The Bogleheads' Guide to Retirement Planning (35 page)

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Authors: Taylor Larimore,Richard A. Ferri,Mel Lindauer,Laura F. Dogu,John C. Bogle

Tags: #Business & Economics, #Investing, #Personal Finance, #Business, #Business & Money, #Financial, #Non-Fiction, #Nonfiction, #Retirement, #Retirement Planning

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Roth accounts can also offer a good source of bridge income. Roth IRAs allow you to withdraw all contributions (but not earnings) at any time, for any reason, without any penalties or taxes. For Roth IRA funds that were converted from a traditional IRA, you must wait at least five years before withdrawing these funds tax- and penalty-free. For example, if you rolled over a 401(k) to a traditional IRA and then converted this to a Roth IRA at age 35, you could withdraw these funds, starting at age 40, with no penalties and no taxes. And unlike a SEPP program, there are no schedules of withdrawal that you must maintain. You can take out as much as you want, whenever you want.
Of course, once withdrawn, you can deposit funds back into your Roth account only based on annual contribution limits. You must have earned income below the modified adjusted gross income limits to contribute to a Roth IRA. Unlike contributions, your earnings must stay in the account until age 59½, or penalties will be levied (except for special hardship cases). Roth 401(k) accounts behave like Roth IRAs, once you are no longer employed by the sponsoring company. While employed, you cannot withdraw funds from the sponsoring employer’s Roth 401(k) account.
Traditional 401(k) plans typically do not allow withdrawals prior to age 59½ without penalty. However, some company 401(k) plans do allow penalty-free withdrawals starting at 55, if you stay employed with the company until age 55. After you turn 55, you must retire from the company to access these funds. As 401(k) plans are widely used, this may be an effective source of bridge income for many early retirees. Review your company plan documents to determine if they offer early withdrawals starting at 55. Taxes are still owed on withdrawals, but no penalties apply.
A 457 plan is similar to a 401(k), except that it is available only to government workers. If you have a 457 savings plan, this presents another potential source of bridge income. Unlike 401(k) plans, you can withdraw 457 funds prior to 59½ without penalty, as long as you are no longer with the employer. You will pay income taxes on any withdrawals, as these funds were invested on a pretax basis.
Bridging beyond Retirement Accounts
In addition to the alphabet soup of retirement accounts, you most likely have assets in after-tax accounts, too. Your after-tax investment funds are available to you whenever they are needed. However, they may have large capital gains (especially any funds or stocks that have been growing for decades), and there may be significant long-term capital gains taxes on your withdrawals. But besides taxes, there are no trigger dates or penalties associated with tapping these funds as a source of bridge income.
Reverse mortgages are another possible source of income for those 62 or older. Reverse mortgages, however, generally have high fees and low rates of return for the home owner. For these reasons, reverse mortgages should be a last resort for providing income. Depending on mortgage interest rates, tapping the equity in your home or real estate via a fixed loan or home equity line of credit (HELOC) may make more sense than a reverse mortgage. However, using home equity is not a prudent source of income for most retirees, especially those retiring early. Your home is more than a piggy bank. In fact, if you need to use your home equity to fund early retirement, you are probably not in a realistic financial position for a successful early retirement. Many early retirees have paid off their mortgages, giving them one less monthly payment in retirement.
Another potential source of bridge income involves possible changes in retirement account laws. Government legislation is periodically proposed to loosen access to retirement account funds due to hardship, economic need, or recession relief. It’s possible that before you reach your existing trigger dates, laws could be changed to give you penalty-free access to your retirement accounts earlier than current constraints. However, since these possible changes cannot be planned, it is judicious to assume that existing laws will remain in place.
If the idea of retiring early cold turkey is too scary, you can do a trial retirement. Request a one-year unpaid sabbatical if offered by your employer. This will give you the opportunity to decide if early retirement is the right choice or if you need paid employment for your emotional health or economic well-being. Nobody needs to know that you are toying with the idea of early retirement. As you work out your plan for early retirement, remember that a decision to annuitize or initiate a SEPP program is irreversible.
