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Cash bridge to ER?
Old 02-13-2012, 08:49 PM   #1
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Cash bridge to ER?

Following my intro post, my first big question concerns stretching our cash to cover expenses between now and age 59.5. To recap, DH would like to retire next year at age 53. I'll be 55 then, with four years left until I can tap my IRA. Then more income streams will kick in and we should be okay after that. (I'll work on the next five years once this is sorted out.)

I created a detailed 5-year cash flow plan based on our actual spending over the last few years and conservative assumptions: medical expenses growing at 6%, other expenses at 2%, and a fixed-rate mortgage. Then I added back a travel allowance. My thinking is that we'll want to travel now, while we're relatively young and healthy, because who knows what will happen in the future? I also want a cushion to cover major expenses that might come up, like replacing our two cars and the roof.

I assumed that interest rates will remain flat and our after-tax funds will have 0% growth, which I guess equates to -2% or so real return. DH's pension COLA will cover some of the inflation. I'm willing to trade upside potential for safety for this first part of ER, while still maintaining a comfortable lifestyle. We can always cut expenses if necessary.

At our current spending level, this is tight, so the first thing I want to do is refi our mortgage. We owe a balance of $127k at 5%, with payoff scheduled for 2018. My CU offers a 10-year home equity loan at 3.49% with closing costs about $1000. We'd recoup that in less than two months. This would free up enough cash during the next five years to give us a $30k cushion for emergencies, if we spent at the maximum rate and didn't earn a penny on our savings. The payoff date would be pushed back from 2018 to 2022, but I figure we can pay it off after I hit 59 if that makes sense. We'd also lose some of our current tax deduction but I don't think that should drive our decision.

I also looked at the PenFed mortgages and HEL's but none of them seemed to make sense—either the costs were higher or the term too short. But I like their 5/5 HELOC as a potential source of emergency cash. We'd lock in a rate of 3.78% which wouldn't reset until about a month before I hit 59.5. So worse case, we take out a loan at 3.78%, the rate switches to their max of 5.78% and we carry that for a few months until I hit 59.5. Then we have the option of paying it down with retirement funds. I'm sure we'd cut our other spending, too, if that happened.

My other emergency contingency plan is to tap our ROTHs. Between us we contributed about $17k. Both will be five years old in 2014, and if I understand this correctly we can withdraw the contributions then without penalty.

On the income side, I'm planning to start my pension when he retires. I can take a "level 62" option, which means a large annual payout until I turn 62, then a much smaller one after that. The pension has no COLA, so my reasoning is that the money is more valuable now then later, and prevents us from making penalty withdrawals from IRA's before 59.5. The lump sum doesn't make sense to me because it would bump us into the next tax bracket. I checked the online annuity calculators and my pension seems to give a much better payout for the same starting sum. I also like shifting the interest rate risk to the pension company.

So that's it for now. Is there anything I'm missing or that doesn't make sense? I have a nagging feeling I'm overlooking something simple and obvious since a lot of this is still new to me.
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Old 02-13-2012, 09:15 PM   #2
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Doing a SEP 72t will allow you to access your IRA penalty free before 59.5
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Old 02-13-2012, 09:18 PM   #3
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Doing a SEP 72t will allow you to access your IRA penalty free before 59.5
Thanks, I forgot to mention that. I've considered it but I'm concerned about the decreased flexibility or restrictions it imposes. If I started now I could stop just after age 59.5, but I won't be sure we need the money until we need it, years from now.

Do you think I should set one up anyway? What are the downsides?
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Old 02-13-2012, 09:44 PM   #4
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Where will you stash the money you need till you reach 59 1/2? Given a roughly 6 year time frame, I would not be comfortable having that money incur any risk.

Edit: The title of the post may have answered my question.
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Old 02-13-2012, 10:12 PM   #5
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Where will you stash the money you need till you reach 59 1/2? Given a roughly 6 year time frame, I would not be comfortable having that money incur any risk.

Edit: The title of the post may have answered my question.
I really, really like having cash in the bank for short-term cash needs. It suits my stingy and risk-adverse nature. I know I have to balance that with growth potential for the longer-term. Right now about half the after-tax money is in a MM account earning almost nothing, but most of the other half is invested in a conservative portfolio. Getting that sorted out is my next project.
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Old 02-14-2012, 08:39 AM   #6
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Originally Posted by Wendy View Post
On the income side, I'm planning to start my pension when he retires. I can take a "level 62" option, which means a large annual payout until I turn 62, then a much smaller one after that. The pension has no COLA, so my reasoning is that the money is more valuable now then later, and prevents us from making penalty withdrawals from IRA's before 59.5. The lump sum doesn't make sense to me because it would bump us into the next tax bracket. I checked the online annuity calculators and my pension seems to give a much better payout for the same starting sum. I also like shifting the interest rate risk to the pension company.
I am guessing you realize this, but you should be able to roll a pension lump sum into an IRA, defer taxes now, and withdraw in the years ahead to control the tax hit. But it sounds like you have several reasons that make you want the pension income starting soon, in which case lump sum rollover issues are moot. FWIW...

