What to spend first?

[Beachbound]

So I am about 3 months from officially retiring at age 55. 28+ years in the same career/same company. It’s been great money and leaving the high paycheck is scary for sure. But- the stress, the 24/7 contact, I know it’s time to go.

My question is since my company does not offer “the rule of 55” and signing up for a SEPP would not give me enough of the needed funds for the next 5 years- where do I draw first, and how much cash to I hold on to, or spend before drawing from 401k funds?

A little more info- I’m fortunate to have a decent pension, which if I let grow until 62/67, along with SS should give me enough to cover all my living expenses. So my 401k money is really only needed to fund my bridge from say 55-65. My needed income for those 10 years will be high, $120,000 a year max. At 65, and with a planned moved- no house payment- expenses will drop to 80-90k. Cash from current home will pay for new home outright. It’s the current mortgage and taxes that create the spend gap right now. Staying in big house now for parents near by who are self sufficient, financially stable, but want to stay close (84/87yo). I’ll stay in this house 5 years max- but could go sooner if funds require. Our move will be to NC where we lived 20+ years before moving to Florida to be closer to my parents. I can always travel back and forth if needed and stay with them- but won’t have the “Big house cost” to deal with when the move becomes financially necessary.

I’ll have cash on hand in savings, and after company separation/stock pay outs, etc to cover 18-24 months. But should I use all this cash first before drawing any taxable income?

My 401k is just under 1m. Non-taxable is only just under 60,000.

Just don’t know how much “penalty funds” to take. Only when I use everything else- or take some right away in smaller batches to avoid a big hit when I am 57/58 and still not reaching 59 1/2?

So much good information and advice on this site- just don’t want to make the wrong decisions, or order of withdrawals/spend funds.

 

[BrianB]

I think you need to spend some time with FIREcalc or Fidelity's Retirement Planner to give yourself a plan, but a $120k / yr spend rate will empty your retirement accounts by the time you are ready to take your SS & pension.

There are some gaps in the information you have given that make it really hard to make specific recommendations. Can you reduce that $120k annual spending over the next 5 years? Will your pension & SS really provide the full $80-90k per year that you will need after moving? Is the pension inflation adjusted? Will you have money left from your current home sale after you buy your new home? What about the "lumpy" expenses like replacing car(s), travel, and enjoying life?

Remember that your fully paid retirement home will still create ongoing costs - taxes, insurance, utilities and maintenance.

Also remember that in any 10 year period there will likely be two or more market corrections that can be brutal when you are counting on continuous withdrawals.

If I were you I would seriously cut spending now (-30%?), get a different job to create some cushion in your draw-down, or both.

Sorry I can't be more optimistic.

Edit to add:

Have you read this post from this forum, it raises some really important issues you need to consider: https://www.early-retirement.org/forums/f47/some-important-questions-to-answer-before-asking-can-i-retire-69999.html

BrianB

 

[RunningBum]

I'd look for other ways than taking that 10% early withdrawal penalty. No Roth, or HSA with eligible expenses to use for tax-free withdrawals?

How much equity do you have in the house? How close does a SEPP get you? How about a HELOC, to supplement the SEPP? Or downsize the house now. Or figure out how to cut your expenses. Everything BrianB said above.

I realize this means you can't pay for your retirement house outright, but using a SEPP you'd have extra income to make mortgage payments later.

Not that you should count on an inheritance, but is it likely you'll get a fairly sizeable one at some point? That could influence my choices.

Have you factored in income taxes (fed, and state when you move) on that pension & SS?

I hear you about getting away from the job stress, but there's a lot of stress with retiring on a plan that's perhaps not well thought out.

If you want to stick with your idea, I'd say you want to spread out your income between now and 59.5. I'd also stop any 401K contributions (except for company match) you are making now so you keep it available in taxable.

 

[pacergal]

How will you pay for insurance? I think you need to show some income for the ACA, so using "all cash" from your payout might not be best for the next two years, unless your state qualifies you for medicaid or free insurance for low income.

