Our (risky?) 72(t) SEPP strategy for FIRE

[A Bird In Hand]

As we enter our 50's, and as our retirement account balances have risen sharply in recent years, I've been thinking more carefully about how and when to pull the plug. The two main options on the table are to grind it out until 55 and use Rule of 55, or to bail earlier and rely on SEPP + cash savings + taxable brokerage + Roth basis + 457b to get us to 59.5.

For the purposes of this thread, I'm talking about the bail-early-and-SEPP option. Here are the basic facts:

• Ages ~50, ~49
• 3 kids in or approaching college age in the next few years, with college expenses almost fully covered via scholarship and 529
• House is paid for
• About $3.9MM in pre-tax accounts
  • ~$500k in previous employer plans
  • ~$35k in traditional IRA, and the rest in current employer plans)
  • ~$215k in a 457b that we can use upon separation with no penalty
  • The balance in current employer plans
• ~$215k Roth IRA's, about $120k basis
• ~$100k Roth 403b, all of it basis, but most in roughly $15k-$20k tranches that finish seasoning over the next 1, 2, 3, 4, and 5 years
• ~$110k of savings, HYSA, and matured I-Bonds
• ~$40k of taxable brokerage in VTI, about half of it basis
• Spending in the $100-$120k/yr range (recent and upcoming lumpiness makes it harder to say for sure). But for the purposes of this thread, assume $106.5k.
  • $86.5k essential spending
  • $20k discretionary
• Assuming lifespan of 95 years, so the money would need to last up to 45 years

To achieve $106.5k spending, we would withdraw $133k in the first year -- you may recognize this as the top of the 12% tax bracket for MFJ. We would owe $11,600 in federal tax. Our state does not tax retirement income. ACA bronze plan would be about $10k/yr in premiums, and with our typical rate of medical care use, we anticipate an additional $3k in out of pocket medical expenses in an average year. I'll intentionally round this up to $5k. Therefore, income available for spending would be: $133k - $11.6k - $15k = $106.5k. As you have probably already inferred, we'll be optimizing for ACA credits rather than for Roth conversion opportunities.

Our strategy for income would be SEPP for the first $100k, and the remaining $33k would be a combination of 457b + cash savings + taxable + Roth basis. The SEPP would be structured like so:

• Create four separate IRA's between us
  • $500k in each IRA, mostly coming from employer retirement plan rollovers
  • 3.5% amortization method from each IRA, yielding $25k/yr x 4 = $100k/yr

If we exhaust all of the 457b, taxable, savings, and Roth basis by the age of 59.5, the composite withdrawal rate across our entire portfolio would be about 3.6% in the first year. If we manage to stick to the $133k spending on average until age 59.5, the rate is closer to 3.0%.

The main risks (and mitigating strategies) I've thought of:

Risk	Mitigation
Inheritance windfall, fun employment opportunity, money-making side hustle pushing us into higher tax bracket, losing ACA credits	Change one or more SEPP buckets to RMD method (~$56k/yr)
SORR, really bad markets in the early years	Reduce discretionary spending (full reduction means ~2.6% withdrawal rate)
Large one-time unplanned expenses	Reduce discretionary spending and/or pay for with cash/taxable/Roth/HELOC
Unexpected medical (accidents, illness); max family premiums + OOP ~$30k/yr	Reduce discretionary spending and/or pay for with cash/taxable/Roth, hardship withdrawal
Tax law changes: ACA credits, tax rates, etc.	Reduce discretionary spending and/or pay for with cash/taxable/Roth
Higher than expected inflation	Increasing withdrawals from cash/taxable/Roth, potentially reducing discretionary spending

I'm sure there are other things I haven't thought of here. But I'm interested in getting some feedback:

• Is the plan coherent?
• Is the plan safe, risky, somewhere in-between?
• Have I overlooked any major items?
• Overall: thumbs up, or thumbs down?

 

[mrfeh]

I would not want to retire at 50 and plan on using SEPP at 55. Too many questions/variables.

Only other comment is that you're looking at a 45 year retirement. 4% rule of thumb does not apply.

 

[A Bird In Hand]

Only other comment is that you're looking at a 45 year retirement. 4% rule of thumb does not apply.

Personally I don't think the 4% rule really applies to anything meaningful in real life -- though I definitely use it as a convenient shorthand when spitballing.

At any rate, in the scenarios I outlined I'd be at a baseline of ~3.0% withdrawal rate with $20k discretionary spending per year, or 3.6% if we had to spend an additional ~$20k/yr beyond our planned expenses, every single year for 9 nears. FireCalc shows a ~95% success rate of withdrawing 3.9% with constant spending power (3% inflation increase every year). So by that metric, the plan doesn't seem particularly risky from a running-out-of-money perspective.

