Prioritizing investments for ER/FI

[Zoot Allures]

Hi all,

First things first, not that it really matters: I was using the name "planteater" here until I got over my shyness about talking about money in a public forum. So now I'm using the handle that I usually go by in online and other circles.

So, I'm familiar with the basic four-point plan for investing promoted by the Bogleheads and others:

1. Company plan (401k, 403b, etc.) up to the company match
2. Roth IRA up to maximum contribution limit
3. Company plan up to maximum contribution limit
4. Taxable Investing

I'm wondering whether and how someone in my situation would modify this plan. First, my company gives a defined contribution of 5% of my salary, so there's no match per se. Second, I want to declare FI in about ten years (age 51), which means I'll need some funds to get me through my 50s until I start withdrawing from my 403b (unless of course I use rollovers to IRA, 72t maneuvers, etc. to get my 403b money without penalty). So in broad terms, how would a mustachian aiming for ER on my timetable go about adapting this four-point plan? I do plan to work some after 51, of course.

A few more details for the record. I have five figures in my 403b and a few thousand in cash. Haven't opened a Roth IRA yet but plan to this year. I have a rental house that covers the mortgage plus a little, and I rent an apartment for myself. I have a company pension plan that will pay out pretty handsomely if I put in another 10 years of service as I hope to do. I've been throwing a lot of my income toward debt for as long as I can remember, but that's going to end soon and I'll have upwards of $25-30k/year available for investing. My sense is to max out the 403(b) at $17k, max out a Roth IRA at $5k, and put what's left over in a taxable account that might double as down payment savings if I decide to buy again. Thoughts on that? And if I decide to save more aggressively for a down payment by putting more money in my taxable account, where would I reduce first: 403b or Roth IRA?

I'm sure all of this has been addressed at length in other threads and MMM posts, but somehow it always seems more complicated when you plug your own life into the equation.

Edit: My money is with Vanguard, btw, and I still have a lot to learn about asset allocation. I'm at 60/40 right now in the Moderate Growth Fund and am feeling lately like I could take more risk.

[astadt]

Spine

Without knowing the details of your pension its really hard to make recommendations. Do you think you can live off of the payoff?

If not, do you think that investing 3-13K a year in a taxable account will make up the difference until you can withdraw from your 403b?

You may want to invest less in your 403b and put the rest in a taxable account. I realize you'd have some tax advantaged account space but you need to focus on your ER phase. I think investing in a Roth is an ok idea because you'll have access to your principle if you need it.

[Zoot Allures]

Hey astadt--thanks for the reply.

Without knowing the details of your pension its really hard to make recommendations. Do you think you can live off of the payoff?

I don't think I can live off the pension, but it'll be a nice chunk. Something like $1K/month if I start withdrawing at 55, or $2K/month if I wait until 65. Of course, that doesn't take inflation into account, but it also doesn't factor in any raises I might get, so the payout could be higher. It could also easily be less if my company changes the formula it uses for pensions. I've sort of assumed I would wait until 65 to collect because the monthly payout is so much more, but I'd definitely be interested in hearing any arguments to start collecting at 55.

If not, do you think that investing 3-13K a year in a taxable account will make up the difference until you can withdraw from your 403b?

Yep, that seems to be the big question here. It's tempting to max out that 403b, but I really have to think about that period from age 51 to 59. I just did some back of the envelope math, using a simple compound interest calculator and assuming a 7% return, and here's what I came up with (based on a total available sum for investing of approx. $26K/year):

403b: current balance of $41K plus $11,250/year (10% of salary from me + 5% from employer) = $247K at age 51. Let it sit until age 59. Ending balance = $424K.

Roth IRA: $5K/year for 10 years = $84K. Let it sit until age 59 = $144K.

Taxable account: $10K/year for 10 years = $148K. Withdrawals from this sum over 8 years until age 59 = $18.5K/year (not sure how to calculate continued growth of the principal over the withdrawal period). Combined with part-time/freelance work, I think that would be enough. Could always supplement with the Roth if need be, as you noted, astadt.

Does this sound basically right? At age 59, I'd have $568K between the 403b and Roth IRA. Considering the addition of SS and pension payout, that would seem to put me in a pretty good zone for a 4-5% safe withdrawal rate.