What does Firecalc say about your finances and spend plan?
Have you answered the questions in the forum under Early retirement FAQs: : Some Important Questions to Answer Before Asking - Can I Retire?

 

[Finance Dave]

You've received some good comments already, but one thing to consider once you get your strategy is to take from the 401k only enough to get you to a low tax bracket, and try to come up with the rest in some "after tax" fashion such as Roth (you didn't mention one, perhaps don't have one) or your $60k after tax.

Like you, I got burned out on the long hours and 24/7 contact working for a Fortune 500 multinational company...so I left at 51 y.o. and took a job as a home inspector making 60% less...but I enjoyed it and made good enough money for 5 years that we kept saving and building our retirement funds. It has worked out well for us, and I now do small handyman jobs for "beer and sports car" money...I make about $9k/year now (I work about 200 hours/year) and will do this for another 2 years or so.

Good luck

 

[SnowballCamper]

Not really enough info to answer... But my guess is that a SEPP needs to be party of the plan to get you from 55 to 60. It's my understanding that if you're over 59.5 and the plan has been in effect for five years you can change it...

 

[MarieIG]

Can you find a less stressful job to cover medical, expenses and get you to 57 1/2?

 

[aaronc879]

You don't mention retiree medical so I assume you won't have any which means you need to go on ACA. That requires you to have taxable income so you can't use all the cash, you will need to use some 401K money and pay a penalty. I would take $20K from the 401K or maybe a little more if married and then use cash for the rest. That way you get basically free health insurance premiums for the first couple years.

Can you take your pension right away or in a couple years? Is it COLA'd? That could be a better option than paying thousands in 401K penalties.

 

[Aerides]

You have 18-24 months of expenses, and a 401k you can't tap without penalties for 4.5 years - do I have that right?

I think you need to find a creative plan to cover the extra 2.5 years, as 401k penalties will be ugly.

 

[SecondCor521]

There is a recently implemented rule that says you can use up to a 5% interest rate when calculating an SEPP payment. Depending on the method you use and the balance you have, that might work.

You could also, of course, roll the 401(k) into an IRA and then do an SEPP.

While SEPP rules are rigid, they have become more flexible over time (like the 5% interest rate rule above). And for someone who's 55 or so and knows their numbers, they can work well.

 

[Gumby]

There is a recently implemented rule that says you can use up to a 5% interest rate when calculating an SEPP payment. Depending on the method you use and the balance you have, that might work.

You could also, of course, roll the 401(k) into an IRA and then do an SEPP.

While SEPP rules are rigid, they have become more flexible over time (like the 5% interest rate rule above). And for someone who's 55 or so and knows their numbers, they can work well.

That's what I was thinking - roll the 401k into a tIRA, set up 72(t) withdrawals to generate income sufficient to qualify for the ACA and do any kind of work that strikes your fancy to cover the gap until the pension/SS kicks in. Once the stress of mega-corp is gone, you might find you actually don't mind working, just not there.

 

[DrRoy]

I understood the rule of 55 to be an IRS regulation, not subject to your company to say yes or no. Why don't you look into that.

 

[aaronc879]

I understood the rule of 55 to be an IRS regulation, not subject to your company to say yes or no. Why don't you look into that.

It's up to your companies 401K administrator. I have only worked at one place that allowed the 'rule of 55'.

 

[SecondCor521]

I understood the rule of 55 to be an IRS regulation, not subject to your company to say yes or no. Why don't you look into that.

I think the rule of 55 is actually a federal law. But all it says is that the company must permit withdrawals after the age of 55 to which the employee will not be subject to the 10% penalty. It does not require employers to offer any sort of payment schedule or periodic distribution arrangement. Merely permitting the employee to completely cash out their 401(k) without penalty meets the requirements of the law, but still may not meet the employee's cash flow and tax preferences satisfactorily.

