Saturday, March 16, 2013

Counting Chickens

I'm sure the recent steady rise of stock prices has a lot of people feeling richer -- myself included.  Although I've been reluctant to make many new additions to our FI Portfolio recently, the reality of our finances is that most of our investments are held in long-term retirement accounts which have benefited greatly from the return of markets to record highs.

In a classic case of counting chickens before they hatch, I projected the future performance of our retirement savings over 25 years (the length of time between the average age of my wife and me [34] and 59.5 years old [when current US laws would allow us to start to withdraw money from these accounts without penalty]).  I used the sum of the most recent market values of our retirement accounts (as of last Friday's close) and assumed several different average rates of return to see a possible range of outcomes.

As you can see in the image below, assuming a conservative 3% annual return, we would have a million dollars in our retirement accounts in 25 years.  Each 1% increase in the average rate of return above 3% would significantly add to our nest egg when we reach the government-approved retirement age.  At a 5% annual return, we'd have $1.6 million.  If we can somehow manage to see 8% returns on average, our retirement assets would swell to $3.3 million.

Of course, our investments are not guaranteed to go up.  As an extreme example, we could see a 30% drop in value next week, meaning the starting amount in year 0 of the table would be significantly less, and the numbers in year 25 wouldn't be as impressive.  However, even in that more pessimistic scenario, after 25 years the end result should allow us a modest lifestyle in our golden years.

One thing my table doesn't show is any new contributions we will make to our retirement accounts.  We both get matches from our employers on contributions to our workplace savings plans.  We also expect to continue adding the max amount to our Roth IRAs every year we are earning a paycheck.  So it's possible that the year 25 row values are on the conservative side.

The point of this exercise for me was to confirm my suspicion that we have oversaved for our retirement up to this point in our lives, and undersaved for the 25 -year span between the present and when we are 59.5 years old.  When you also consider that we should get something in the form of Social Security benefits in our 60s, the possibility that we've oversaved for retirement becomes even more likely.

The reality of our current situation is that we have 25 years to bridge, but I don't see us getting our FI portfolio to a point where it would produce enough income to allow us to quit full-time work any earlier than 10 years from now -- given our current savings rate and lifestyle.  By that point we'd only need to cover 15 years until we could tap our retirement savings.  And by then we could probably afford to spend some of the principal of our FI portfolio (along with the income) in order to get ourselves to age 59.5.

I've been trying to come up with creative ways to access our retirement savings early so that we can make a smoother transition to part-time work or early retirement.  Unfortunately the current US tax laws don't have many loopholes to aid people in our situation.

If we happened to see a new bull market in the near future and had several years of significant gains (similar to what happened in the 1995-1999 timeframe), I wouldn't necessarily be opposed to pulling some money out of the retirement accounts early and paying the 10% penalty.  I think this would be an extremely fortunate and unlikely scenario though.

We can withdraw our Roth IRA contributions at any time without penalty.  I think this would be helpful making a final push to get our FI portfolio where we wanted to be.  For example, if in the future we had $500K in our FI account and our goal was to have $600K in income-producing assets, we could take $100K of contributions out of our Roth IRAs and move it over to the FI account to reach our goal.  This won't make a huge difference in the near term, however.  This would likely be a shortcut we could use several years down the road.

We could always stop contributing to our retirement accounts.  This would allow us to divert more income to our FI portfolio.  But since we get matching contributions from our employers, it seems like we would be neglecting an opportunity for free money by making that choice.  Even if we decided later to withdraw from the accounts early and pay the penalty, our employers are matching at a rate higher than the 10% penalty -- so we would still come out ahead in the end.  And as I said before, any contributions we make to the Roth IRAs can be withdrawn penalty-free later, so it makes more sense to me to contribute to the Roths now to allow an opportunity for some income/appreciation to occur in the tax-sheltered account until we are ready to pull the contributions back out.  So stopping retirement contributions seems like a bad choice to me.

My wife has also talked about making lifestyle changes that would help us reach our goal sooner.  For example we could sell our current house and downsize to a very inexpensive location (a trailer in the middle of nowhere) and pinch our pennies while waiting for our investments to compound over time.  This sounds sort of romantic, but it would be a major change and would require us to give up a lot of things we currently enjoy.  I think there is probably a middle ground to be found here, but it would require a lot of planning and discussion so we can agree on what we want from life over the next 25 years.

