6.5 Ways to Overcome The Early Retirement Gap to Age 59.5

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

Bridge Deck
Will the bridge to your sand-filled retirement be short and straightforward? Or will you need a sound plan to span the long gap?

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

Splash Financial
One way to make sure you can enjoy retirement is by paying down your debt early in your career. Splash can help you with that.

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.

If you want to read more about this you can check out the articles written by Big Law Investor, Money Under 30, and Route to Retire.

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.


2 thoughts on “6.5 Ways to Overcome The Early Retirement Gap to Age 59.5”

  1. Another reason to make changes is to adjust you tax liability in retirement after RMD hits. RMD hits at age 70.5 and has a built in ballooning tax bite. It turns out once your in the middle of RMD making changes to try and streamline the tax burden is very expensive. So there’s an aspect of pre 70.5 behavior that directly affects your post 70.5 returns and lower taxes means more money for you to spend.

    I’ve done/am doing this not just thinking about it, since I am fully retired and living off the proceeds. The taxable account with accumulated long term capital loss is IMHO the best bet. You can grow this account in parallel with your 401K and other retirement accounts and if you plan you can easily tailor the plan. 30K per year for 20 years @ 4% gives you a million bucks. 90K per year draw for 10 years ($900,000) leaves you with 400K still left in the bank. You can withdraw for 15 years without running out of money. As long as you stay under 101K (married jointly) withdrawal your cap gains are zero. If you go over 101k having some LTCL means you still pay no tax. You can get 6% return using a (low risk) 16% total stock/84% total bond portfolio so its a good bet your money will be there when you need it.

    If you use another (numbered) plan like a 457 you have to pay taxes since its ordinary income and the govt wants their money. You’ve already paid the govt on the post tax money. With the million buck plan you also have plenty of money to aggressively Roth convert (but not too aggressive, my analysis is 50-60% of your IRA is a good compromise between lowering future taxes (good) and creating a systematic SORR (bad) in your portfolio). In my case I’m Roth converting between 1 and 1.2M over 4 years living off tax free cash from my post tax account and sleeping in.

    By moving 66% from a 1.5M IRA to Roth I save roughly 300K in taxes over a 25 year period (living in a post age 70 RMD) which is 300K more I will have to spend or a cushion if bad times come.

    Live off cash tax free, Roth convert, save taxes when you’re old, what’s not to like?

    Discuss among yourselves

    • Sounds like a solid plan, Gasem. I do want to flesh it out for any other readers following along.

      1. The 101K number for 0% long term capital gains that you mention comes from the new 2018 rates that stay at zero as long as your income is less than $77,201 (married). This number + $24,000 standard deduction = 101K. So, any income less than that will keep you in the 0% long term capital gains tax rate.

      2. I agree that your draw down plan sounds solid. Convert some money in your early years of retirement to Roth. Lean on your taxable account (plus some cash). And decrease your post 70.5 tax burden when RMD’s hit.

      This will be my plan, too, though I am not contributing to a taxable account until my debt is gone. For now, its just my 403B, wife’s governmental 457, and backdoor Roths. This is because it’s either matched money or space we lose at the end of each year. Everything else goes to debt. Once gone, the taxable account starts.

      3. Everything depends on how early you want to retire and how long of a gap you will have to 59 1/2. A sizeable taxable account is beneficial regardless, but I still prefer the tax advantage of the retirement accounts preferentially over the taxable account so long as you have enough money to bridge the gap to being able to use them.

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