Otherwise, another well thought out post!
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Old 02-15-2012, 01:20 PM   #7
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Midpack, thanks for the reminder. That would be a good strategy if the pension was funding our retirement, but I think it has greater value as a way to cover expenses in ER and let our retirement accounts grow. The "level 62" option makes this work for us, letting us get most of the money now without the lump-sum tax hit.
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Old 02-15-2012, 02:35 PM   #8
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A couple questions. No 401k? As you probably know, you can access a 401k after 55 without penalty. No taxable investments? Those are my RE to 59.5 source of living expenses.

Is your refi of just the existing balance or is it a cash out refi and that is what the $30k is? If it is a refi of your balance then perhaps you can do a cash out re-fi and build additional taxable investment funds needed for the bridge to age 59.5.
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Old 02-15-2012, 03:30 PM   #9
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For my imediate spending needs the first few years, I've been buying a 5 year CD at penfed every year, so I'll have 1/2 my needs met with the CD. Not a great rate right now, but better than MM. You could always buy 1 5 yr, 1 4 yr, 1 3 yr, etc... Penfed
is now paying 2.25 for the 5 yr. Gives ultimate safety for first few years of cash. Even if I have to cash in I only loose some interest, so I get my entire capital back.
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Old 02-15-2012, 03:59 PM   #10
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Originally Posted by pb4uski View Post
A couple questions. No 401k? As you probably know, you can access a 401k after 55 without penalty. No taxable investments? Those are my RE to 59.5 source of living expenses.

Is your refi of just the existing balance or is it a cash out refi and that is what the $30k is? If it is a refi of your balance then perhaps you can do a cash out re-fi and build additional taxable investment funds needed for the bridge to age 59.5.
Hi pb4uski, thanks for answering.

Neither of us have a 401K. I have an IRA and he has a TSP, but he'll retire before age 55. We have taxable investments that we will spend down unti I can access my IRA. But we want a cash cushion beyond our living expenses to cover emergencies and travel. The $30k was my initial estimate, but I've been crunching numbers for two days and have a new plan.

I'll refi the mortgage to free up some cash over the next 5 years. If we spend at the anticipated rate, that will give us $60k to spend on emergencies or fun. That seems like a lot but it could go fast if we need a new roof, well and septic field all in the same year (unlikely, but it could happen). We considered a cash-out refi but it doesn't make sense to borrow more than we anticipate needing now.

I'll apply for PenFed's 5/5 HELOC to lock in a fixed rate as a back-up. I can pay that off from the IRA when I turn 59.5, as I can't imagine it would be more that $50k. We also can withdraw at least $25k in Roth contributions if needed.

So I think I've at least got an idea on how we can cover both anticipated and unanticipated expenses through this early retirement phase. DH might not retire next January anyway, but I like having at least a broad plan in place in case he does.
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Old 02-15-2012, 04:04 PM   #11
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Originally Posted by RetireBy90 View Post
For my imediate spending needs the first few years, I've been buying a 5 year CD at penfed every year, so I'll have 1/2 my needs met with the CD. Not a great rate right now, but better than MM. You could always buy 1 5 yr, 1 4 yr, 1 3 yr, etc... Penfed
is now paying 2.25 for the 5 yr. Gives ultimate safety for first few years of cash. Even if I have to cash in I only loose some interest, so I get my entire capital back.
Thanks for the tip. I was just looking at PenFed's CD rates and the seem pretty good. I also heard that ING might have decent MM rates and could be a better place to park our free cash than my CU.

We'll spend this money over the next 5 years, so it might make sense to trade off some risk for a better return, for the cash we need in years 4-5. That's one of my next projects.
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Old 02-15-2012, 04:43 PM   #12
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Thanks for the tip. I was just looking at PenFed's CD rates and the seem pretty good. I also heard that ING might have decent MM rates and could be a better place to park our free cash than my CU.
Also look at AMEX bank as they pay higher than ING. Go to Bauer Financial and look at their rates and how they rate banks and credit unions. You may find something else that meets your needs.

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Old 02-15-2012, 04:45 PM   #13
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Also look at AMEX bank as they pay higher than ING. Go to Bauer Financial and look at their rates and how they rate banks and credit unions. You may find something else that meets your needs.

