Dilemma tapping tax-advantaged accounts

[rrspike]

hi - i'm all fired up about the prospect of early retirement, and I like the approach in bob clayatt's book on the 4% safe withdrawal method. This may be an old joke (i'm a newbie), but at first i thought this was referring to a contraceptive alternative. Anyway, i have a dilemma which can't possibly be unique (?):

I'm 51 yo, planning to early-retire at 53. I will have approx $1MM in stock and bond mutual fund account assets at early retirement. I figure i need about $36-40K per year for living expenses, all of which i'd like to receive from the account (i.e. hadn't planned on any part-time work yet).

...80-85% of my nest egg is in tax advantaged accounts (401A, 457(b), 403B, IRA). In aggregate, the balance of my taxable savings and the tax advantaged savings is enough (or will be enough) for me to use a 4% safe withdrawal method if i had penalty-free access to all the funds. That's my dilemma - i know i can get access to the tax advantaged accounts before the normal retirement age without penalty, by taking 'substatially equal payments' according to IRS rules, but those payments are based on annuitizing the account balance. Ideally, I'd like to follow the safe withdrawal method and preserve the account assets, rather than draw down the acounts.

Does anyone know of a strategy I can use to efficiently utilize the assets in the tax advantaged accounts prior to normal retirement age which will allow me to preserve the assets and use a safe withdrawal method to fund my early retirement ? Paying a 10% penalty on premature withdrawals would add too much to the withdrawal amount for me to stick to the 4-4.5% safe withdrawal. Is there a way to leverage the substantially equal payments approach without drawing down the account? Or, is there a way to absorb the 10% penalty and stay true to the 4% safe withdrawal.

Any pointers would be appreciated...

Welcome, RR.

Are you realizing that withdrawing it doesn't mean that you have to spend it?* That is, you can do your withdrawals with your SEPP, but if that's more than you want according to the 4% SWR, you can just save the excess in your taxable account (or put it into a Roth).

You'll pay taxes on it, of course, but it's still yours.

[Ed_The_Gypsy]

rrspike,

You can withdraw without penalty using 72T, as you say. You are then committed to continue to do it for a period of 5 years. But, did you notice that you have several choices? The one I like is using the single life expectancy table:

http://www.retireearlyhomepage.com/letable02.html

At 53, your expected remaining life (so sayeth the IRS) is 31.4 years. Assuming you have exactly $1,000,000 then, you could arrange to have 1/31.4 * $1,000,000 = $31,847 taken out the last day of Dec of the previous year. Vanguard (for example) will do this automatically for you, either as one payment or 1/12 of it every month.

Let's say that the balance grows at 4%. So, ($1,000,000 - $31,847) = $968, 953 becomes $1,006,879 by the end of the next Dec.

The next year you will be 54 and your factor is 30.5. Your next withdrawall would be 1/30.5 * $1,006,879 = $33,012. And so forth.

At 4%, you should be starting with more like $1,081,600 in two years, so it gets a little better. With better growth, your annual withdrawal will be even better--most of the time.

Now, if you started today at 51, your factor would be 1/33.3, so your first annual withdrawal would be 1/33.3 * $1MM = $30,030. See, you could start TODAY!

And, as Al said, if you experience an embarassment of riches (eventually, at age age 61, when it becomes 1/24.4 = 4.1% by the above table, you will be taking out larger chunks of the pot than 4% as the years go by), you could save some instead of spending it.

If I were in this situation (sadly, not), I would go for it and find a part-time job to my liking to keep me busy until I want to take SS. After 62.5, you can access any amount you want without penalty (gotta pay taxes as income, though!), whereupon you could bring a chunk or several chunks, out putting it into something that produces more capital gains (taxed at a lower rate) than income. After this exercise, then start taking SS so that you avoid very high marginal taxes that hit you when you have income at the same time you are taking SS. Scott Burns wrote about this.

How does this sound to the crowd?

ed

[gindie]

TromboneAl-

Great answer.

However, the Roth option doesn't work if his only source of income is the 401K, etc.* Must have earned income.

[SteveR]

Roll over your funds into IRAs with a different amount in several ones. You can do 72ts only from the ones you want to and will preserve what you don't want or need to withdraw until later.

[rrspike]

tromboneAl, SteveR, gindie, Ed_The_Gypsy,

Thanks ! This is great feedback and i'm going to think through all these ideas. Interestingly, i asked a professional tax advisor about the IRS 'equal payments' on premature withdrawal route, and he said the rules require me to aggregate all my qualified accounts to create a pool for the withdrawal amount calculations. I'm not sure i'm in agreement..
The other thing i noticed is i need to take equal withdrawal amounts for 5 years or until age 59.5 whichever is later.

I'll be digging into the IRS code on this (i feel a US Budget deficit-sized headache coming on..but i got plenty of coffee lined up).

Thanks again for the ideas.

[Ed_The_Gypsy]

rrspike,

Have your tax advisor show the reference. I, too, believe he is wrong.

Read John Greany's notes on the subject. He boiled it down very well. See:
http://www.retireearlyhomepage.com
and dig around. Much more fun than reading the IRS stuff.

You said, "...equal withdrawal amounts...". I hope you are thinking of 'Substantially Equal Periodic Payments' (SEPP), not 'equal amounts'. Equal amounts may result from annuitizing according to a percentage which may be hard to do correctly. I know a chap who annuitized and had to do it over later. Big headache. I strongly prefer the life expectancy method. Very simple and never a problem with the IRS.

You may be right on the 5 yrs or 59.5, whichever is later. All I remember is the 5 yrs part as I am much closer to 59.5 than that. Sorry. Would 59.5 cause you a problem? After you start to withdraw, why would you stop in the middle?

[maddythebeagle]

Does anyone know of a strategy I can use to efficiently utilize the assets in the tax advantaged accounts prior to normal retirement age which will allow me to preserve the assets and use a safe withdrawal method to fund my early retirement ? Paying a 10% penalty on premature withdrawals would add too much to the withdrawal amount for me to stick to the 4-4.5% safe withdrawal. Is there a way to leverage the substantially equal payments approach without drawing down the account? Or, is there a way to absorb the 10% penalty and stay true to the 4% safe withdrawal.

How much of the money is in the 457 account? You can take that money out at separation of service (I assume you work(ed) for a state/local government/teacher at some point) so you can use that money first

[rrspike]

Originally Posted by The Beagle Formerly Known as Maddy

How much of the money is in the 457 account? You can take that money out at separation of service (I assume you work(ed) for a state/local government/teacher at some point) so you can use that money first

less than $50K. Thanks, i do need to find out more about the 457 options.