 

[NW-Bound]

... I’ll have cash on hand in savings, and after company separation/stock pay outs, etc to cover 18-24 months. But should I use all this cash first before drawing any taxable income?

My 401k is just under 1m. Non-taxable is only just under 60,000...

I believe there's some confusion here about nomenclatures.

IRA and 401k are actually called nontaxable accounts, because capital gains and dividends generated in the accounts are not taxed. Yes, the whole balance of the accounts will be taxed later at withdrawal. These accounts are also called pre-tax.

On the other hand, when you take the money that you already paid income taxes on and deposit in a brokerage account to invest, the account is called "taxable", although the tax liability of these accounts is only levied on the gains, and not also on the principal like the pre-tax accounts are.

I used to mis-name these account types too, but the above are the commonly accepted definitions.

A quick search on the Web on the terms "taxable account" and "non-taxable account" will provide further elaboration.

 

[Flyfish1]

I agree with the above comments, the Rule of 55 is a federal law. Administrators do not get to pick and choose whether you participate. Our company changed administrators last year and I specifically asked if they allow it and the response was that they have no authority to deny it - since it is a federal law.

 

[pb4uski]

^^^ That's correct, but as mentioned in post 14 above there is no requirement to allow partial withdrawals and that becomes the sticking point, so OP should inquire as to what their withdrawal options are if they leave the employer after 55.

 

[Exchme]

If the pension is not COLA'ed then I vote that you can't retire yet at this spending level. In the OP, there was one use of "our", the rest is "I". Is there a spouse and if so, does the pension include benefits to the survivor? Does the statement that expenses will be covered by pension + SS include spousal SS benefits that will disappear when the first spouse passes?

The assets seem kind of skinny to me for the spending desired, I wouldn't be able to handle the risk that the market stays down for the whole 10 years I am trying to draw from savings (there are several decade-plus time frames in the historical data where the markets are down for over a decade). Maybe heavy use of TIPS for the portion you are going to spend would get rid of market risk, but that also eliminates market growth possibilities.

From a "I'm happy with my plan, how do I execute it" standpoint, the 72(t) option might help. Dinkytown.net has a calculator showing how much you can withdraw each year penalty free-looks like the max is over $60K/year. That is about right with your cash plus your Roth (I assume the term non-taxable means Roth). You need to start that when you retire and make withdrawals for at least 5 years. I have always heard this is very complicated to get the amounts exactly right and there are very severe penalties for doing it wrong, so you need a pro to set it up.

 

[Beachbound]

Thank you all for the comments- I appreciate the advice. To clarify a few of the questions-

- budget for max of 4 years would be 120 max. That is based on current spending and definitely has some fluff that could be cut if needed. But I want to plan for the worse.

- current home is worth 1.1 million with 480,000 still owed. Move planned in 3-5 years (58-60) to downsize home to NC. New home budget 400,000 which will be plenty for where we choose to live. Timing is based on parents health, how retirement spend is going etc. I want to at least stay out for 1-2 years after first retirement. But the current home is expensive. Only 5 years old- so no major expenses expected soon. The house between mortgage and high taxes is 45,000 a year of that spent.

- pension (non-cola), ss self and spouse at 62 = 94,000. At 67 = 134,000.

- inheritance will be maybe 100,000 each, plus parents home in Florida. 2 siblings not close by.

- company does not participate in rule of 55, so any 401 k withdrawals with have 10% penalty and 22% initial federal tax.

- cash is currently $130,000. When I separate from company, another $60,000 in stock options paid, $160,000 in esop paid and taxed, and a supplemental pension paid 13 months later at $55,000 lump sum.

- health insurance would come from ACA beginning 2024, so yes, would like to keep my income as low as possible for subsidies.

- I can start my pension at anytime after 55, but like SS, it grows the longer I wait. At 55 it’s $27,468. At 65 it’s 53,100. I can start whenever I choose.