[astadt]

Spine

Those numbers look pretty good. I wouldnt really count on your taxable money growing at 7% over the short term just because you have to use it within ten years. Since Im going to recommend waiting till 65 to take your SS I'd recommend you put more money in your Taxable accounts (maybe 30% more) and we can see what those numbers are.

That would either come out of your 403b or more mustashian lifestyle changes (not sure where youre at with that, but it certainly is relevant).

[Zoot Allures]

I wouldnt really count on your taxable money growing at 7% over the short term just because you have to use it within ten years.

Ah, right--I forgot I need to be a little more conservative with that stash. Not sure if that means I'd invest it less aggressively or just be especially aware of the risk and have a backup plan. Maybe both.

Since Im going to recommend waiting till 65 to take your SS I'd recommend you put more money in your Taxable accounts (maybe 30% more) and we can see what those numbers are.

Would you recommend waiting until 65 to collect on my pension plan also? Or is that what you meant? Either way, I do see the value of increasing the short-term stash in my taxable account. Ideally I could do so by upping my savings % rather than shortchanging the other vehicles. I'm pretty mustachian already in my spending.

I saw a thread on another ER site about taking pensions early...people seemed to be in favor of it because even if the early payment is lower, it's a guaranteed payment that is much less likely to be taken away once payout begins. (My company is quite stable, though.) Also, there was the argument that by taking pension early, you can withdraw less from other savings and reap more compounding benefits that way.

[astadt]

Your Short term cash should be conservatively invested. All you need is another short term roll back to force you into a bad situation (like dipping into SS and messing up the rest of your retirement. I dont want you working at Walmart unless you want to.

Im not sure how your pension would work if you took it early but if it makes sense, take it for all of the reasons you listed. Other wise you could take a larger chunk from your Taxable account early on and wait a few years until it makes more sense to take your pension.

[JohnGalt]

(unless of course I use rollovers to IRA, 72t maneuvers, etc. to get my 403b money without penalty).

Why wouldn't you just use these options? 

At your, presumably, low tax bracket in your ER timeframe, you should do just fine using the roth IRA roll-over to roll-over the funds you will need to withdraw in 5 years every year.  That just leaves the first 5 to cover out of taxable accounts (or Roth contributions).

[Zoot Allures]

Why wouldn't you just use these options? 

I guess I'm just not totally clear yet on how the math and benefits all work out. Seems like tax efficiency is the big advantage of maxing out the 403b now and rolling over to Roth IRA later. I suppose another consideration is whether and how much to draw down the principal in the 403b as opposed to just skimming off the earnings.

At your, presumably, low tax bracket in your ER timeframe, you should do just fine using the roth IRA roll-over to roll-over the funds you will need to withdraw in 5 years every year.  That just leaves the first 5 to cover out of taxable accounts (or Roth contributions).

Yeah, I want to make sure I understand this. What exactly is the deal with the five-year holding period?

[JohnGalt]

Why wouldn't you just use these options? 

I guess I'm just not totally clear yet on how the math and benefits all work out. Seems like tax efficiency is the big advantage of maxing out the 403b now and rolling over to Roth IRA later. I suppose another consideration is whether and how much to draw down the principal in the 403b as opposed to just skimming off the earnings.

At your, presumably, low tax bracket in your ER timeframe, you should do just fine using the roth IRA roll-over to roll-over the funds you will need to withdraw in 5 years every year.  That just leaves the first 5 to cover out of taxable accounts (or Roth contributions).

Yeah, I want to make sure I understand this. What exactly is the deal with the five-year holding period?

I haven't looked into 403b specifically so I don't know if anything is different from 401k - but, as I understand, roth contributions can be withdrawn at any time, penalty free.  When you convert a traditional IRA to a roth, you pay taxes so those dollars aren't really any different from contributions - there is just a 5 year seasoning requirement before they're treated as such.  So, after 5 years, they can be withdrawn penalty free.

[Lars]

Without knowing the details of your pension its really hard to make recommendations. Do you think you can live off of the payoff?

I don't think I can live off the pension, but it'll be a nice chunk. Something like $1K/month if I start withdrawing at 55, or $2K/month if I wait until 65. Of course, that doesn't take inflation into account, but it also doesn't factor in any raises I might get, so the payout could be higher. It could also easily be less if my company changes the formula it uses for pensions. I've sort of assumed I would wait until 65 to collect because the monthly payout is so much more, but I'd definitely be interested in hearing any arguments to start collecting at 55.