We could also try harder to change from full-time to part-time work.  However as I've mentioned before, it doesn't seem like there are many opportunities for us to work part-time in our current fields -- employers seem to want to hire professionals for full-time positions only these days.  (As an example, my employer has all but eliminated part-time positions across the firm.  Current part-time employees are "grandfathered" in but no new part-time positions are being offered.)  In order to shift to part-time, we'd need to find new types of employment, and the most common part-time work is found in very low-wage jobs.  It might be possible for us to create our own higher-paying part-time jobs, but it seems to me that getting to a point where one can work in a part-time consulting or entrepreneurial role requires a large amount of up-front effort (in hours, stress, money, education/licensing, etc).  I really don't want to take on a huge commitment for something meant to last only 5-10 years.  I'm not looking to embark on a new 25-year career.  I'm looking for the path of least resistance.

I keep hoping I'll stumble across something new that I haven't considered (or didn't know about) which would help us in our situation.  Until then we'll continue to work our jobs and save as much as we can.


  1. Hmm, I don't know...

    If that were me sitting on almost $500k in accessible funds I think I'd stop working right now. I don't know what your expenses are, but is it not possible to roll all this money over to one IRA and set up a SEPP? Figuring on a 4% SWR, you'd be getting almost $20k/year for the rest of your life. This doesn't count the taxable account to juice your income. Plus, you have the house you could tap into if you wanted to downsize slightly.

    Maybe I just hate my job enough, but with the position you are in I think I could get pretty creative and figure out how to retire within a few months.

    Best wishes!

    1. You're probably right, and this post was my own way of venting my frustration that I can't find a way to make things work out. I've checked into the SEPP (72t) and unfortunately it doesn't seem like the best solution. In our case we'd see max $14K per year, and that would be subject to tax, reducing it closer to 10K. Plus that would be a drawdown of principal which I'm not sure I want to do this early on. And then what happens when we turn 60? Would we have enough left to last us another 30-40 years at that point?

      If there was a way to withdraw a larger amount without penalty, I would be more compelled to do that. But $14K per year is not enough to interest me right now.

      I'm hoping the market swings wildly one direction or the other in the near future. If it drops, I can add to our taxable savings. If it rises, then the case for taking a large premature distribution from the retirement accounts gets even stronger.

  2. Have you done any research on the 72-T Early Distributions that are allowed? This would seem to be a possible or at least partial solution to what you are wrestling with.

    1. I have done some research. See my response to DM above.

      The 72t/SEPP guidelines are very inflexible. You must choose one of the three approved methods, and then follow it to the penny, or risk penalty on the entire amount. The longer the plans remain in place, the larger the risk that something gets messed up. In our case it would need to last around 25 years. Lots of room for error there.

      Plus as I mentioned before the current allowable amount for our situation is small enough to be less than useful ($14K pre-tax), and as time rolls on, inflation is going to erode the significance of that amount with each passing year.

      I think it would be at best a partial solution. I think we need to save up a bit more before that makes sense as part of a comprehensive plan for early retirement.

  3. My goal is to not have to tap the 401k through 72-t and rely solely on dividend income and the occasional income opportunity if I don't decide to go to work after FI. My job has me gone from home way too much and I don't want to have to deal with that any longer than I have to.

    1. Sounds like you have a good plan in place. Hopefully you don't find yourself in my position realizing you have more than you need in long-term savings and not as much as you'd like in taxable accounts.

  4. Regarding your retirement contributions, you discuss stopping them and continuing them. But there is a third choice; you could cut back. Contribute enough to get the full match, but no more.

    1. Good suggestion. My contributions were already scaled back to the level of "just enough to get the match" (a step we took when we embarked on the Death to the Mortgage project), but we'll probably cut my wife's workplace contributions soon as well.

  5. Have you considered rolling your tax-advantaged accounts into a Roth IRA in stages? You would pay income tax as your roll the IRA or 401(k) into the Roth, but then you can withdraw the roll-over as principle.

    1. Yes! I love this strategy. I hope we can use this someday.