Have you thought about the different phases of your post-retirement financial life? In this post, Physician on Fire shares three main epochs of early retirement.
When discussing the funding of early retirement, I’m guilty of being fairly vague. Save at least 25 years’ worth of anticipated expenses and you should be good to go. That’s what the 4% Rule says, right?
The vagueness is intentional. Everyone’s situation is different, and you have to customize the way in which you’ll access your money, based on how much you have, in which accounts it’s located, and what income streams you might currently have or expect to benefit from in the future.
I’ve shared a tentative drawdown plan in the past, but such a plan becomes outdated over time. Any plan should be dynamic, and it should change as your money situation changes.
One way to think of your retirement is in terms of epochs. Not to be confused with the fuzzy tree-dwellers from Return of the Jedi, an epoch is a period of time that can be differentiated from others based on defining characteristics.
In this case, the epochs of early retirement will be defined by the source of your spending money, how you access it, and what you spend it on. Kudos to Gasem for inspiring this post with this comment.
The Epochs of Early Retirement
There will be numerous important years that define your epochs.
21. You can legally drink! But you’re not early retired yet unless you inherited a fortune or became a Youtube sensation.
Retirement. Obviously, the year in which you retire from your main source of income is a pretty big deal. For me, that happened in the summer of 2019 at age 43.
55. The year in which you turn 55 is a milestone for those who remain employed with a 401(k). That’s the year in which you can leave your employer and start accessing that money.
59.5 When you turn 59.5, you are able to easily access all IRA money without penalty or the necessity for “tricks” like the SEPP via Rule 72(t).
62. You are eligible to start taking Social Security, although most people reading this blog will probably be better off delaying until full retirement age or age 70.
66 to 67. Depending on when you were born, your “full retirement age” at which you can collect a full Social Security benefit is in this range.
70. At age 70, you can collect the maximum amount of Social Security if you delay until then to begin receiving your benefit.
72. The year in which you turn 72, you will be forced to start drawing down traditional IRA and 401(k) money. Forced withdrawals start at about 4% and increase incrementally to over 10% as you age.
Personally, my plan is to retire from medicine well before age 55 and delay Social Security until age 70. Therefore, I can break the future down into three main epochs:
- Epoch I: Retirement to Age 59.5
- Epoch II: Age 59.5 to Age 70
- Epoch III: Age 70 to Infinity (and Beyond!)
Epoch I: Retirement to Age 59.5
The early years can be the trickiest, depending on how your portfolio is structured. Money that can easily be accessed penalty-free includes taxable investments, 457(b) investments, Roth contributions, and Roth conversions (after a 4-to-5 year “seasoning period”).
It’s best to leave Roth money alone if you don’t need to access it. They’re the most valuable dollars in your portfolio.
I will have two income streams that will probably continue through age 59.5, so there will be two or three distinct periods within this timeframe — subepochs, if you will.
457(b) Income While it Lasts
I have a non-governmental 457(b) that is essentially deferred compensation; it’s not mine until I withdraw it. It’s got two to three years worth of living expenses in it, and I plan to drain it down over 5 to 6 years or more, depending on market returns.
Small Business Income While It Lasts
What started as a blog in early 2016 has become something of an online business venture. By the time I pay expenses and shareholders, donate half of the profits and pay taxes, I’m left with about 25 cents per dollar of revenue.
Nevertheless, 25% of a profitable business is nothing to sneeze at, and we’re about at the point where it’s about enough to support our living expenses… as long as the good times last.
When Those Income Streams Cease to Age 59.5
The future is unknowable, but let’s say those income streams run dry by the time I’m 50 years old. I’ve got about another decade to cover before the next epoch.
I could use Substantial Equal Periodic Payments to access tax-deferred money early, but I don’t foresee that need. I could also build a Roth ladder to make that money more accessible, but I don’t plan on spending money from a Roth IRA unless I have no other option.
We’ve got at least half of our portfolio invested in a taxable brokerage account, and that money’s accessible at any age for any reason, and it will serve us well during this decade.
There will be dividends of about 2% of the value of our index funds (at least based on the current dividend yield). I’ll take them, although I’d just as soon create my own dividends by selling shares and maintaining control of how my “income” is taxed.
I don’t automatically reinvest dividends, as doing so can foul up attempts at clean tax loss harvesting, and I’ve got the money redirected to a money market fund. In retirement, rather than manually reinvesting the dividends, I can have them sent to a high-yield savings or checking account as needed.
If that dividend yield does not fully support us, I will gladly sell some of those shares. Some people scoff at the idea of selling principal. However, if I invested $1 Million dollars in the brokerage account and it’s eventually worth closer to $2 Million, am I selling principal as long as the value of the account exceeds my cost basis?
Even if I do draw down principal to below my cost basis, there is money in tax-deferred and Roth accounts that will be compounding untouched for more than a decade. The goal is not to drain the taxable account down to nothing, but as long as it lasts throughout this first epoch, there would be no real cause for concern, and there’s little chance of that happening.
The latter part of this first epoch includes the years in which we will be drawing down the 529 Plans we built up for our sons. It’s important to plan for your children’s higher learning before retiring early, and the college and graduate / professional school years will be upon us within the next decade.
Epoch II: Age 59.5 to Age 70
The second epoch of early retirement occurs over an approximately eleven-year period from late in my sixth decade to the beginning of my eighth.
There will be some carryover from the latter part of the first epoch with continued dividends and selling of shares from the taxable account.