What is your target income, or alternately, minimum and preferred income in retirement? Based on your information, it seems reasonable that social security and the pension will exceed your minimum income needs at 67. This would make your plan quite robust if true. If the market is performing poorly in your 50s, withdrawing from the pension at 55 could improve your odds of success.

Have you checked with a retirement calculator like FIREcalc to see how well things work when the markets don't behave nicely?

[Zoot Allures]

What is your target income, or alternately, minimum and preferred income in retirement? Based on your information, it seems reasonable that social security and the pension will exceed your minimum income needs at 67. This would make your plan quite robust if true. If the market is performing poorly in your 50s, withdrawing from the pension at 55 could improve your odds of success.

Have you checked with a retirement calculator like FIREcalc to see how well things work when the markets don't behave nicely?

I'm aiming for about $25-30K/year in retirement. Maybe more at the beginning because I may still be paying down a mortgage. The pension alone should cover a huge chunk of my needed income, so I'm very fortunate in that regard (fully vested this November!). I've played with FIREcalc a little and the results are promising, but I'm not sure how accurate the data I'm entering are. Bit of a guessing game.

I'd love to be able to move my FI date up a few years, so I guess I'll just keep an eye on my portfolio and run the numbers periodically on my estimated SS and pension payouts (which of course will be less if I quit my job sooner).

[grantmeaname]

Ah, right--I forgot I need to be a little more conservative with that stash. Not sure if that means I'd invest it less aggressively or just be especially aware of the risk and have a backup plan. Maybe both.

You've got the right idea here. You may be able to take on more risk. It really depends on your flexibility as much as your timeline. If the next 2008 happened when you were planning on retiring in 2022, would you be willing to work another two years? If so, you may not need to become more conservative in your asset allocation at all. It's easy for a 30-year-old retiree to say they'd go back into the workforce for a spell, but less appealing for a 51-year-old.

Since Im going to recommend waiting till 65 to take your SS I'd recommend you put more money in your Taxable accounts (maybe 30% more) and we can see what those numbers are.

Would you recommend waiting until 65 to collect on my pension plan also?

You should calculate when taking your pension is optimal. For social security, the latest withdrawal is the best. Frank over at Bad Money Advice has a great post where he goes through the math for social security. If you have the benefit rules for your pension plan, you could do the same thing. It may actually be that taking the pension as a lump sum is actually most profitable at 52 or 55, or it may be better to draw down your private accounts in order to start taking benefits (or the lump sum) later. You just don't know until you do the math, and it'll depend on a handful of tiny factors like the formula used to define lump sums (think of the buy vs. rent discussion that goes on everywhere for another example of this).

Yeah, I want to make sure I understand this. What exactly is the deal with the five-year holding period?

If you're rolling your 403b into your Roth IRA upon retirement, you need enough money between your Roth IRA, your taxable accounts, and your earned income from side gigs to cover five years of living expenses. Each year starting the year you retire you'll want to roll over enough to cover a year's expenses; then it sits and "seasons" in the account for five years, and then you can withdraw it without tax or penalty. If you retire in 2022, like you're planning, you would figure out how much you need to live on in 2027 and roll over that much from your 403b to the Roth IRA. In 2023, you'd draw down money that was contributed directly to the Roth IRA and money in taxable accounts to pay bills and you'd rollover the money for 2028's expenses. The tax efficiency comes from the fact that you're paying income tax on 2028's expenses and presumably very little else in 2023, as opposed to contributing to a Roth 403b during your career and paying (more) income tax on it then. All this time, you can only take out money that has been contributed, not earnings. You have to wait until 59.5 to touch any earnings, or you'll pay a 10% penalty. (Interestingly, when funds are moved from your 403b, each dollar stays characterized as an earnings dollar or a contributions dollar.)
Did that clear things up or just muddy the water?

[Zoot Allures]

It's easy for a 30-year-old retiree to say they'd go back into the workforce for a spell, but less appealing for a 51-year-old.

I hear you. But when you don't even think about this stuff until age 40, then 51 really feels like ER! So yeah, I could always keep working a couple more years if I need to.

You just don't know until you do the math

Indeed. I guess for now I just need to save like a motherfucker and periodically run the numbers to see where I'm at.

Did that clear things up or just muddy the water?

Very clear--thanks! Interesting about the contribution and earning dollars in the 403b remaining separate after they get transferred to the IRA. That makes sense, given the way Roth IRA withdrawals work.