Planning For an Early Exit

When the French were on the streets earlier this year, I meant to write about how I felt that the protesters’ position was, at its core, correct. If you think back to the futuristic movies of the 1950s, it was no one’s dream of the 21st century that we would work longer. I don’t think that staying on the job is the point of increasing life expectancy.

And so, I find it perfectly reasonable to have a goal of departing full-time employment before the current Social Security age (67 for most), at which point you have access to a steady stream of guaranteed income. The main impediment, of course, is having the savings to fund the years between the cessation of full-time income and age 67. That is completely obvious.

Less obvious is the need to have arranged your savings correctly. Planning for an early exit needs to start well before – perhaps a decade before – the actual event.

Let’s start with your workplace retirement plan (401(k), 403(b), TSP). Perhaps you have heard of the “Rule of 55.” In brief, you can withdraw your savings from the workplace retirement plan of your final employer without penalty if you leave that employer at the age of 55 or older. The rule is as simple as that. But consider what it does not say:

• If you leave your employer before age 55, you cannot take distributions from your retirement plan without penalty until you reach the “usual” age of 59 ½.

• If you leave your employer at age 55, your penalty-free access is to that employer’s 401(k). You cannot access the 401(k) of a previous employer penalty-free.

One planning implication, therefore, is that if you have an old 401(k) floating around, you need to think carefully about the choice between rolling it into an IRA or combining it with your current employer’s plan. The downside of using an IRA is that you will not be able to access the account until age 59 ½. If your preferred “early exit” age is 60, no problem. If it is earlier than that, you may have unintentionally limited your options.

In retirement planning, there is a natural tendency to focus all eyes on tax-advantaged investment vehicles, such as IRAs and 401(k)s. But if you are trying to fill the gap between, say, age 50 and 60, those instruments may be of limited or no use to you. Saving in a plain ‘ol taxable account has to be part of the early exit plan. Depending on your income goals, this could mean maxing out your workplace retirement plan to fund your plus-60 years, and complimenting that with a taxable account rather than a Roth IRA.  What you give up in tax advantage, you gain in flexibility.

One of the biggest impediments to retiring early is the need to purchase health insurance before you become Medicare-eligible at 65. It’s pretty hard to estimate what the price tag will be ten or more years from now, but I feel safe in assuming it will be really, really expensive. When estimating health insurance premiums, I like the Kaiser Family Foundation Health Insurance Marketplace Calculator. With that in hand, accompanied by an assumption of healthcare inflation resuming its usual pattern of outpacing general inflation, you can run the dismal math.

Aside from factoring that into your savings goal, the need to purchase health insurance again affects how you arrange your accounts. When you are buying health insurance in the marketplace, your goal is to minimize your monthly premium by maximizing the amount of the Premium Tax Credit. Lower taxable income = higher tax credit. And how do you lower your taxable income in retirement? By drawing down assets that are not reportable as income, i.e., Roth accounts (if you are past age 59 ½ in the usual case) and regular taxable accounts.

This health insurance math also turns the typical advice of taking distributions from a Roth account last, after traditional retirement account savings, on its head. The usual advice makes sense when your goal is to leave this earth with the largest possible balance left over for your heirs. But when you are looking to fund your pre-65 exit from employment, your priorities must change.

I have used the word “retirement” throughout for convenience. In fact, your vision may be more like mine, a ratcheting down of work obligations through your 50s. But whether your plan is a career change, or you are a true FIRE-er, it matters where you build your nest egg.

(Hey, I’d love to be in touch regularly. My free newsletter contains this blog, as well as other articles written by myself and others. Please consider subscribing by visiting the MoneyByLisa home page.)