IRAs and 401(k)s
What’s new is the ability to make withdrawals of any size as needed from an IRA (which could contain money rolled over from a 401(k) or 403(b). Even if the money isn’t necessarily needed now, it might make sense to start withdrawing it as soon as it’s available while watching your total taxable income to ensure you’re not pushing yourself into a higher federal income tax bracket that you don’t want to be in.
Another strategy that could begin in the first epoch and will certainly continue into the second is strategic Roth conversions. Instead of withdrawing funds from a tax-deferred account to create taxable income, you can convert the money to Roth instead, paying income tax at your marginal bracket, which could be quite low as a retiree.
The main reason to either take traditional IRA withdrawals or make Roth conversions at this stage is to reduce or avoid Required Minimum Distributions (RMDs) that will start in the third and final epoch.
Another reason to do so would be the anticipation of higher future income tax rates. I don’t know what the future holds, but if I had to guess if income tax rates will go up or down after the current rates sunset after 2025, I’d put my money on “up.”
One could start collecting Social Security as early as age 62, but that’s not currently part of my plan. Delaying Social Security offers an excellent return on investment, as the monthly benefit at age 70 could be about 1.8x that at age 62.
A reason to start collecting checks early (at 62) would be a lack of faith in the solvency of the program and the corresponding uncertainty that you’ll be receiving any money at all if you wait. A bird in hand is sometimes better than a few in the bush.
A second reason to get that money as soon as possible is poor health or a family history of early demise. The decision to delay Social Security pays off somewhere in your early to late eighties depending on how you do the math. If you feel very unlikely to see your 80th birthday, delaying until 70 makes very little sense.
I anticipate there will be changes made to the program in the nearly twenty years between now and my eligibility at age 62, but as of now, I anticipate delaying Social Security as long as possible.
Smack dab in the middle of this second epoch is Medicare eligibility at age 65. Don’t make the mistake of believing your healthcare expenses will be minimal from here on out. Many of today’s Medicare recipients are spending in excess of $10,000 a year on healthcare.
Nevertheless, if you’ve been purchasing health insurance off the rack for years, you could see your healthcare costs cut by half or more at the age of 65. If some form of a Medicare for All plan becomes the law of the land, this could be a moot point.
Age 70 to Infinity (and Beyond!)
When I reach the age of 70 late in 2045 (according to current law), I’ll start collecting Social Security. I do not anticipate receiving the largest benefit possible, which would have required 35 years of paying the maximum possible), but I do expect I’ll have passed the second bend point, so my benefit won’t be that far below the max.
If you have very low taxable income, you might pay little or no tax on your Social Security benefit, but I fully expect to be taxed on 85% of my benefit. Most readers of this blog can expect to have enough taxable income to have most of their benefit taxed at their marginal income tax rate, as well, but 15% of the income is exempt from taxes.
Required Minimum Distributions
If, and this is a big if, I still have tax-deferred money sitting in a 401(k) or IRA, the government will make sure I start depleting it. If you don’t start taking out the mandated amount annually starting in the year in which you turn 72 (2047 for me), the penalty is 50% of what the RMD would have been.
I hear it’s surprisingly easy to have the penalty waived if you goof this up, but I’m not going to take my chances with the federal government.
As mentioned above, RMDs start at just under 4% and reach over 20% if you make it to 104. At the tender young age of 115, the RMD is over 50%.
A lot of people like to talk about having an RMD problem. As in, their RMDs will be so large, they’ll be forced into the highest tax brackets in retirement.
It would take a very large tax-deferred balance for this to be an issue. For example, a couple with a $9 Million total IRA balance would give you an initial RMD of about $330,000. After subtracting $24,000 for the standard deduction, they are easily in the 24% federal income tax bracket (based on today’s bracket which goes up to $321,450).
So one way to not have an RMD “problem” is not to have an 8-figure IRA balance. I would argue that if you do have an 8-figure IRA balance, paying taxes on the withdrawals should not be much of a problem.
Nevertheless, I’m not keen on being told what to do with my money, and I’d just as soon have those tax-deferred balances down to zero by the time I would be forced to withdraw what the government demands I take each year.
Under the current tax code, I think Roth conversions to fill up the 24% federal income tax bracket make perfect sense. When truly retired, I should have lots of room in which to do so.
While I jokingly refer to the age of infinity (and beyond!), I expect my telomeres will continue to shorten, my coronaries to continue receiving deposits from the meat that I eat, and I will eventually pass away.
Estate planning should begin well before even the first epoch of early retirement, but the specific plan becomes most important when needed, which I hope will be at least a decade or two into the third epoch.
Proper estate planning should include the following at a minimum:
- Beneficiaries named on all accounts
- A Last Will and Testament
- A Living Will
- Healthcare Power of Attorney
- Revocable Living Trust if you have assets subject to probate
There is certainly more to estate planning than a handful of bullet points, but that’s a good starting point.
If you find yourself in the fortunate position of having another so-called problem like an estate worth more than the federal estate tax exemption (currently $22.8 Million for a married couple), you will have more work to do.
An easy way to deal with it is to donate enough during your life or upon your death to bring your estate value below the exemption level. Cash value life insurance can also play a role; this is one of the few instances in which it might make good sense to own a permanent life insurance policy.
Estate and inheritance taxes vary widely by state and can start at much lower net worth values. Depending on the potential cost and how important it is to remain in place, it could make sense to spend your latter golden years in a state where an estate tax will be a non-issue.
So that’s how I’m looking at my early retirement financial timeline. There will be three main epochs with a few subepochs as the milestones come and my hair grays and goes. It’s never too early to start thinking about how you’ll approach the spending aspect of all that money you’ve been diligently saving.