Positioning for a Potential Early Retirement

In an earlier post, Many Paths Lead to Financial Freedom, I noted that my current path leads to retirement at age 60. Why 60? There are multiple reasons, some of which were highlighted:

  • Financial ignorance in my 20s
  • Early marriage and children
  • Credit card debt in my 20s to mid-30s
  • Divorced at 35
  • Retired from active duty (Army) at 38
  • Focused on education and earned graduate degree (MBA) later (age 40) in working career

However, the most significant factor is that I currently work for an employer whose defined benefit plan requires that I work until age 60. That specific age doesn’t apply to all employees. The eligible age for retirement is based on a few factors, chief among them are the employee’s age and the number of years of employment. It just so happens that based on my age when I started and the number of years required, my eligible retirement age lands squarely on 60.

Planning

Actually, there are a couple of situations in which I could retire a little bit earlier. In the first situation, I could retire a couple of years earlier having met the ‘minimum years of employment’ requirement. However, because I would have less than 30 years and being younger than 60, there is a penalty – that would impact the annual payment permanently – associated with doing so.

In the second situation, my employer would offer early retirement for employees that fall within a particular window. This is a fairly common occurrence for many employers when they are looking to trim the workforce for a variety of reasons. Of course, you never know when the early retirement will be offered or how long the window will remain open. While the formula is reduced slightly in the second situation – and a one time lump sum (typically $25,000) is offered as part of the deal – the impact isn’t as severe as the first situation.

With that as the backdrop, the question becomes, “What would I have to do now to be prepared should an opportunity to retire a little earlier than planned present itself?”

The short answer is save a lot of cash. How much cash? My rough calculation is $72,000 for each year that I would retire before age 60. How did I arrive at that number? Well, that’s the long answer.

The first part to the long answer is why cash, or a cash equivalent such as certificates of deposit? Accessibility. For the 1 – 3 years (age 57, 58 or 59) that I retire before age 60, I won’t have access – without penalty – to monies in my retirement accounts. Therefore, the money I would need to tide me over until I can reach into any retirement accounts needs to be easily accessible.

The $72,000 I referenced earlier was not simply pulled out of midair. As part of my retirement plan, I have calculated how much money I desire as an annual income and the minimum amount I would need.

My desired income is $150,000 in today’s dollars. However, once we account for inflation – I plugged in 1% – you can see in FIGURE 1 that $150,000 in 10 years would be equivalent to $165,693.32 [Required Amount]. The Reduced Amount [$135,793.04] represents how much the value of $150,000 would decrease in 10 years at a 1% rate of inflation.

Inflation Calculator

FIGURE 1

Just to carry me over for the 1 – 3 years, I could live with less, the minimum needed. How did I arrive at $72,000? Two years ago the wife and I tracked every expense for the entire year. Everything! Our spending came to just under $90,000.

Considering that our $2,000/month mortgage will be paid off before we head into retirement, I backed that $24,000 out, leaving me with $66,000, which I just rounded down to $65,000. Using the magical Inflation Calculator again, you can see in FIGURE 2 that $65,000 becomes $71,800.44, which I simply rounded up.

Inflation Calculator II

FIGURE 2

So there you have it, my friends. While my retirement plan is constructed to provide $150,000 (today’s dollars) of annual income after age 60, I have determined that at a minimum I need to save $72,000 for each year I might retire before age 60 if such an opportunity arises.

Blogger-in-Chief here at RetirementSavvy and author of Sin City Greed, Cream City Hustle and RENDEZVOUS WITH RETIREMENT: A Guide to Getting Fiscally Fit.

13 Comments

  1. My pension locks me in at retiring at the earlier at 55. They have since started to increase that age but I think I’m grandfathered in. Age 55 is about 19-20 years away and part of me considered an even earlier retirement but like you there is a penalty. I guess if I had a lot saved up, maybe I’ll just take the penalty but it’s hard to say no to that kind of money. And as for withdrawal rules, I’ve read of various methods though I haven’t really looked into them like the Roth Ladder or 72t, etc.