WINDFALLS, UNEMPLOYMENT, AND DISABILITY
Windfalls, whether they come from the lottery, inheritances, lawsuits, showbiz, sports, or buyouts, carry with them special concerns. The good news is that the same retirement advice applies to windfalls as to other sources of income. It makes no difference if the nest egg was slowly built over 25 years through diligent, regular savings and compounding interest, or if it comes via one comically large check from the lottery office in front of the cameras. What may differ is the mind-set of the early retiree.
Most early retirees have been planning, calculating, and brainstorming for 10 or more years before pulling the trigger. Your challenge is to ensure that the windfall doesn’t become easy come, easy go. Today, even a multimillion-dollar lottery jackpot may not be enough for a successful early retirement. Lump-sum lottery payouts are usually half of the advertised jackpot. Taxes consume half of what remains. After buying a new BMW and a McMansion, you may find yourself scraping by, unable to afford the lifestyle you imagined a millionaire is supposed to live.
CASE STUDY: STEVEN
Ten years ago, police officer Steven retired immediately after winning a $2 million lottery at age 48. He had no experience managing large sums of money and became overwhelmed by advice and requests for loans/gifts. His life that first year was far from the happy lifestyle he envisioned. Fortunately, he kept a cool head and did not make rash decisions, except for a few large loans to family and friends. Loans became gifts when family members could not repay. He did not want to lose relationships over the debts. Steve is single and lives on a small, fixed budget. He takes two marquee vacations a year (Hawaii and the Bahamas) but otherwise lives frugally. He is considering part-time security work to make his vacations longer and nicer. Although he does not regret winning the lottery, it did not make his life a storybook ending of happiness and freedom from worries. He advises windfall receivers to take it slow, give no loans, and make no significant purchases for at least a year. He suggests that you trust only yourself with your money. Also, be aware that feelings of envy can ruin relationships.
Whereas windfalls may lead to voluntary early retirement, other events may occur to create an involuntary early retirement. Pick your favorite euphemism. Whether you are downsized, rightsized, outsourced, cosourced, fired, or subject to job elimination, layoffs can lead to a long job search. During this search, after realizing that they can handle the economic and emotional aspects of being unemployed, some people simply stop looking for new work. At some point, they stop saying, “I’m an engineer” and start saying, “I’m retired” when asked what they do.
Disability
If you become permanently disabled, you may be an involuntary early retiree. Living on Social Security Administration (SSA) disability presents some challenges. There are two SSA disability programs: disability insurance and supplemental security income. Disability insurance pays benefits to you if you’re insured, meaning that you have worked long enough and paid Social Security taxes. The second disability benefit (supplemental security income) pays benefits based on financial need. To receive payments, you need to apply for disability status and be approved. Because Social Security pays only for total disability, no benefits are payable for partial or short-term disability. Disability under Social Security is based on your inability to work.
To determine if you are disabled, the SSA uses a rigorous process, based on five questions.
1. Are you working? If yes, you generally cannot be considered disabled.
2. Is your condition severe? It must interfere with basic work-related activities.
3. Is your condition on the list of disabling conditions? If not, SSA decides if it is of equal severity to a listed medical condition.
4. Can you perform your previous work?
5. Can you perform other types of work? If you cannot adjust to other work, your disability claim may be approved.
Once approved, you remain on disability for the rest of your life or until your condition improves and you can work again. You get an annual raise called a cost-of-living adjustment (COLA). But you cannot work
and
receive disability. Your income is limited for life, which creates restrictions that nondisabled people do not have. Also, you may have health care costs associated with your disability that further constrain your standard of living. (See Chapter 15 for more details.)