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Thanks, I'll add that to my list. I suspect the search for good rates will be an ongoing project, unfortunately.
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Old 02-15-2012, 05:12 PM   #14
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.....I'll refi the mortgage to free up some cash over the next 5 years. If we spend at the anticipated rate, that will give us $60k to spend on emergencies or fun. That seems like a lot but it could go fast if we need a new roof, well and septic field all in the same year (unlikely, but it could happen). We considered a cash-out refi but it doesn't make sense to borrow more than we anticipate needing now......
Your constraint seems to be that a big part of your nestegg is in IRA/TSP that are subject to the 10% penalty and you need penalty-free sources of cash until the IRA/TSP can be accessed without penalty in 4.5 years or so.

I think the cash-out refi would help solve the problem. While it is true that you'll be paying 3.49% on the extra cash out, you will also be earning say, 1% on the cash and avoiding the 10% penalty and earning whatever the IRA funds are earning. Plus the 2.49% difference is not a total loss as it will increase the amount your can convert from IRA to Roth each year if you itemize once you are retired (and is arguably part of the price of freedom and peace of mind).

I guess in theory that a HELOC would do the same thing at a lower cost, but I would be wary in that many people who had HELOCs had a hard time drawing on them when they needed to.
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Old 02-15-2012, 05:20 PM   #15
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Your constraint seems to be that a big part of your nestegg is in IRA/TSP that are subject to the 10% penalty and you need penalty-free sources of cash until the IRA/TSP can be accessed without penalty in 4.5 years or so..
Correct, and you put it much more succinctly than I did! And I am willing to pay for peace-of-mind. The time frame is actually 5.2 years from now, which is why I looked at a 5/5 HELOC.

But what are the problems with HELOC draws? Has this happened with PenFed? I didn't consider that risk, and we probably wouldn't draw the money (if we did at all) for at least 3 years from now.
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Old 02-15-2012, 06:08 PM   #16
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....But what are the problems with HELOC draws? Has this happened with PenFed? I didn't consider that risk, and we probably wouldn't draw the money (if we did at all) for at least 3 years from now.
This is from a federal reserve document.

"Plans generally permit lenders to freeze or reduce a credit line if the value of the home "declines significantly" or, when the lender "reasonably believes" that you will be unable to make your payments due to a "material change" in your financial circumstances."

also see What You Should Know About Home Equity Lines of Credit

I could see your DH no longer being employed being viewed as a material change in your financial circumstances. That is part of the reason why I refi'd before I RE'd because I figured that a refi would not be possible once I RE'd.

As for PenFed's policy, I dunno.
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Old 02-15-2012, 06:16 PM   #17
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Thanks again. I just posted this question to an older thread on HELOCs, to see if anyone has feedback on PenFed.

The change in employment status could be an issue, if they know about it, although we will have pension income at that point. But I wonder if this is more of an issue with high LTV loans. Our mortgage is about 28% LTV; adding a $50k LOC brings it to 40%; even adding $100k is only 50%. Or course they might not see it my way!

That's why I will have other back-ups: the Roths, or IRA withdrawals with the 10% penalty. I assume that if we have a major expense we'll cut some other spending to compensate.
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Old 02-15-2012, 06:24 PM   #18
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Neither of us have a 401K. I have an IRA and he has a TSP, but he'll retire before age 55. We have taxable investments that we will spend down unti I can access my IRA. But we want a cash cushion beyond our living expenses to cover emergencies and travel. The $30k was my initial estimate, but I've been crunching numbers for two days and have a new plan.
You may know this (or I might have missed it in the discussion someplace) but there is the option of taking payments from TSP based on life expectancy -- there is no penalty for being under age 55. I believe this method or an annuity are the only two options to avoid the 10% early withdrawal penalty if under age 55 when you retire. This may not be of interest but just wanted to make sure you were aware.
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Old 02-15-2012, 08:18 PM   #19
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Thanks, Lakedog. I'm not completely familiar with all of our TSP options, although I hope to keep the money in it as long as possible. Luckily we have a number of avenues to raise cash if we have an ER emergency.
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Old 02-15-2012, 09:55 PM   #20
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Thanks, Lakedog. I'm not completely familiar with all of our TSP options, although I hope to keep the money in it as long as possible. Luckily we have a number of avenues to raise cash if we have an ER emergency.
W2R is the resident expert on the civil-service TSP, but while these two posts are more oriented toward the military, they have a bunch of links from the TSP website. I suspect they're pretty close to your situation:
TSP withdrawal options | Military Retirement & Financial Independence
TSP annuity options | Military Retirement & Financial Independence
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