Money Audit: Can I Retire Early?

Money Audit Money Audit: Can I Retire Early

Mint devotees James, 51, and wife, Carol, 43, hope to mark 2018 as the year they achieve what many only dream of accomplishing: retiring early from the daily grind.

He’s a technical manager and she’s a self-employed real estate agent residing in Birmingham, Alabama. Their net worth totals $1.66 million (not including their mortgage-free home).

“Is financial independence within our reach?” James asked via email.

At first glance, I thought, “absolutely.”

But most of their money is tied up in retirement savings vehicles like a 401(k), SEP IRA and a pension, which require that you reach “retirement age” to make withdrawals without penalty, usually 59 ½ years-old.

Assuming the recommended distribution of about 4% from their investments each year in retirement starting at age 60, their nest egg can more than cover their cost of living once they become eligible to withdraw from those accounts. Plus, James says his social security payments will be roughly $3,000 per month once he can begin collecting.

But can the couple feasibly retire now?

Ahead of some suggestions for James and Carol, here’s a bigger snapshot of their finances:

Household Income: $160,000 per year

Savings/Investments: $1.66 million

  • $1.2 million in a Roth IRA, SEP-IRA and 401(k)
  • $192,000 expected lump-sum distribution from pension
  • $221,000 in a brokerage account
  • $50,000 in cash

Debt: Zero. Everything’s been paid off.

Monthly Spend: About $3,000 not including vacations and payroll taxes.

  • Groceries $350
  • Cell Phones $135
  • Car/homeowner/umbrella liability insurance $177 combined,
  • Health insurance $400• Life insurance $25
  • Gasoline and car maintenance $230• Power $160
  • Property tax $150• Leisure $150• Dining out $200
  • Utilities $65
  • Medical $100
  • Gifts $200
  • Clothing $125
  • Non-grocery $125
  • Home maintenance $150
  • Auto registration $25
  • Other $250
  • Vacations and travel $1,700
  • Payroll Taxes $2,600

Okay, here are my thoughts.

Let’s Run Some Numbers

How much money would the couple realistically need each year to maintain their current lifestyle (which I don’t think is lavish)? And where would they source that money?

Let’s guesstimate.

Their current expenses – minus the cost of payroll taxes from Carol’s real estate company, which would, presumably, be much lower once she winds down the business in retirement – are roughly $4,700 per month.

No longer receiving health benefits through James’ employer, the family would need to secure their own medical insurance until qualifying for Medicare at age 65. Until then, they could easily see their medical expenses jump by a factor of two – maybe more.

That means that they’d need about $6,000 per month to keep status quo…at least until their 13-year-old daughter is headed to college, at which point their expenses may creep higher. However, James said they’re working on a plan to mitigate those costs by encouraging their daughter to earn high school Advanced Placement credits, which can be applied toward college credits. The family estimates providing $10,000 per year for their daughter’s schooling, while she’d cover the rest. (And by the way, they may be able to tap their Roth IRA for college expenses when the time arrives.)

Their current cash savings and brokerage account investments total $271,000. After taxes, I figure money could stretch about three and a half years. James still wouldn’t be eligible to withdraw from his 401(k) at that point.

Don’t Quit (Yet).

Instead, take the year to transition.

As stated, with so much of their savings tied up in a 401(k) and various IRAs, it will be eight years before James – and 16 years before Carol – can qualify for penalty-free withdrawals from their retirement portfolios. The remaining money in their traditional savings and brokerage accounts ($172,000) is only enough to cover them for a limited number of years given their current expenses and the fact that they’ll need to pay more for medical insurance.

For these reasons, now may not be the best time to quit their careers cold turkey.

James even admitted to not wanting to leave the workforce entirely.

Instead, the couple wants to channel their skills into new lines of work that offer more time and flexibility. With his technical skills, James envisions bringing in some income through consulting work. As a real estate agent, Carol looks forward to staying active in the market, but working on fewer deals.

I suggest they utilize the first half of this year to better map out – and even experiment with – their work/life framework in early retirement.

Can James plant some seeds this year for securing consulting work and land a client or two? Can Carol wind down, say, 20 to 30% of her business and start working on projects she’d like to pursue in retirement?

