Bridging Strategy

[Cornbread OMalley]

A bridging strategy came to mind last week as I was mulling over my situation while eating a sweet potato in the office.  I recognized that I have three distinct pots of money available and accessible at different times in my life: 1) the taxable accounts, 2) the TSP, 3) Roth IRA.  The amount in each as of my last net worth check is:

1)  Taxable accounts $541,206
2)  TSP account $232,356
3)  Roth IRA $117,651

So if I retired today I need to have enough money in my taxable accounts to reach age 59.5 (the age I can take distributions from my TSP and Roth funds, but for this strategy I will save the Roth distributions for last).  Meanwhile, as I am consuming the money in my taxable accounts, the TSP and Roth will still continue to grow.  At age 59.5 I can open the TSP pot of money and start using it for living expenses.  The amount in the TSP account should be sizeable especially since the TSP account has been growing for the previous 20 years.  I can exhaust the TSP funds and finally tap into the Roth funds.

I think this strategy is a viable one, and the aspects to implement this strategy successfully are: 1) start saving as early in life as possible, 2) maxing out tax-deferred accounts like 401k and Roth IRA as soon as possible, 3) saving as much as possible in taxable account series of index funds covering the full spectrum of the market, and 4) automating contributions.  I did not account for my pension and social security to keep the explanation of the bridging strategy simpler.

Adding up all expense categories and averaging for 12 months gives me $4400 as my average monthly spending.  So I pay $52,800 each year to live.

If I retired now and maintained my spending at $4400 a month using only my taxable accounts, my taxable accounts would last 10 years ($541,206 divided by $52,800).

I played around with the numbers some more assuming I moved to LCOL area to cut my rent in half to $1000.  I also assumed the expenses of working were zero.  My monthly expenses now are $3200.  My taxable accounts would last 14 years ($541,206 divided by $38,400).

It goes to show that optimizing in big-ticket areas like housing can impact the timeline to FI.  I have a lot of optimizing and saving to do still.  Comments and suggestions are welcome.

[Monkey Uncle]

I presume you are aware of the various strategies to withdraw from qualified retirement plans prior to age 59.5?

http://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

Why not start a Roth pipeline from the TSP as soon as you quit work?  If you just sit on the TSP until you're 59.5 and then start taking withdrawals, you'll be paying tax on the withdrawals at the ordinary income rate.  Because your withdrawals from the taxable account will presumably be qualified capital gains and dividends that are taxed at the 0% rate, you can use your standard deduction and exemptions to cover your Roth pipeline conversions.  A properly executed Roth pipeline would allow you to pay tax at the 0% rate on a large chunk of your TSP funds.

Also, your taxable account should last longer than you have calculated due to investment growth, assuming we don't have another "lost decade" like 2000 - 2009.

[Choices]

After you 'retire' roll your TSP into an IRA. It takes a while but can be done and the place you open your IRA can help you. That way you'll have tons more (and better) investment choices and can start the Roth IRA conversion process as previously suggested.

[Cornbread OMalley]

Thanks for the tips, you two!  You made me a little bit smarter!

[tonysemail]

MDM pointed me towards www.i-orp.com which calculates an optimized drawdown strategy for your assets.

[Cycling Stache]

A bridging strategy came to mind last week as I was mulling over my situation while eating a sweet potato in the office.  I recognized that I have three distinct pots of money available and accessible at different times in my life: 1) the taxable accounts, 2) the TSP, 3) Roth IRA.  The amount in each as of my last net worth check is:

1)  Taxable accounts $541,206
2)  TSP account $232,356
3)  Roth IRA $117,651

So if I retired today I need to have enough money in my taxable accounts to reach age 59.5 (the age I can take distributions from my TSP and Roth funds, but for this strategy I will save the Roth distributions for last).

Adding up all expense categories and averaging for 12 months gives me $4400 as my average monthly spending.  So I pay $52,800 each year to live.

If I retired now and maintained my spending at $4400 a month using only my taxable accounts, my taxable accounts would last 10 years ($541,206 divided by $52,800).

Comments and suggestions are welcome.

On the plus side, you're in excellent shape.  Your math is not quite right, though, because you assume no growth in the market as you withdraw your money from your taxable accounts.  The much more likely scenario is that the market will grow over the 10 years that you're withdrawing money, in which case it takes longer to draw down.  That's why the 25x formula works--because it builds in market growth while you're in the withdrawal stage.

Also, if you are not already doing so, you should definitely max your TSP/401(k) contributions.  Besides the fact that there are ways to access it, as others have indicated, you have plenty of money in non-retirement accounts already.

Finally, although people often don't seem to include social security, they should.  Assuming you have worked and earned a while, and if you're getting the annuity as a federal employee, those amounts add up to quite a bit at full retirement age.  While there might be some changes or reductions, it seems unlikely to disappear completely.  People in the news and general retirement guidelines often discount social security because it pales in comparison to the super spendy retirements that people imagine, but compared to most Mustachian budgets, it likely will cover a lot of ground in annual spending.  Accordingly, if you're within 20-25 years of retirement, your money doesn't necessarily have to be self-sustaining forever like people who retire at 30 or so.

To conclude, then, you're in great shape, and perhaps better shape than you realize.

[Monkey Uncle]

Finally, although people often don't seem to include social security, they should.  Assuming you have worked and earned a while, and if you're getting the annuity as a federal employee, those amounts add up to quite a bit at full retirement age.  While there might be some changes or reductions, it seems unlikely to disappear completely.  People in the news and general retirement guidelines often discount social security because it pales in comparison to the super spendy retirements that people imagine, but compared to most Mustachian budgets, it likely will cover a lot of ground in annual spending.  Accordingly, if you're within 20-25 years of retirement, your money doesn't necessarily have to be self-sustaining forever like people who retire at 30 or so.