UNRETIRING
Life happens. Things change. Even the most dogmatic, organized planner cannot predict all life events. Issues with dependents, health care, partner relationships, accidents, deaths, market crashes, or unexpected natural disasters can put a serious wrinkle in early retirement plans. Perhaps you will discover that living on 3 percent or 4 percent of your nest egg is not acceptable. You may need to
un
retire. Americans are working longer into their sunset years in today’s soft retirement world.
CASE STUDY: KEVIN
Kevin retired early as an electrician at 54. He is now 66. He unretired at 63 by picking up a part-time job at a retail store near his home. He started working again not because he needed the income but, rather, because he wanted to help out his heirs and keep himself busy. He wanted enough income to fully fund his Roth IRA that will become a de facto college fund for his grandchildren. At work, he enjoys helping people, has a flexible schedule, and has a feeling of accomplishment, without the headaches and stresses of his earlier career. In retrospect, he thinks he should have worked a few more years to alleviate his worries about running out of money.
There are several nonfinancial reasons that you may unretire and rejoin the work force. Boredom may set in. Interactions with people (coworkers and customers) can be sorely missed. Your batteries may be fully recharged after a few years off, and you may be ready to go back to work with renewed vigor and enthusiasm. Perhaps you’ve found a new passion and wish to turn a hobby or volunteerism into your next career. Sometimes, when you give up looking for work, your dream job falls into your lap, so you decide to rejoin the workforce.
The good news is that the barriers to unretiring are few. There are no papers to sign, no contracts to rip up, no unretirement parties to attend, and nobody is expecting the gold watch back. Just grab that tie (or hammer, paintbrush, laptop, or car keys) and get back to work. Start rebuilding your nest egg so you can re-retire later at that magical 4 percent safe withdrawal rate.
CHANGING YOUR MIND ABOUT EARLY RETIREMENT
There are several other reasons you may change your mind about early retirement. Your pension and Social Security benefits will undoubtedly be smaller when you retire early. Usually, your salary is at its highest as you are nearing retirement (your 50s and 60s), due to your experience and inflation adjustments. Social Security payments are based on your career earnings. That means your benefits will be higher if you wait. Also, many employers calculate pension payouts based on a formula of your three to five highest annual salaries and your years of service.
The biggest financial reason to remain in the workforce is more obvious: retirement means that you stop making money and need to start spending money. Psychologically, you need to flip the switch between saving and spending, knowing you cannot replenish your nest egg as you have always been able to do. You must be prepared for the potential stress of tapping into money that you’ve spent a lifetime accumulating. You must get comfortable watching your net worth decrease. However, the good news is that at a 4 percent or less withdrawal rate, you should still experience some years when your net worth increases from above-average annual returns on your investments.
Working full-time has a great side benefit that should not be underestimated. It’s difficult to spend much money doing anything else while you’re working. With all of your extra free time in retirement, you may spend more on entertainment, travel, hobbies, and that endless to-do list of home improvements. Your utility bills may increase. You may find that you could afford to retire based on your preretirement budget but simply cannot live on 80 percent of your preretirement income before tax. Conventional wisdom has been that you need 80 percent of your preretirement income, but this may not apply to your situation.
Unretiring, or simply not retiring early, may be the most prudent course of action for your circumstances. It’s more fiscally conservative to retire at a normal, traditional retirement age. And although it is dangerous to generalize Boglehead behavior, our philosophy is to retire only if you have the resources to remain invested, can weather market downturns, will stay the course, and are able to effectively manage the costs of your retirement.
Feeling empowered and able to retire early is a freeing achievement. It’s ironic, though, that many people who are in a position to walk away from their jobs and retire early start finding their career more meaningful and fulfilling, without much of the stress that normally accompanies a 9-to-5 job. You’re now free to explore other positions, take a chance with a new company, or volunteer for a risky short-term position. You do not need to grovel for a small cost-of-living raise. You know that if it gets unbearable, you can just walk away. And if your employer knows this, too, you may be treated differently. If your contributions are valued, you will receive meaningful work, making your job a profitable endeavor for both you and your employer.

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