Meantime, could they stow away another $70,000 in the bank? With about $120,000 in cash– the equivalent of two years of living expenses –the family then has a long, liquid runway to fully build out this next chapter in life and establish new revenue streams to support their expenses. Eventually earning a combined $60,000 a year in part-time work would be a healthy target so that they could extend the need to tap their retirement portfolios – to perhaps even beyond age 59 ½.

And speaking of retirement portfolios…

Keep Investing, but Be Mindful of Stock Exposure.

Just because they’re retiring, doesn’t mean their investments should get out of the game, too. It will be many years before James will want to withdraw from his 401(k) and Carol from her SEP-IRA. [By the way, for James, once he quits his job, he may want to transfer his 401(k) to a Traditional IRA to be able to continue making some annual contributions.] If the market takes a dip or a dive, they should have enough time to recover.

That said, too much exposure to stocks at this stage in life, and particularly because of their soon-to-be reduction in earnings, means they don’t want to be overexposed to the stock market.

A very general rule of thumb is to subtract your age from 100 and make that your stock percentage in your portfolio allocation. So, Carol, who is 43 years old, would want to be about 57% invested in stocks and the rest in bonds and cash. James would want to be around 49% invested in stocks. If they believe their risk tolerance is below average, then they may want to consider investing even less in stocks.

In summary, early retirement (aka living life on their terms sooner than later) is not unfeasible for James and Carol. Calling it quits tomorrow? Not so much. But if James takes the year to build inroads in the world of consulting and Carol to unwind some of her clientele while exploring other passions and pursuits (and all the while both continuing to save), I think that in a few years they could be fully immersed in their definition of early retirement!

 

Farnoosh Torabi is America’s leading personal finance authority hooked on helping Americans live their richest, happiest lives. From her early days reporting for Money Magazine to now hosting a primetime series on CNBC and writing monthly for O, The Oprah Magazine, she’s become our favorite go-to money expert and friend.

Comments (7) Leave your comment

  1. I was also going to mention the rule of 55 to help dispel this 59 1/2 age that everyone points to regarding 401k. Only restrictions are that it is based on account from your last employer at time of retirement.

  2. Rule of 55 will allow them to w/d penalty free before 59 1/2 age as long as the w/ds are from 401k at employer at time of retire. Check the fine print on your 401k to ensure no issue there, then consolidate your 401ks into this one before retiring (as you can only access the 401k of employer you retired from…)

  3. You can also use rule 72t from the IRS: equal payments for greater than 5 years or past 59.5 years old. It’s sad to see ‘financial planners’ either ignore this availability or not be proficient in their field.

    As the others stated, you can also withdraw penalty-free after January 1 of the year you turn 55; it doesn’t necessarily have to be retirement-just quit!

    1. Good points! Also, the employer’s 401(k) plan document must support the early separation exception provision of the tax code. Most plans do allow this exception, but a few don’t.

  4. I retired 5 years ago at 52. My finances were similar to the couple in this article. Before I retired, I tracked my living expenses for 5 years to make sure I had a handle on my expenses.

    There are many work-arounds to the 59 1/2 rule. For example:

    1) The 401(k) rule mentioned in the comments applies to employees who terminate their employment in the year they turn 55. Note that you can be 54 when you quit as long as you turn 55 by Dec 31 of that year.

    2) Another exception to the early distribution penalty rules is called Substantially Equal Periodic Payments (SEPP). Under the SEPP rules, you can be ANY age, but the distributions must continue for 5 years from the start date or age 59 1/2, whichever occurs later. Warning: SEPP is a fairly complex tax maneuver, so get some help and follow the rules exactly in order to avoid the early distribution penalty.

    3) This family can probably tap into their Roth IRA account(s). You can always withdraw your Roth contributions tax-free and penalty-free. You just can’t take distributions of the earnings from a Roth IRA before 59 1/2 unless you meet the requirements for an exception to the rules. Before attempting this, make sure you have all your Forms 5498 to substantiate your Roth contributions.

  5. The advice in this article about limiting exposure to stocks is inconsistent with the research of MIT-educated engineer turned financial planner, William Bengen, on safe retirement withdrawal rates. Bengen argues rather convincingly that the safest retirement portfolio (least chance of running out of money) is 75% stocks, the rest bonds. If this seems counter-intuitive, read Bengen’s classic article, “Determining Withdrawal Rates using Historical Data” published in the Journal of Financial Planning.

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