- I will show large income for 2023, so will be on cobra for Aug-Dec. Jan 2024 go to ACA, but will show income of 53,100 with supplemental pension payroll. 2025 and beyond- income would only be from whatever 401k withdrawals are needed. Only $60,000 of that 401k is in a “Roth 401k” and has been taxed. All other is pre-taxed.

Thank you again for the comments- I learn so much from this forum and everyone’s advice and experiences.

 

[pb4uski]

I think you have enough to retire but not by a long shot based on what you have written. The bigger problem is penalty-free access to your 401k money from ER at 55 to 59-1/2.

You'll need to do a cash flow schedule to see if you can cover 55 to 59-1/2. If you can't or it is uncomfortabley close, then you might consider a cash out refinancing or HELOC to get you from 55 to 59-1/2. What is your current home mortgage interest rate? Another alternative to solve the liquidity problem would be to roll the 401k into an tIRA and then do a SEPP/72t.

Des your employer allow partial withdrawals from your 401k? Does it allow 401k loans? If so, are 401k loans required to be repaid when you leave?

Can you downshift to part -time?

 

[pb4uski]

I'm skeptical that your employer can arbitrarily assess a 10% penalty if your plan is a 401(k) plan and you leave serveice after age 55... the IRS criteria below:

To discourage the use of retirement funds for purposes other than normal retirement, the law imposes a 10% additional tax on certain early distributions from certain retirement plans. The additional tax is equal to 10% of the portion of the distribution that's includible in gross income. Generally, early distributions are those you receive from a qualified retirement plan or deferred annuity contract before reaching age 59½. The term qualified retirement plan means:

• A qualified employee plan under section 401(a), such as a section 401(k) plan
• A qualified employee annuity plan under section 403(a)
• A tax-sheltered annuity plan under section 403(b) for employees of public schools or tax-exempt organizations, or
• An individual retirement account under section 408(a) or an individual retirement annuity under section 408(b) (IRAs)

In general, an eligible state or local government section 457 deferred compensation plan isn't a qualified retirement plan and any distribution from such plan isn't subject to the 10% additional tax on early distributions. However, any distribution attributable to amounts the section 457 plan received in a direct transfer or rollover from one of the qualified retirement plans listed above would be subject to the 10% additional tax.

Exceptions to the 10% Additional Tax

Distributions that aren't taxable, such as distributions that you roll over to another qualified retirement plan, aren't subject to this 10% additional tax. For more information on rollovers, refer to Topic No. 413 and visit Do I Need to Report the Transfer or Rollover of an IRA or Retirement Plan on My Tax Return?

There are certain exceptions to this 10% additional tax. The exceptions below apply to distributions from a qualified plan other than an IRA. For a complete list, look at the Appendix for Notice 2020-62PDF.

• Distributions made to your beneficiary or estate on or after your death.
• Distributions made because you're totally and permanently disabled.
• Distributions made as part of a series of substantially equal periodic payments over your life expectancy or the life expectancies of you and your designated beneficiary. If these distributions are from a qualified plan other than an IRA, you must separate from service with this employer before the payments begin for this exception to apply.
• Distributions to the extent you have deductible medical expenses that exceed 7.5% of your adjusted gross income whether or not you itemize your deductions for the year. For more information on medical expenses, refer to Topic No. 502.
• Distributions made due to an IRS levy of the plan under section 6331.
• Distributions that are qualified reservist distributions. Generally, these are distributions made to individuals called to active duty for at least 180 days after September 11, 2001.
• Distributions that are excepted from the additional income tax by federal legislation relating to certain emergencies and disasters.
• Distributions up to $5,000 made to you from a defined contribution plan if the distribution is a qualified birth or adoption distribution.
• Distributions made to you after you separated from service with your employer if the separation occurred in or after the year you reached age 55, or distributions made from a qualified governmental benefit plan, as defined in section 414(d) if you were a qualified public safety employee (federal state or local government) who separated from service in or after the year you reached age 50.
• Distributions made to an alternate payee under a qualified domestic relations order.
• Distributions of dividends from employee stock ownership plans.

