year or two of annual expenses saved up in a cash reserve for the first year or two you retire. There are major advantages to this below (i.e. Roth Ladder Conversion and letting your investments grow).
This may seem obvious, but thought it necessary to mention. Now for the more juicy stuff…
Number 2. The taxable account
Another source of money is your taxable account. This is the first account that you should draw down in retirement. It has the least tax benefit and has the most flexibility in terms of access. You simply take the money out that you put in, pay your long-term capital gains taxes on your gains (held for more than one year).
One of the big reasons for this post is that most people actually stop putting money into their 401K/403B and instead put it into a taxable account, because they think this is the only option in early retirement. Not so, my friend.
Number 3. Partial FIRE
One of the least complicated ways to have enough money in early retirement is to have income from work. I hear you saying, “Wait a minute! I thought we were talking about retirement.”
This is true, but let me give you an example. My main gig is working as an anesthesiologist. I can partial FIRE in one of two ways.
First, I can take a step back to 0.5 FTE (Full-time equivalent) or 0.7 FTE. That may provide time for me to do things I want to while still earning access to retirement accounts, health care benefits, etc.
Second, I could also consider working on other things that bring me joy, but aren’t my main gig. Say I retire early and devote more time to this website or to real estate or creating inventions. There are many examples of physician side hustles. All of these may take up less time than a full-time job, provide income, and allow you to still have an active retirement.
After all, the people that retire well still have passions that they pursue. Playing golf every day is going to get old after a while (though right now that’s hard to imagine). You need something to do when you retire. Hopefully, it can also make a little money for you.
Number 4. Access your 457 in early retirement
The one thing I will say that 457’s are definitely useful for (if they have good investment and distribution options) is early retirement. Unlike your retirement accounts, you can access the deferred compensation 457 as soon as you leave your employer. You’ll, of course, pay taxes on what you deferred… but that’s fine. At least you aren’t getting slapped with the 10% penalty.
I am not currently contributing to my employer’s 457. However, they have good distribution options including annuities (for my wife and me) and the option to receive the money over a fixed period of years (2-30 years).
This is perfect for early retirement. I could subtract my current age from 59.5 and stretch my 457 until I can access my 401K/403B. Or I could take it out over a shorter period of 5-10 years to avoid getting hit with high taxes while I perform a Roth Ladder Conversion on my 401K (see below). Also, a shorter time period means I don’t have to worry about the financial stability of my institution longer than necessary once I am gone and have no idea how it’s doing.
Number 5. Roth Ladder Conversions
This has been written about elsewhere. So, I’ll point you to these references instead of belaboring the point. I do want to mention it, though, because it is a really good strategy to use in early (full) retirement as long as you can keep your taxable income low enough to take part.
The basics involve converting your 401K/403B into a taxable IRA upon leaving your employer. (I believe that this must be done within 60 days of leaving most employers). You then take your money out of the Traditional IRA and convert it (i.e. you get taxed) to a Roth IRA. You can then take your money out of the Roth IRA tax and penalty free. There’s a catch, though.
The key is you have to wait 5 years to access that money! So, you still need five years of money saved up in early retirement (likely from numbers 1-4 above) to get you through five years.
Number 6. Substantially Equal Periodic Payments
I have talked about SEPP options to avoid the 10% 401K/403B penalty before. However, it is an option that you have to access money in early retirement before age 59.5
Click the link above to read specifics. The gist is that you can arrange for equal payments to occur for you from your 401K/403B for five years or until age 59.5 (whichever happens later). This can provide some money, if you need some not covered by the four above.
Number 6.5 Take Roth contributions out
This one isn’t a full number for a reason. You can choose to take any Roth contributions out tax-free. However, this has two problems.
One, you have to determine the proportion of which is your (non-taxable/penalty free) contribution and what is growth. So, if you want to take out $10,000 and $9,000 of this is the contribution (not taxed/penalized) the remaining $1,000 will be taxed and possibly be assessed a 10% penalty if accessed early. This starts to get complicated.
Second, you should be accessing your Roth money last as this is money that is best left for your inheritance and also has the biggest tax benefit. You’ve already paid the tax. Let it grow tax-free and take it out tax-free later.
I mention this because it is, technically, an option. Just not one that I would choose.
What are your thoughts? Do you plan on retiring early? Have you already done so? What was your plan to fill the gap prior to age 59.5? Leave a comment below.