Investments Structure for retiring pre-55

[Uncle]

New member here (hello!). I’ve been wondering how people who retired before 55 have their investments/income structured.

I’ve been maxing out my 401K (some % company match up to 6%), Roth IRAs, and putting 5% into my company’s Employee Stock Purchase Plan. At age 43 (spouse is 45), my plan is to retire at 55, but if I can do it earlier I will. Assuming a pre-55 retirement, I’m trying to figure out whether to continue to max my 401k and just take the penalty, increase the % for my ESPP, or just invest taxable index funds.

My info:

401K: $400K
Rollover IRAs: $400K
Roth IRAs: $300K
Employee Stock Purchase Plan (ESPP): $25K
Checking/Savings/Emergency Fund: $50K
Household Income: $100K
Mortgage: $190K @ 3.3% on $350K house

Eligible for favorable ESPP, healthcare company – even if there is a data breach or scandal, the stock will probably still continue to rise. Every 6 months I can purchase at 15% off the lower of the beginning price or current price.

Thanks for any feedback!

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[pb4uski]

The easiest way is to accumulate taxable account funds at least equal to what you will need to live between when you retire and age 59 1/2 when you get penalty free access to tax-deferred funds... especially if you are retiring before 55.

If retiring at 55 or later, then in most cases you can tap into 401k penalty free if your plan allows withdrawals that make it useful to do so. For some plans, withdrawal restrictions are an impediment.

 

[KenZ71]

I'm in a very similar position, my plan is save in the IRA partly for the tax advantage givve better growth potential & partly because the tax rules make me slow down before taking the funds for fun stuff.

My ESPP has same benefits so I max out and use the account to pay for cars every 5 to 8 years.

To fund my planned early retirement @ 50 I will either use Roth IRA contributions which can be withdrawn tax free or take the tax hit from 401

 

[Uncle]

I won't be at the number I want at 50... I think for me 53 would be the earliest I could go. But at that point, it would be easier to wait until 55 to get the early 401k exception. I'd just prefer not to work that long

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[Scuba]

We saved a lot in a taxable account. Gives you a lot more flexibility. While your company stock sounds like a great deal, I’m sure you understand the risks of having your job and a big part of your portfolio with the same company. If anything ever happened, you could lose a lot quickly. Enron, Lehman Bros, Arthur Andersen, etc., employees found that out the hard way.

 

[Human]

Sounds like you have a great handle on things.

I retired pre-55, and I’m still under that age. I have a fairly large percentage of my investments outside of tax deferred accounts, but that was largely due to fate (a few years without a 401k and some high earning years). And yes, that’s helpful now. That said, I always maxed out 401ks and IRAs and have a hard time advising otherwise.

A couple of other thoughts from my experience. First, not paying my mortgage off early helped support saving beyond tax deferred accounts. Second, with the right work, working part time can be a fulfilling way to help fund the gap from retirement to age 59.5.

 

[MrLoco]

I don't know. I tend to be more cautious than most. I appreciate your optimism but here are some things to think about.

- You currently have $ 1.1 to 1.2M all in tax-deferred/tax free accounts. VEry nice job. In 12 years how much will this grow? Is this money heavily invested in equities to reach a number you feel comfortable with in 12 years when you turn 55? I would not feel comfortable with less than $3M in 10 years. Probably closer to $4M. Will your pot grow by $1.8M+ in 12 years?

- Will you mortgage be paid off in 12 years? If not, this will most likely be your biggest monthly expense post 55.

- Obviously, between 55 and 65 you will need healthcare coverage. You mention your company offers a plan for retirees? Great! But will this plan still be available in 12 years?

- Entitlements will most certainly change in 22 years when you reach MEdicare age. And any SS benefit a retirement calculator spits out....I would reduce that by 25-40%.

- Do you have children? Are future college costs (which have historiclly outpaced inflation) accounted for?

Just some things to consider. Good luck.

 

[Senator]

I’m trying to figure out whether to continue to max my 401k and just take the penalty, increase the % for my ESPP, or just invest taxable index funds.

I assume you max out the 401K by putting in $18K+ into it.

Do both. I assume you get a discount on the company stock. It will also help you to live on less.

When I had a ESPP, I could put 10% of my salary into it. It was a 15% discount off the price of either 1/1 or 7/1, whichever was lower.

You can always get money out of a 401K without penalty.

 

[BeachOrCity]

I would make your absolute floor on 401k the money that gets matched.

Calculate 7 years expenses in today’s dollars. That is your taxable account target minimum. Put yourself on a trajectory to meet this number. With taxable savings each year.