    • You might take the time to confirm if you are in fact grandfathered. If not, that would likely change – perhaps not significantly – other factors with respect to your retirement plan.

      With respect to withdrawal, my take is that the two most important factors are the rate, (addressed by approaches such as following the Required Minimum Distributions [RMD] and the familiar 4% rule), and taxes, where the general belief is that funds should be withdrawn in the following sequence: taxable accounts (e.g. earnings from a brokerage account), tax-deferred accounts (e.g. 401k), and tax-exempt (e.g. Roth IRA).

      Thanks for stopping by and sharing your situation and thoughts, my friend.

  2. Great post and great overview of your financial situation. Hearing the history of “how did ____ get to this point?” helps others (like myself) plan my own financial future. This comment you made stood out to me: “Accessibility. For the 1 – 3 years (age 57, 58 or 59) that I retire before age 60, I won’t have access – without penalty – to monies in my retirement accounts.” This is probably the biggest issue people face when considering early retirement. I know multiple people who are shooting for retirement at age 50, which I think is a good ‘target’ for those who are in their 30s and able to plan that far ahead. One of them told me about a ladder IRA, which I think is a great option for those shooting for ~age 50. But the point is this: people who want to retire early need to think about cash flow and access. Most of your cash will be tied up in retirement accounts and unable to access without penalty.

    • “But the point is this: people who want to retire early need to think about cash flow and access. Most of your cash will be tied up in retirement accounts and unable to access without penalty.” Exactly. As I first touched on in the Many Paths Lead to Financial Freedom post, my circumstances basically dictate that I will be working until 60 even though I will have significant resources before that time. If I had started retirement planning earlier (I got wise in my mid 30s), I may have done things differently to position myself for retirement at 50 or so. But again, the choices I made combined with withdrawal rules for retirement accounts have locked me onto a path – which I’m not complaining about – that basically locks me into 60 as the earliest retirement age.

      Thanks for joining the conversation, my friend.

  3. Reminding me of the below average pay in Wisconsin lol. I’ve thought about moving for a lot more money in places that have similar cost of living, but It’s pretty hard to leave family and friends behind. Just remind myself that money isn’t everything.
    Sounds like a well thought out plan, wouldn’t expect anything less from you.

    I’m not sure if it’s of any help, but I recently read a post from a guy that negotiated his own severance package. Sounded like you’ve already started negotiating a bit, but maybe there’s another angle to play.
    1500days

    • There really isn’t any room for negotiation with my employer; it is what it is. “Sounds like a well thought out plan, wouldn’t expect anything less from you.” Thanks, I believe so. It is a plan developed over a number of years that considers every potential factor (e.g. passive income, portfolio income, tax rates, inflation, RMD, social security, expenses, the 4% rule, etc.). If you ever make it to southeastern, AZ I’ll share my working spreadsheet – developed over a number of years – that looks at all those linked factors and makes changes in real-time and let’s me see what would happen if a change(s) are made to one or more factors.

  4. James, you are a freakin’ rock star! Great plan, great analysis. If only more Americans were so mindful. I love it. Got a couple of questions for you. When you calculate your net worth, do you include the value of your pension? And if you do, how do you calculate the value of it?

    • A lot to cover, my friend. I’ll start with my bottom line. There are really only four things that matter with respect to retirement planning – my focus and the primary focus of this blog – and they are: passive income, portfolio income, expenses and decumulation (withdrawal). I’ll touch on the first three and leave the last for another conversation … a lot to think about and consider when you get to drawing down your money in retirement.

      I define wealth, or financial freedom, as when you can live your chosen lifestyle (that might require $25,000, $50,000, or $100,000, it will vary for everyone depending on their expenses and plans) and no longer require earned (labor) income. I cover the topic in Have You Settled on a Definition of Wealth?