 

[A Bird In Hand]

I realized after my initial post that there are other amounts for the SEPP IRAs that would work with higher interest rates. Going up to the max of 5% for the amortization or annuitization methods, the total SEPP accounts would only have to total about $1.64MM instead of $2MM -- leaving ~$2.26MM in non-SEPP pre-tax.

 

[tulak]

A quick look and it seems fine to me. I have a similar plan to get me to 59.5.

One thing I see that you left out is social security. It doesn’t make a big difference, but it could push you closer to 100% in Firecalc. I assume a 20% reduction to keep it conservative.

The other concern is how your 500k/IRAs are invested. Make sure that they are invested in a way to guarantee the 25k/year withdrawal.

Which leads into SORR. Have a plan. I have 8-10 years in TIPS, maturing every year until 2036 (the first 2 years are cash/treasuries). I’m still working, but I’ll keep the TIP ladder going by buying 10 year TIPS at auction in January. When they mature, I’ll reallocate them to equities if I don’t need the income.

 

[A Bird In Hand]

A quick look and it seems fine to me. I have a similar plan to get me to 59.5.

One thing I see that you left out is social security. It doesn’t make a big difference, but it could push you closer to 100% in Firecalc. I assume a 20% reduction to keep it conservative.

The other concern is how your 500k/IRAs are invested. Make sure that they are invested in a way to guarantee the 25k/year withdrawal.

Which leads into SORR. Have a plan. I have 8-10 years in TIPS, maturing every year until 2036 (the first 2 years are cash/treasuries). I’m still working, but I’ll keep the TIP ladder going by buying 10 year TIPS at auction in January. When they mature, I’ll reallocate them to equities if I don’t need the income.

Thanks! I did include 75% of expected SS in my FIRECalc.

I haven't given much thought to how the SEPP IRAs would be invested. The TIPS idea is interesting, but I'll need to investigate that more carefully so I understand it. My thinking is that even in the worst case, if I were invested 100% stocks (which is not my intent), the chances of it dropping by 50% over a 9 year period is exceedingly unlikely; but even if it did, it seems unlikely I would run out of money in those IRAs. My main lever to mitigate that would be to switch to RMD method if there were catastrophic losses in the early years especially.

 

[zinger1457]

I would not want to retire at 50 and plan on using SEPP at 55. Too many questions/variables.

I believe the plan would be to start using SEPP at 50 and continue to at least 59.5 to go with the 72t requirements. Not a lot of other options if one wants to retire before 55 and most of their savings are in IRA/401K type accounts.

 

[pb4uski]

I would not want to retire at 50 and plan on using SEPP at 55. Too many questions/variables.

Only other comment is that you're looking at a 45 year retirement. 4% rule of thumb does not apply.

It wouldn't bother me at all to retire at 50 and use SEPP withdrawals if I had $3.9 million.

$133k withdrawal is only 3.4% WR on $3.9m. Age or what hoops one has to jump through to get penalty free withdrawals isn't relevant. Plus, the OP didn't mention SS at all so that's another plus.

 

[A Bird In Hand]

I believe the plan would be to start using SEPP at 50 and continue to at least 59.5 to go with the 72t requirements. Not a lot of other options if one wants to retire before 55 and most of their savings are in IRA/401K type accounts.

Correct, SEPP from ~50 until 59.5. Had I been a little cleverer, earlier on we would have put more into Roth and taxable to bridge the gap. But as it is, I can either use SEPP to avoid the 10% penalty, wait until age 55 for Rule of 55, or just retire whenever I want to and pay the 10% penalty.

 

[A Bird In Hand]

It wouldn't bother me at all to retire at 50 and use SEPP withdrawals if I had $3.9 million.

$133k withdrawal is only 3.4% WR on $3.9m. Age or what hoops one has to jump through to get penalty free withdrawals isn't relevant. Plus, the OP didn't mention SS at all so that's another plus.

Re: my bold emphasis above...hey now, you're leaving out my cash, taxable, and Roth! All told it's a little north of $4.35MM. So $133k is actually only about 3.05%!

 

[pb4uski]

You made my point... better!

 

[SnowballCamper]

At your asset level of $3.9M in tax deferred, why not go big on the SEPP? Make it big enough to cover your worst case inflation spending scenario, up to about your max of ~240k. Sock the excess in the regular brokerage for lumpy expenses. Sure you'll have to pay the income taxes, but they're coming eventually anyhow. Leveling the income over the years reduces RMD taxes later.

 

[SecondCor521]

OP, I think you generally have a solid plan.

I realized after my initial post that there are other amounts for the SEPP IRAs that would work with higher interest rates. Going up to the max of 5% for the amortization or annuitization methods, the total SEPP accounts would only have to total about $1.64MM instead of $2MM -- leaving ~$2.26MM in non-SEPP pre-tax.