What is left over I would put in 401k or esSP. Make sure your current value of esSP stays under 10% of NW. Sell along the way to maintain this.

Your backup plan if you need extra cash is 72t.

 

[Uncle]

I’m aware that there is a good chance I’ll be working to 55 and possibly 56, 57, 58 – but hey, it’s good to have options in case I do better than expected.

A little more info:
- My target number is $3M, planned 3% WR. Our family of 4 is currently living on ~$55K/yr post tax, so $90K/yr in retirement seems reasonable
- 20 yrs left on Mortgage
- Two daughters (I assume big bills for college, weddings)
- Healthcare: I’ll have access to a high-deductible plan any time after 50. I’ve budgeted $15K/yr for health ins.
- currently close to the max for 401k contributions - ~$17K/yr
- Currently all investments are in equities indices – mix of large-, mid-, small-cap, international, etc. Bonds/bond funds will be something new to me in the next few years

Senator – can you explain getting $’s out of 401k without penalty? Some sort of hardship withdrawal?


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[scrabbler1]

Uncle, when I was putting together my ER plan back in 2007-08, I knew I needed to have a lot more in my taxable accounts than I had already. But I also realized that I didn't need as much in my retirement account (401k to become a Rollover IRA). At the time, I had about 2/3 of my money in tax-deferred and 1/3 in taxable. I needed to reverse that.


The key part of this conversion was to cash out the company stock using NUA so I could get it taxed at fairly low rates (LTCG). This blob of money was half the tax-deferred, or 1/3 of the total portfolio. Doing this cash-out allowed me to reverse the ratio to 2/3 taxable. I invested this huge windfall in late 2008 into a bond fund at rock-bottom prices and it has generated all or nearly all of the income I need to fund my ER.


I haven't had to touch principal in the 9 years of ER, so my WR has been nice and low, around 2%. The rollover IRA, along with my frozen company pension and SS make up my "reinforcements" I can begin tapping into when I turn ~60. This is why I split my ER plan into two parts. The first and most important part was getting from age 45 to age ~60 intact using only the taxable part of my portfolio. The second part is the far easier part, as my longer-term outlook only gets better once the reinforcement arrive.

 

[Sunset]

I'm in a very similar position, my plan is save in the IRA partly for the tax advantage givve better growth potential & partly because the tax rules make me slow down before taking the funds for fun stuff.

My ESPP has same benefits so I max out and use the account to pay for cars every 5 to 8 years.

To fund my planned early retirement @ 50 I will either use Roth IRA contributions which can be withdrawn tax free or take the tax hit from 401

Stretch that out to every 10 years, and perhaps you can avoid paying the extra 10% tax penalty from 401K withdrawals as you will have enough $$$ outside the 401K

 

[rodi]

A few thoughts.

Since you are in the planning stages and have some time before you pull the trigger.
- Do 401k till you get any match. Never turn down free money (the match).
- Put the rest of your new investments in taxable brokerage accounts. This will give you some flexibility.
- Consider a "churn and burn" strategy on the ESPP. Obviously you know your company stock better than me... but I always felt uncomfortable having significant company stock because if the company tanked I was out stock AND a job... too many eggs in one basket. Call it the Enron issue. I took full advantage of ESPP- purchasing the max amount of discounted stock every 6 month window... and sold it as soon as it was purchased. It helped my savings, locked in the 15% minimum return on investment, etc. And I didn't lose sleep at night if the stock went down.

Looking back - I wish I had put more of my savings in taxable rather than tax deferred accounts. But I was in a much higher tax bracket before retirement than I am now... so perhaps I did the right thing deferring taxes then.

 

[Uncle]

Thanks for the feedback so far, I appreciate the thoughtful responses. Key nuggets:
- "Get all of the 401k match"
- "If I retire before 55, build up [60 - retirement age] years of funds in taxable accounts (and start now)"
- "Fund some in ESPP but be wary of over-allocating here"
- 72t is something new to me... good to know it is an option

Any other considerations or strategies?

_______________________

 

[RobLJ]

I'm up about 35% over the last 3 years, since I'm working parttime and DW (younger) worked after we moved to Reno.
So parttime can be an interesting strategy--although a lot of this is the market conditions which can work for or against you.
DW is retiring soon, so I'm beginning to do withdrawals, two years after I though I would be doing so. Perhaps few have the option of working part-time (online) for their employer, to be sure. I enjoy it.
I'm starting at 3.5% SWR, will go up to 6% for two years before my SS, then back down to 4% (or below if needed.)