(emphasis added). https://www.irs.gov/taxtopics/tc558

Check with your tax advisor.

 

[Beachbound]

Thank you- the 10% penalty I referred to would be from the IRS since no “rule of 55” from employer. And yes, loans are available from 401k, but would have to be paid in full upon leaving, so no help there.

Spouse does have a smaller 401k- about 130k, and is 1 year older. So could take that when they reach 59 1/2 without penalty to fund another year before pension/SS.

So looking at most needed 2 large withdraws 401k that come with IRS penalty- say $20,000 if $200,000 total taken max. Not idea for sure- but not worth working another year either- or committing to a 5 year SEPP etc.

A 10 year annuity to bridge the gap also would give security, but it the long run, I could lose there using 1/2 of my 401k to set up?

House mortgage rate is just under 4%.

 

[MarieIG]

I had briefly considered taking monthly payments from my 401k with my former employer. The $95 fee they charged, for each and every withdrawal, tipped the balance in favor of an IRA rollover. The .52 % administration fee charged quarterly to the account, did not help.

Conversely, some 401k plans are great. Presumably, OP will examine his closely prior to making a determination as to whether to stay in the plan, or roll the account into an IRA.

 

[rmorris50]

I’m in a very similar situation where I have most of our $3m NW in pre-tax retirement accounts. So to retire early it’s hard to find a away to access enough of the money without the penalty.

But it’s worth pointing out your effective federal tax rate paying the penalty may very well be no worse than that if you continued working. I have projected out all sources of income, taxes, and expenses for the rest of my life so I can play with all kinds of scenarios of how to best access my money. In the process I’ve learned that paying the penalty of accessing pre-tax money doesn’t result in a higher effective tax rate than if I kept working and paying the tax on my income. The bigger risk is accessing too much money too early and the plan imploding later in retirement.

So yes naturally we all want to avoid the penalty but really the penalty is about us not getting the tax arbitrage if we retire early.

Also, I’ve found if I just leave my pre-tax untouched until RMDs kick in, I’m getting kicked into the higher marginal tax brackets and will pay an effective tax rate similar to that when I was working!

So given all that, generally speaking I plan to use pre-tax money first in combination with after tax savings, and leave Roth type money for last. Even if it means paying the penalty here and there. Of course I’ll try to avoid that or minimize that.

 

[Beachbound]

I’m in a very similar situation where I have most of our $3m NW in pre-tax retirement accounts. So to retire early it’s hard to find a away to access enough of the money without the penalty.

But it’s worth pointing out your effective federal tax rate paying the penalty may very well be no worse than that if you continued working. I have projected out all sources of income, taxes, and expenses for the rest of my life so I can play with all kinds of scenarios of how to best access my money. In the process I’ve learned that paying the penalty of accessing pre-tax money doesn’t result in a higher effective tax rate than if I kept working and paying the tax on my income. The bigger risk is accessing too much money too early and the plan imploding later in retirement.

So yes naturally we all want to avoid the penalty but really the penalty is about us not getting the tax arbitrage if we retire early.

Also, I’ve found if I just leave my pre-tax untouched until RMDs kick in, I’m getting kicked into the higher marginal tax brackets and will pay an effective tax rate similar to that when I was working!

So given all that, generally speaking I plan to use pre-tax money first in combination with after tax savings, and leave Roth type money for last. Even if it means paying the penalty here and there. Of course I’ll try to avoid that or minimize that.

Yes- thank you. The tax man will get us all one way or another- but trying to make it the minimal is the goal for all. My payroll checks now have over 45-50% deductions between taxes, contributions, insurance. It’s surprising when I do look at my take home pay-how different that is from my salary. What I make, and what I take home and live on are 2 different figures for sure. Some stays- but rates will be much lower than what I pay now working.