Missing piece of the ER puzzle (for me)...

[MaudMan]

Greetings Mustachians!

I've been very fascinated with the whole early retirement (ER) thing for the past 10+ years, and I've been saying I will retire by 55 or sooner (I'm 46 now) for a long time now. Granted, 55 is likely not considered ER in this forum, but that's my current goal nonetheless. :)

Anyway, I read/listen to MMM, ERE, and a host of other FI/ERE blogs & podcasts all the time. In fact, it seems like that is all I read or listen to anymore.  I understand all the the general concepts and mathematics of how to achieve FI and then live off the cashflow from investments.  But what I seem to be totally missing is exactly HOW & WHERE all the currently retired [early] folks invested their money prior to achieving their goal of FI/ER.  Pretty much everything I read advises to max out tax advantaged accounts such as 401Ks, IRA's (Roth and traditional), HSA, pay down mortgage early, eliminate debt, etc.  I've been doing all that, and it leaves very little money left over to invest in regular non-tax-advantaged accounts which I assume I will have to live on when I retire early. 

Therein lies the missing piece of the puzzle for me.... What exactly DO I live on when I retire early?  I don't believe I can start drawing Social Security at 55 or younger, and I can't really tap the retirement accounts at that age, can I? It seems I need a big ol' pile of cash somewhere, or a huge sum of money in an investment account earning more than the 3-4% I'd have to draw against it each year to live.

Should I stop investing in all the tax advantaged stuff and pour everything into a regular investment account for the next 10 years?  It seems that would drastically increase the amount of tax I'm paying on my current job income, and further reduce the amount I'm able to save for the future.

If you have any questions about my specific financial situation, let me know. But if it helps to formulate your response, I do make a low 6-figure income, I max out my 401K and a Roth IRA for both my wife & me each year. We pay extra toward our mortgage which is ~$92K on a ~$160K home, we save an extra $500/month into a regular investment account, and we do own a short-term/vacation rental property that currently produces around $1000/month in positive cash flow.  Our monthly living expenses are roughly $5K.  We have no other debt except our home and a mortgage on the rental property, and I have a 6-month emergency cash stash.  BTW, this cash stash does not include our regular investment accounts -- this is cold hard cash earning around 3.5% interest and we can get our hands on it quickly in an emergency.

Thank you!

[Gin1984]

Search for the Roth pipeline.  You can pull money from a Roth as long as the contributions have been there for five years.

[Eric]

What it boils down to is that you need to fund your first 5 years of retirement through your after-tax accounts, which will probably be a combination of savings, regular brokerage accounts, rental property income, and Roth contributions.

After that, the conversions you've been doing from your traditional IRA to your Roth IRA will be accessible penalty free.

http://jlcollinsnh.com/2013/12/05/stocks-part-xx-early-retirement-withdrawal-strategies-and-roth-conversion-ladders-from-a-mad-fientist/

[MDM]

What it boils down to is that you need to fund your first 5 years of retirement through your after-tax accounts, which will probably be a combination of savings, regular brokerage accounts, rental property income, and Roth contributions.

After that, the conversions you've been doing from your traditional IRA to your Roth IRA will be accessible penalty free.

http://jlcollinsnh.com/2013/12/05/stocks-part-xx-early-retirement-withdrawal-strategies-and-roth-conversion-ladders-from-a-mad-fientist/

+1

Another option (if available to you) is a 457 plan, which has no age 59.5 constraint.  457 plans are limited to government or non-profit companies.  Some private companies have a 457-like "deferred compensation" plan.  Even when the company has such a plan it may be offered only above a certain pay level - see this thread.

In any case, you are doing the right thing by planning ahead.  As Eric mentioned, it is likely that your income could come from a variety of sources (and several examples are given) - you'll need to choose the ones that fit you best.

[This_Is_My_Username]

I do make a low 6-figure income, I max out my 401K and a Roth IRA for both my wife & me each year. We pay extra toward our mortgage which is ~$92K on a ~$160K home, we save an extra $500/month into a regular investment account, and we do own a short-term/vacation rental property that currently produces around $1000/month in positive cash flow.  Our monthly living expenses are roughly $5K.

You have 100k pretax salary,(+12k for the rental) max out two people's retirement accounts, and spend 60k pa. 

It looks like you are saving only a small percentage of your annual income. 

But you need to fund the gap between age 55 and your retirement account access date with at-call cash. 