 

[brucethebroker]

Sounds like you have a great handle on things.

A couple of other thoughts from my experience. First, not paying my mortgage off early helped support saving beyond tax deferred accounts. Second, with the right work, working part time can be a fulfilling way to help fund the gap from retirement to age 59.5.

With the right work, a PT job can be a fulfilling way to help fund your entire retirement even AFTER you "retire". Choose something with flexible scheduling that allows for frequent travel, sabbaticals, etc. A little earned income goes a long way towards extending your nest egg when your asset base is a little light.

 

[RetireAge50]

We retired at 50 with most money in tax deferred. To bridge the gap we plan on using Roth contributions, proceeds from sale of house, taxable money, and pensions. If needed will start a 72t (easy enough).

The taxes are almost nill now (would have been 25% had I not deferred).

 

[Cobra9777]

...I’ve been wondering how people who retired before 55 have their investments/income structured...

We worked hard to build up the taxable account for about 7-8 years before retiring at 52. But we never stopped maxing-out the 401Ks as well. Roths did not exist in the early years when our tax bracket was low. We're now 56/57 and income consists of 2 small pensions, some rental income, and dividends/withdrawals from the taxable account. We're now doing Roth conversions and still debating when to take SS.

 

[pb4uski]

I’m aware that there is a good chance I’ll be working to 55 and possibly 56, 57, 58 – but hey, it’s good to have options in case I do better than expected.

A little more info:
- My target number is $3M, planned 3% WR. Our family of 4 is currently living on ~$55K/yr post tax, so $90K/yr in retirement seems reasonable
- 20 yrs left on Mortgage
- Two daughters (I assume big bills for college, weddings)
- Healthcare: I’ll have access to a high-deductible plan any time after 50. I’ve budgeted $15K/yr for health ins.
- currently close to the max for 401k contributions - ~$17K/yr
- Currently all investments are in equities indices – mix of large-, mid-, small-cap, international, etc. Bonds/bond funds will be something new to me in the next few years

Senator – can you explain getting $’s out of 401k without penalty? Some sort of hardship withdrawal?


_______________________

My guess is that Senator was referring to the fact that most 401k plans allow penalty free withdrawals if you leave service in or after the year that you turn 55. However, if you are planning to rely on that, you should find out if there are any restrictions on withdrawals... some plans limit withdrawals to a degree where it ends up making the feature less useful.

I am confused though...if you are living on $55k post tax why do you think you need $90k? Typically, your taxes wille a lot lower once you retire. Ours would be $0 if not for Roth conversions.

Also, it looks like you have totally ignored social security. The addition of SS, or even 70% of SS if you want to be conservative, should make a big difference in the amount that you need to have and still a prudent WR. Or put another way, it is your ultimate WR, once SS and any pensions are on line that is important. We retired at 56 and while our withdrawal rate in these early years is a bit high, after my small pension and SS start our WR will be under 3%,

If you don't end up with a lot of taxable funds when you retire, you can withdraw Roth contributions without penalty or do a 72t on your IRA. However, withdrawing Roth contributions is typically a last resort because of the value of tax-free growth.

 

[kaudrey]

My taxable accounts are about 1/3 of my investments, which will be enough, with my DH's pension to get us from when I retire at 52 to when I can draw my accounts at 59 1/2.

 

[Uncle]

I am confused though...if you are living on $55k post tax why do you think you need $90k? Typically, your taxes wille a lot lower once you retire. Ours would be $0 if not for Roth conversions.

Also, it looks like you have totally ignored social security.

Whoops, I left healthcare out of that $55k as it's taken out pre-tax. So tack on another ~$10-15k for that in retirement.

Also, you're right, I am assuming little to no Soc Security, and will be happily surprised if I get SS benefit when the time comes.

_____________________

 

[SecondCor521]

Thanks for the feedback so far, I appreciate the thoughtful responses. Key nuggets:
- "Get all of the 401k match"
- "If I retire before 55, build up [60 - retirement age] years of funds in taxable accounts (and start now)"
- "Fund some in ESPP but be wary of over-allocating here"
- 72t is something new to me... good to know it is an option

Any other considerations or strategies?

_______________________

You might consider a Roth pipeline. The short version:

Save up 5 years of expenses in a taxable account.
After you retire, convert 1 year of expenses from traditional IRA to Roth IRA and pay income taxes (but no 10% penalty) on that money.
After 5 years in retirement, withdraw 1 year of expenses from Roth IRA, paying no taxes on the withdrawal.