      With that as a backdrop, I believe that ‘Net Worth’ is a useless metric. I go into the details in the linked post. I note in that post, “At the end of the day, the numbers most people assign to the value of their homes and cars are really irrelevant, particularly with respect to retirement planning. As an example, I am quite certain that the wife and I have about $50,000 in equity in our home and I would peg the combined value of our cars – both paid for – at ~$30,000. We are at 10 – 11 years away from retirement. Even if we were planning on downsizing to a smaller home in retirement and going from two to one car, what good does it do to assign a value to our home and car(s) right now? None.” Again, what matters is passive income and portfolio income.

      A quick example. Let’s say I want to have a retirement income of $50,000 in 10 years when I’m 60. Let’s further assume that I calculate that I will have $25,000 in passive income from two different sources. That leaves me with $25,000 I need to come up with via portfolio income. We know from the 4% rule (questioned by some, but a valuable formula for rough planning) that in order to cover $25,000 annually I need $625,000 (25,000 / .04) in my savings/investment portfolio (brokerage account, checking, savings, 401(k), IRA, etc.). In this very basic example, I can retire, I don’t need labor income, as my passive sources and the balance of my portfolio suggests I can live my chosen lifestyle without working. The (perceived) values of my home and cars – especially 10 years out from retirement – are irrelevant. I tell people forget about figuring net worth and focus on developing sources of passive income and building their investment portfolio.

      Based on what I just covered, I don’t believe there is any real value in trying to assign a value to a pension – $25,000 in the example above – beyond understanding its role in your overall retirement plan and how it relates to portfolio income. However, just for fun, in What is Your Pension Worth? I provided a way you might compare the value of a pension to the value of a 401(k) or other retirement account.

      This is what I wrote: As an example, my employer uses the following formula for those that retire before age 62: 1% × High-3 Average Pay × Years Service. This is how it would look for someone who worked 30 years, 4 months (4/12 years or 30.33) when their highest three years – typically the final three – of salary averaged $100,000 … .01 × 100,000 × 30.33 = $30,330.

      Substituting that $30,330 with a nice even number, say $20,000, what would be the dollar value of that $20,000 be in retirement? In other words, we typically track the value of our retirement plans (e.g. 401(k) and IRAs) and have a target number (e.g. $500,000) in mind for the day we retire. How would we convert that $20,000 pension to a comparable retirement plan number? Is a $20,000 annual pension equivalent to a $500,000 401(k) account balance? Is it worth more, less?

      With $20,000 as the first relevant number, let’s look at the second relevant number, the number of years most planners assume people will spend in retirement, or at least should plan to spend in retirement, 30 years. With those two numbers we could just use the very simple formula, Number of years (30) x Annual Pension ($20,000) to get $600,000. That’s it, right? Not quite. The problem is that number does not account for inflation.

      As I touch on in Rendezvous With Retirement, while one part of retirement planning is science – in that some things are known and quantifiable – other parts of retirement planning are art, meaning that some assumptions/projections have to be made. Accounting for inflation is an example of art since none of us know what it will be over the 30 years you might spend in retirement. Therefore, we’ll take a look at a couple different assumptions/projections to get a sense of the difference.

      Using an inflation calculator – the results below are from the Inflation Calculator, a complementary tool to RWR, available as a free download – we get the following for 1% and 1.5% inflation on $600,000. Note that Required Amount is what would be required for the future amount to retain the same value as the present amount and Reduced Amount shows the reduced value of the present amount after inflation is accounted for over a given number of years:

      Pension Projection I
      Pension Projection II

      As you can see, inflation can have a significant impact on the value of your money and it can vary depending on the level of inflation. So there you have it, once we account for inflation, we can project that a $20,000 annual pension is roughly comparable to a $445,153.75 401(k) or IRA account balance, at an annual inflation rate of 1.0%; or $383,857.46 at an inflation rate of 1.5%. Of course, if your employer’s defined benefit plan includes a Cost of Living Adjustment (COLA) that matches the previous year’s rate of inflation, the impact of inflation would be negated. Unfortunately however, not all benefit plans provide a COLA, or if they do, they may not offset the full rate of inflation.