The solution is either:

(1) over the next 9 years, save 35% of your take-home income.  This will fund 5 years of expenditure. 
(2) work until age 60.
(3) find a clever legal method to access your retirement accounts early (I don't live in your country)

[MaudMan]

Thank you all very much for the responses so far! Some great stuff to consider and read more about. It sounds like I need to really focus on funding that first 5 years of early retirement. Of course, it becomes a lot less daunting by either increasing rental/business income, or reducing our annual living expenses (or both). 

[Derby]

Another thing that a lot of people are unaware of is that if you retire from a company at age 55 or greater, you can start taking money out of your 401k (at that company only) without penalty. So if you have a 401k with sufficient funds, you can withdraw from that until you reach 59 1/2.

[MaudMan]

Another thing that a lot of people are unaware of is that if you retire from a company at age 55 or greater, you can start taking money out of your 401k (at that company only) without penalty. So if you have a 401k with sufficient funds, you can withdraw from that until you reach 59 1/2.

That is definitely good to know as well! I hope to retire from the company I'm at now, and I should have more than enough to live on for well over 5 years in my 401K by that time. I think I would rather convert the 401K to T-IRA, and then to Roth IRA (hopefully all tax free). I'll focus on other means of supporting the first 5 years of my retirement, but it's nice to know I could tap the 401K if I needed to. Thanks!

[Eric]

MaudMan -- there are also 72(t) withdrawals.  They (probably) aren't enough to live on but if you're combining them with other income, savings and such, and they only have to be drawn on for 5 years, those could be an option for you as well.

(I don't like them for longer time frames, such as my own which would be 15+ years, but I think for shorter times to age 59.5 they can be useful)

[PathtoFIRE]

I think you hear a lot less about the mechanics of how to pay yourself in early retirement for 3 reasons:
1) most readers are far from that step, so the focus is on the early stuff, like saving and reducing spending
2) the questions that you ask are a lot easier to answer than the early and much more daunting things
3) the questions that you ask have to be tailored a little more to everyone's specific situations, so broad generalized topics are not quite as useful in the context of blog readers, etc.

With that said, there are a few apparently (I say that because #1 above still applies to me) tried and true methods:
1) post-tax savings (CDs, after-tax investments, etc.)
2) rental incomes
3) converting the pre-tax 59.5 accounts into usable income (Roth pipeline, 72(t), etc.)
4) side gigs or part-time work
5) royalties and other passive income sources

Which you use will entirely depend on your own situation. I am one of those that is saving nearly exclusively in stocks/bonds, with a roughly equal split between pre-tax accounts that are maxed and then excess in after-tax, so I plan on heavily leaning on #1 above, and using #3 to fine tune what I need, and maybe doing #4 if I can find something that I really like. A number of people here will have a lot of rental income, so #2 will be their mainstay. MMM seems to have used mostly #2 and #4, with #5 coming in to play once he started this blog, as I get the sense he hasn't had to touch his stock/bond investments at all and just keeps adding. Authors and musicians may lean on #5 along with #4.

Your situation sounds a bit like mine, so I would research the suggestions given to you above on how to tap the tax-deferred accounts before 59.5, but I wanted to lay out the broad range of possibilities, as you have plenty of time to get into the rental business, or start a paying hobby or side gig, or even create content/art that can pay you for years to come. For me, our income is high enough that it just makes sense to keep our nose to the grindstone and grind out another 5 years, but I think if my current situation was projecting FIRE in 10 or 15 years, I would be strongly considering diversifying my choices.

[Bikeguy]

Retire mid year, when your overall taxable income for the year is really low and you will be in a lower tax bracket.   Don't put anything into a tax deferred account that year.   Count on that money when doing your planning for how much post tax money to save beforehand.

[Roland of Gilead]

You could do like we are doing and sell your home, live off the cash.  This has several advantages.

1)  You will have no income if most of your stock market money is in tax deferred or Roth accounts.  No income = no taxes, yay!

2)  You don't have to worry about the real estate market crashing  :-)

3)  Because you have no income, you can do IRA to Roth conversions for free.  If you want a super subsidized with fries silver ACA plan, you will need about $22,000 of MAGI to be above the poverty cutoff (but still receive maximum cost sharing and subsidy).  The IRA to Roth conversion can supply this MAGI.

After five years you can take the money you converted into Roth back out of the Roth and use it for expenses...tax free, penalty free, age unimportant and doesn't raise your MAGI.

[El Marinero]

Another thing that a lot of people are unaware of is that if you retire from a company at age 55 or greater, you can start taking money out of your 401k (at that company only) without penalty.

This is absolutely true, and I'm quoting it because it needs to be repeated until everyone on this board knows it!