The above was about the only thing that I would have suggested.

The other suggestion / question is why two IRAs for each of you for the SEPPs? Why not just one IRA for each of you and do one SEPP each, for a total of two (instead of four)? The only reason I can think of would be if you were wanting to bring them online at different times or run two different SEPPs...which you *can* do but it's added complexity. Keeping the balances low by using a 5% interest rate and keeping the dry powder in non-SEPP IRAs is smart too.

You could also "calve off" an additional IRA from the non-SEPP IRA and start another SEPP program at age 55 if you wanted to - this could be a mitigation tactic for the "higher expenses" risks in your table.

You might try to hang on to work for another year or two to delay starting the SEPP and shorten it by a year or two, but you may have other reasons to want to stop working which may override the value of having a somewhat shorter SEPP duration.

At your asset level of $3.9M in tax deferred, why not go big on the SEPP? Make it big enough to cover your worst case inflation spending scenario, up to about your max of ~240k. Sock the excess in the regular brokerage for lumpy expenses. Sure you'll have to pay the income taxes, but they're coming eventually anyhow. Leveling the income over the years reduces RMD taxes later.

Since SEPPs are forced income, and the OP seems to be concerned about flexibility and tax planning, I agree more with the OP's approach to size the SEPP at somewhat less than annual spending. They can always increase their taxable income and levelize their marginal rates by doing Roth conversions on the non-SEPP IRAs.

 

[jazz4cash]

I skimmed through so maybe I missed it. What are the stipulations for your state to not tax retirement income? I ask because my state has a limited exclusion on retirement income. Taxpayer must be 65 with income from a pension or 401k. There is a cap and IRA distributions do not qualify. I am curious if your state's retirement income tax exclusion is unlimited. .

 

[gauss]

If you can scrape together ~ 500K in funds that don't have a 10% Early penalty (which it looks like you should be able to do if I am reading your opening post correctly) , you could fund your living expenses for about 5 years.

Simultaneously you could start doing yearly 100K Roth conversions that you could access penalty free beginning in years 6-10 or so (ie until reaching age 59 1/2). You may wish to do even larger conversions so that you can work down that large pre-tax balance that you are facing during your relatively low earning years and definitely before SS. (In my case our annual Roth conversions take us to the top of the the 24% tax bracket).

Perhaps you could establish a HELOC for your paid off house in case you need a bridge to the 5th year.

In this scenario there would be no 72(t) / SEPP plan needed and you would not need to resort to the potentially more risky 8606 line 22 loophole strategy (see Rollovers from designated Roth accounts and Note 5) that can potentially turn Roth 401k sourced, Roth IRA distributions partially into funds that would be immediately available without 10% Early penalty.

-gauss

 

[A Bird In Hand]

At your asset level of $3.9M in tax deferred, why not go big on the SEPP? Make it big enough to cover your worst case inflation spending scenario, up to about your max of ~240k. Sock the excess in the regular brokerage for lumpy expenses. Sure you'll have to pay the income taxes, but they're coming eventually anyhow. Leveling the income over the years reduces RMD taxes later.

The main reason is optimizing for ACA credits. We'd be losing roughly $9k/yr in credits if we go above ~$154k MAGI. For us that would be ~$81k over the 9 years that we'd be on the SEPP. I haven't carefully weighed this against what we might gain by withdrawing more (e.g., using the excess for Roth conversions)

The other reason is just the inflexibility of SEPP. If life circumstances change, and we get a windfall or have an interesting j*b opportunity or whatever, I think it would be useful to have a smaller guaranteed locked-in SEPP so we could still manage income/taxes.

Finally, it's hard to resist staying in the 12% bracket, which we can do at $133k/yr.

 

[A Bird In Hand]

The other suggestion / question is why two IRAs for each of you for the SEPPs? Why not just one IRA for each of you and do one SEPP each, for a total of two (instead of four)? The only reason I can think of would be if you were wanting to bring them online at different times or run two different SEPPs...which you *can* do but it's added complexity.

The reason for a bunch of SEPPs (4!!) is so I have more levers to pull to potentially control income in a more granular way, should that be desirable for whatever reason. The lever on each would be the one-time allowable switch from amortization -> RMD method, which...depending on how the market does could mean an increase or a decrease in yearly withdrawal.

You could also "calve off" an additional IRA from the non-SEPP IRA and start another SEPP program at age 55 if you wanted to - this could be a mitigation tactic for the "higher expenses" risks in your table.

Good point. I suppose we could do that at any point if needed -- though no later than age 55 would be ideal of course.

You might try to hang on to work for another year or two to delay starting the SEPP and shorten it by a year or two, but you may have other reasons to want to stop working which may override the value of having a somewhat shorter SEPP duration.