      • Hey, James. Sorry it took so long to respond. I had a business trip to Dallas and I’m just now catching up. Awesome response. Can’t thank you enough. The way you calculated the value of a pension makes a lot of sense. And like you pointed out, the wildcard of inflation can’t be ignored. I’m somewhat protected in this regard. My pension has a COLA provision beginning after six years. But I like your main point the best. “[W]hat matters is passive income and portfolio income.” Mrs. Groovy and I now have some impressive wisdom to help guide our retirement decision. You’re the best, my friend. Cheers.

        • Glad you found some value in the post. Good stuff!

          Like you, we have COLAs, both with my current pension, and the future pensions from our current jobs.

          As always, thanks for participating in the conversation.

  5. Well thought out and well reasoned reply. Thank you! We are kindred spirits that’s for sure.

  6. Another idea. You could cut out years of waiting by significantly reducing your spending. Reduced spending is BY FAR the most powerful early retirement tool. $150k per year? How many years of your life is that figure worth? The two biggest reasons why most people over-spend is they make poor choices on automobiles and they live in houses that are larger than they need located in expensive places. Not saying that’s you Perse but it’s reality for many. It’s not that hard to live quite well in this country on far less than what you’re planning for. I’d also caution that assuming only 1% inflation is very ambitious when the real rate (not the rigged CPI) is far higher. I enjoy your blog.

    • Thanks for stopping by and sharing your thoughts. Good stuff!

      “You could cut out years of waiting by significantly reducing your spending.” Yes and no. As I noted in the post, because of the age and time requirements set by my employer, I’m basically locked into retiring at 60 (at the earliest), with the potential exceptions I noted. In short, the best I could hope for is to retire two, maybe three years earlier.

      “$150k per year? How many years of your life is that figure worth?”
      Could we live on less? Absolutely. I noted as much in the post. Our closely tracked expenses two years ago came to $90,000. There are two reasons my plan, and the savings/investment path we’re on now, is $150,000. First, I firmly believe people should expect that factors beyond their control will negatively impact their retirement income. Therefore, you should plan for more than what you need and develop multiple streams of income to mitigate negative impacts. I discuss it in detail in Multiply Your Streams of Income. Second, the wife and I plan to travel the world extensively in the first 10 years of retirement.

      “It’s not that hard to live quite well in this country on far less than what you’re planning for.” Agreed. You’ll get no argument from me. However, we are quite fortunate in that we enjoy a substantial household income and will have somewhere between 10 – 12 sources of income in retirement. We are not inflicting pain on ourselves now in order to save a tremendous amount for the future. We live modestly now – no McMansion or $75,000 cars in the driveway – and are able to invest at a rate – combined with our earned pensions – that will get us to that $150,000 annual retirement income with moderate effort.

      “I’d also caution that assuming only 1% inflation … .” My guess is that inflation won’t average much above 1% over the next 10 years. However, it certainly might. That takes us back to my $150,000. Better to aim high and have a cushion than to aim low and land hard should inflation skyrocket. I’d rather shoot for $150,000, in today’s dollars, and not be too disappointed if inflation is twice as high (2%), as it would still leave me above that $90,000, vice aiming low which would definitely have a negative impact. FWIW, using my calculator, that $150,000 becomes $186,506.15 [Required Amount] and $120,639.46 [Reduced Amount] respectively; and $90,000 is $111,903.69 [Required Amount] and $72,383.67 [Reduced Amount] respectively.

      I discuss inflation in detail – and provide a link to a good historical inflation table in Don’t Forget Inflation.

      For anyone interested, a free copy of my Retirement Planner Workbook, which includes the Inflation Calculator, can be found here.

      Thanks again for dropping by and sharing thoughtful comments.

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