Accessing Investments And Retirement Accounts Now
For centuries people have retired early and yet the word early retirement stirs up a lot of controversy.
I’ve heard it all by now… “you’ll be bored… you will run out of money… you are not being productive… you would be throwing your career and education away…”
This post is about the logistics of living off my investments today, drawing down from my retirement accounts to generate an actual monthly living expense. I’ve never sat down to do this and though I probably should torture my financial adviser and have Andrew run this scenario with me, it’s better that I do a dry run so at least we are on the same page.
I have most of my money invested in tax-deferred accounts which means that I would have to play some stupid accounting games in order to access that money before age 65. I’ve talked about it before, it’s a tedious thing to have to do but quite doable.
The Money And Accounts I Am Working With
I know charts are boring to look at but focus on the highlighted section ‘All Investments’ which is at $420k from June of this year.
The $420k is broken up into $34k of pretty much all cash.
Then $49k invested in taxable (immediately accessible) index funds.
$19k is invested in REITs (real estate investment funds).
$206k is in tax-deferred IRA invested in index funds as well.
$87k is held in a 401k, tax-deferred as well, of course.
Finally $34k in a cash balance plan, similar to an IRA.
Let’s look at a few ways I could start accessing my money from easy to complicated. Remember, if you have a FA then she/he can worry about the minutia and you can just collect the checks.
Eat The Penalties, Put Everything In One Basket
Accessing my IRA and 401k before age 65 could be done by me just cashing them out and incurring a 10% penalty + paying income tax on all the money converted. The income tax I would have to pay regardless of what age I take it out at so it’s not as big of a factor (unless I am in a much higher tax bracket now versus later).
$338k of my money is tax-deferred. So I would pay 10% + 35% for income taxes. That means I would be left with $185k which I could treat as my taxable account
Add the other $83k from my private brokerage investments and I’ll have $268k which I could use to live off of… sort of weak even for me.
This method would be a fail for me. If I were to live off of the dividends as well as selling some of the appreciated stock I would still only have $890/mo. Depending on how the market does, some months I’d be eating cat food and other months fancy vegan burgers.
Convert Only What I Need (IRA Ladder Method)
I can convert a portion of my IRA every year to a Roth IRA. It’s legal and very easy to do. The advantage is that I could withdraw my contributions to the Roth IRA without any penalty and without needing to pay taxes. I would have to wait 5 years after each conversion.
If I wanted to stop working I would finish out this year and start 2017 by converting $20,000 from my IRA to a Roth IRA.
The reason I picked $20k is because converting from IRA to Roth IRA is the same as having $20k of income, which will be taxed. But, up to $20k for 2017 can be earned income and after exemptions and deductions it will only be taxed at the lowest rate … 10%. Assuming I have no other income for that year.
So, only 10% would go to the IRS, that’s $2k. Not bad at all. I would be left with $18k.
IRA Ladder Strategy
Every year I would convert about the same amount, perhaps slightly increasing it for inflation.
I would then just do this conversion every year, essentially creating a laddered conversion. It would be another 5 years before I could access the money without any penalty which would take me to 2022.
I happen to have 1 Roth IRA account already, along with my cash savings these 2 accounts could hold me over for probably 3 years.
Alternatively, I could take an early withdrawal from another portion of retirement account, take on the 10% penalty for another 2 years and wait until my Roth IRA ladder is complete. By 2022 I would have access to my money without penalties or income taxes.
The one caveat is that I can only touch the converted amount and not any of the earnings. The earnings can be accessed at age 65, dipping into the earnings before then is another 10% penalty. In today’s economy I don’t expect the earnings from mutual funds will be all that much anyways.
Appreciated Funds And Dividends
Still reading? Anyone?
I might be just writing for myself here but fuck it, it’s good practice for when I get old and grumpy and walk the streets grumbling to myself.
Converting my money over so that I can access it isn’t the most ideal scenario because with my current spending I would still run out of all of it in less than 20 years. The point of investing in Wall Street is to benefit from the growth of the funds.
Ideally I want to be accessing only appreciated funds and dividends. Appreciated funds can be sold and the profits pocketed while the dividends keep on coming every 3 months.
Index funds have dividends or yields or whatever you prefer to call them. My funds generally have a 2-2.5% annual yield. So every year I get 4 quarterly deposits of 2% into my account. It’s 2% of however much I have invested.
$420k is my total paper investments. $34k of it is held in cash equivalents. So really only $386k can earn the yield which would come out to $7,700/yr. Or $640/mo.
Convert Only What I Need
Let’s say I stopped having any work/job income in 2017. I can then convert just $20k at a time from my IRA every year which would create a 10% penalty and a 10% federal income tax rate. There won’t be payroll but there might be state income taxes as well.
At only 20% that’s about what I would expect to pay once I withdraw my retirement funds by age 60. What I’m trying to say is that despite the “penalty” leaving a bad taste in my mouth, the math actually comes out the same.
My $20k would become $16k of annual income or $1,300 of money straight into my pocket. This is close to what I would be spending if I didn’t have a job to worry about.
Annuitize My Money
We are experiencing a bull market so annuities aren’t even on our radars. It’s mostly the financial advisers, tax planners and CPA’s who are dealing with annuities. This will likely change once bond funds start dropping, stocks start producing negative returns and inflation gets too high for CD’s and savings accounts to be in the positive.
I can take either my IRA or the converted amount from my IRA and give it to a large insurance company and get a fixed monthly payment from them in return.
I won’t go into explaining SPIA’s, but they are worth reading about and fairly straightforward. The main point is that you give up rights to your sum of money in return for a fixed and guaranteed monthly/annual payment for a period of time.
What Is A Realistic Option For Me
In my case I still have the ability to earn income. My money is mostly held in retirement accounts and the advantage there is that I don’t have to pay taxes while they are growing.
I will probably leave my retirement accounts alone and moving forward will stop contributing to traditional, tax deferred retirement accounts and instead either opt for Roth accounts or invest in a private brokerage myself.
If I anticipate a low tax year coming up, such as if I decide to live abroad for a year, then I will convert some money into a Roth IRA which will allow me to at least access the converted amount in case I need living expenses down in the near future.
I don’t want to hold too strong of a position in cash but want to have enough of it around that I can at least pay for my basic overhead for the next 3-5 years.
What’s Your Retirement Plan?
I have colleagues who are wanting to retire as early as age 50 but they don’t have a solid plan on having income between age 50 and when they can actually access their retirement funds (age 59.5).
Will you have a rental income property which will be paid off by age 50?
Will you have several years of cash reserved put away to get you through those years?
Will you build up your private brokerage investments enough that it will generate adequate income for you between age 50-60?
Will you sell a business, property or other investment at age 50 to generate you enough money to hold you over?
Will you move to a much cheaper cost-of-living locale in order to need much less income in that decade?