That's a very good point.  Because of factoring in expected SS and the FERS pension, I'm approaching FI at about half the total assets I would need if I assumed those income sources didn't exist.  The expected amounts can be a bit tricky to calculate, especially the FERS pension if you leave work years before you're eligible to start drawing it.  In a deferred retirement scenario, it does not start increasing with inflation until you reach age 62, so you have to account for the impact of inflation in the years between when you quit and when you hit 62.  These web pages can get you started on the calculations of your expected SS and FERS pension amounts:

https://www.ssa.gov/planners/benefitcalculators.html

https://www.opm.gov/retirement-services/fers-information/types-of-retirement/#url=Deferred-Retirement

[Cycling Stache]

I did the complete social security analysis this morning using the indexed formulas, and while it's a little painful to do, it's an insightful process.

I'm 40 now and have 22 years of earnings, but excluding summer job and small potato years while in school, 16 real earning years.  Social security looks at your best 35 years of earnings, and puts zeros for any years less than 35.  BUT . . . they then use an indexed formula that gives you progressively less benefit for each additional dollar earned once you've earned a fair amount.

What that means for me is that I have already earned enough to get benefits of $1,920 per month (or $23,041 per year).  Of course, I don't get that until age 67, but that is based on my earnings to date and nothing more.

According to my social security statement, if I work and earn max social security salary (currently $118,500) for the next 27 years, my benefits will be . . . $2,851 per month.

That's an increase of less than $1,000 per month in retirement benefits for earning max salaries for the next 27 years.

Of course, they could change benefits or formulas.  But what is interesting is to realize that because of the way the social security formula works, you can already have earned the majority of what you would otherwise get by just having a few good work years as opposed to a 35-year career.

So your money still needs to get you to 67 (or 62 if you take early, reduced benefits), but once you get to 67, you may already have a fair amount of benefits, especially with a federal government annuity factored in (kicks in at 62), that takes care of most of your annual spending needs at that point.  I would at least consider that when thinking about your bridging strategy and what money covers you for what periods of your life.

[Cornbread OMalley]

I did the complete social security analysis this morning using the indexed formulas, and while it's a little painful to do, it's an insightful process.

Cycling Stache, thanks for laying out some of the calculations.  Where can I go to learn more about the indexed formulas?  Definitely something I can add to my kit bag.  I intentionally left out my pension while playing with my numbers with the hopes of showing folks that FI could be reached without a pension.  I will do another analysis in the near future with my pension and the returns from my taxable accounts to come up with a projected after-tax income amount when I retire.

Thanks, everyone, for the continued comments!

[ZiziPB]

I did the complete social security analysis this morning using the indexed formulas, and while it's a little painful to do, it's an insightful process.

I'm 40 now and have 22 years of earnings, but excluding summer job and small potato years while in school, 16 real earning years.  Social security looks at your best 35 years of earnings, and puts zeros for any years less than 35.  BUT . . . they then use an indexed formula that gives you progressively less benefit for each additional dollar earned once you've earned a fair amount.

What that means for me is that I have already earned enough to get benefits of $1,920 per month (or $23,041 per year).  Of course, I don't get that until age 67, but that is based on my earnings to date and nothing more.

According to my social security statement, if I work and earn max social security salary (currently $118,500) for the next 27 years, my benefits will be . . . $2,851 per month.

That's an increase of less than $1,000 per month in retirement benefits for earning max salaries for the next 27 years.

Of course, they could change benefits or formulas.  But what is interesting is to realize that because of the way the social security formula works, you can already have earned the majority of what you would otherwise get by just having a few good work years as opposed to a 35-year career.

So your money still needs to get you to 67 (or 62 if you take early, reduced benefits), but once you get to 67, you may already have a fair amount of benefits, especially with a federal government annuity factored in (kicks in at 62), that takes care of most of your annual spending needs at that point.  I would at least consider that when thinking about your bridging strategy and what money covers you for what periods of your life.

Sounds like you are very close to or have already reached the second bend point for your SS benefit.  After reaching that point, the incremental reward for working more years is fairly low.  The Finance Buff has a good article explaining this https://thefinancebuff.com/early-retirement-social-security-benefits.html

[wienerdog]

I have entered the index factor in a spreadsheet and put in the formulas.  It isn't much data to enter.  I'll see if I can dig it up later.

https://www.ssa.gov/pubs/EN-05-10070.pdf

[Axecleaver]

This link has benefit calculators: https://www.ssa.gov/planners/benefitcalculators.html

This will provide some education on average wage index, PIA and bend points. I'm oversimplifying, but basically: For each year you worked, you take your indexed earnings, multiply that by the wage index factor (accounts for inflation and interest) and divide by 420 (35 years * 12 months) for an average monthly earnings figure. Then you apply it to the bend points. The bend points are basically the points at which you get reduced returns on what you've put into the system. You get:

90% in benefits up to the first bend,
32% up to the second bend,
15% after that.

Which shows why hitting the first bend is a good idea, but continuing to work after the second probably isn't. If you look at how this is calculated, early retirees don't really get penalized (assuming you get to 40 quarters). But late retirees (over 35 years) definitely do. The same benefit amount results for a guy who works 10 years at 80k as a guy who works 20 years at 40k.