More than likely it will take us a year or two to decide which path to take anyway. In a way, it would be much easier if our j*bs became so intolerable that we quit impulsively, or we got laid off. Then we could choose a reasonable path out of necessity and just go with it. A little less conversation, a little more action.

 

[SecondCor521]

The reason for a bunch of SEPPs (4!!) is so I have more levers to pull to potentially control income in a more granular way, should that be desirable for whatever reason. The lever on each would be the one-time allowable switch from amortization -> RMD method, which...depending on how the market does could mean an increase or a decrease in yearly withdrawal.

Understood. If four is good, maybe 8 or 16 are better. ;-)

At a quick glance, it looks like the SEPP IRA would have to about double for the RMD method switch to result in an increase in the SEPP amount.

Good point. I suppose we could do that at any point if needed -- though no later than age 55 would be ideal of course.

That was my thought when I considered a similar path for myself. Keeping the interest rate at 5% helps, because it preserves more non-SEPP IRA dollars for later.

A little less conversation, a little more action.

;-)

Good luck.

 

[A Bird In Hand]

If you can scrape together ~ 500K in funds that don't have a 10% Early penalty (which it looks like you should be able to do if I am reading your opening post correctly) , you could fund your living expenses for about 5 years.

We do have about $500k in cash, 457b, Roth basis, and MBDR conversions that are coming online in tranches over the next 5 years. So you're right -- it could be feasible to mostly fund our expenses. Though we'd be stuck with Medicaid/CHIP. I'm not sure how I feel about that.

Simultaneously you could start doing yearly 100K Roth conversions that you could access penalty free beginning in years 6-10 or so (ie until reaching age 59 1/2). You may wish to do even larger conversions so that you can work down that large pre-tax balance that you are facing during your relatively low earning years and definitely before SS. (In my case our annual Roth conversions take us to the top of the the 24% tax bracket).

Perhaps you could establish a HELOC for your paid off house in case you need a bridge to the 5th year.

We don't have quite enough money in our cash + 457b + Roth basis to fund both living expenses and Roth conversions for five years, but the gap isn't huge. $100k/yr Roth conversions done in years when we have no other taxable income would only be about $7,659 if my math is right. Then add in $15k for expected ACA costs. And $6.5k (assuming $106.5k spending). So roughly a $23k shortfall each year. HELOC could be an option to cover the gap, or we could consider a hybrid strategy: set up a relatively simple/modest SEPP on a $410k IRA to give us ~$25k/yr. We could bump it up a bit higher if we wanted to have a bigger cushion and prevent fully depleting our cash reserves over that 5 year period.

 

[A Bird In Hand]

^ Whoops: I forgot that the 457b is pre-tax, so more of those Roth conversions would be in the 12% bracket than in my example above. But converting at ~12% is still appealing. Plus the primary motivation beyond establishing the ladder for income is reducing the pre-tax exposure to better manage IRMAA and RMD's in the future.

The Roth conversion ladder always appealed to me, but I sort of discounted it because I didn't think we'd have a chance to save 5 years of expenses ahead of time. So we prioritized pre-tax accounts instead. It seems that this nearly turned into a self-fulfilling prophecy

 

[Aerides]

Your 10k for a bronze plan seems low unless you are expecting subsidies? You have to manage your MAGI under $84k (or whatever 2027 winds up being, something near that). Staying under that for 15 years with your budget will be a challenge for you to manage every year. Our bronze plan would near 30k for two if we didn't have any subsidy.

 

[A Bird In Hand]

Your 10k for a bronze plan seems low unless you are expecting subsidies? You have to manage your MAGI under $84k (or whatever 2027 winds up being, something near that). Staying under that for 15 years with your budget will be a challenge for you to manage every year. Our bronze plan would near 30k for two if we didn't have any subsidy.

Yes, we're assuming MAGI up to the top of the 12% bracket: $100,800 + $32,300 SD = $133k MAGI. This puts us at 344% of FPL for a family of 5, and premiums are about $9k/yr for bronze after ACA credits.

The FPL + subsidy calculus changes starting in ~8 years as our kids start aging out of our ACA coverage -- or earlier if they launch before age 26. I think it's worth accounting for this when we stress-test this plan. Our ACA costs could go up a lot if the kids launch earlier than expected, but then again our expenses would also likely be going down in that case.

 

[marinauser]

Cutting it far to close for my comfort. I have watched our expenses climb about 60% over the last 12 years of retirement and we live the same lifestyle in the same house driving the same cars. Likewise, cars need to be replaced as we had to do this year, homes need work done and other of life's uneven expenses come up over longer periods of time. My sense after this time is that take what you think will be safe and add 50% to those assets and you will be much happier over the rest of your life in retirement. We worked too hard to have to watch interest rates, every nickel we spend and have to worry about five years from now to cut it close.. Of course, everyone's personality is different.