Two Stage Retirement Plan

As I wrote a couple of weeks ago, I have a problem with my finances.  Almost all of my wealth is tied up in retirement accounts with withdrawal penalties.  I have just over 2 years of savings in my after-tax accounts and over 20 years of expenses in my tax advantaged accounts.  We could use Roth Conversion ladders as an option but that could be cumbersome.  If I extend my working life a little longer, I could easily come up with a fool proof plan I am confident will work and I don’t have to worry about withdrawal penalties.

Until actually hitting financial independence, I never really put a firm plan on how to handle my finances in early retirement.  I basically thought I’d use the 4% rule, get 25x my annual expenses saved up and pull out 4% per year via some vehicle like a Roth conversion ladder.

Mimicking Another’s Plan

The Our Next Life blog has posted several pieces on their 2-stage early retirement plan.  I recently read their book and they shared the amount of savings (in terms of years’ worth of expenses) they had saved prior to pulling the trigger.  I decided to mimic their strategy but I would interpolate the first stage due to me being a few years older than they are.

The first stage of their plan was to be used between the time they retired and when they turned 59.5 years old.  The second stage consisted of using the money that they have saved in retirement accounts which hold a 10% early withdrawal penalty.  I saw two great benefits to their plan.  The first is that they don’t pay any withdrawal penalties and secondly the funds in their tax deferred accounts are allowed to continue to grow for almost 20 years before they begin to access them. 

The amount of savings as a multiple of annual expenses that they had saved in their two stages were 15X for the first stage and 22.5X for the second stage.  This is a very conservative plan.  The withdrawal rate for their plan is 2.7% much lower than the much discussed 4% rule. 

I built a spreadsheet to simulate their plan for my situation.  Being a few years older than they were at retirement means that to match the first phase of their plan I would need less than the 15X that they had saved.  I first calculated how much money I anticipate saving towards my after-tax and tax advantaged accounts each year.  To be conservative, I used an annual appreciation of only 3% for these calculations, well below historical market performance. 

The chart below shows by year what I project my financial situation would look like compared to theirs. 

The dashed lines show their plan over each year.  The solid lines of the same color are my projected savings in each phase.  Where the two lines cross is when I reach the same financial position as them.   My projection shows that I should mimic their plan just prior to 2022, about 2.5 years away. 

Also shown by the graph is that I am already fairly close to matching their second phase, the tax deferred accounts.  Where I am lacking is the first phase, the after-tax investments which would be used to get to 59.5 years of age.

What is the success rate?

Simulating this plan, Flexible Retirement calculator shows a 99% chance of success:

The gap in my after tax accounts is the reason for Goal #3 of our annual financial planning for 2019.  With Goal #2 completed all available funds are being shifted to fund this phase. 

Asset Allocation for the first phase

The first graph I showed above was using a 3% return on my investments.  Since I built the spreadsheet, I could easily modify the annual return to anticipate the date that I would meet the ONL 2 stage plan.  The results were surprising to me, using a 1% return and also a 10% return the results look like this:

 1% annual returns:

10% annual returns:

Note the timing for the crossing of the blue lines for a 1% return and a 10% return, surprising the difference is only 6 months.  Since I will need this money in the next 3 years, I would like to be more conservative with my investments in this phase.  Noting the difference is only a few months, I am debating changing my after-tax contributions from 100% VTSAX to something more conservative with probable lower returns.  A bond index fund such as VBTLX has a dividend yield at just under 3% so I should come close to meeting the 3% return I used in my calculations.   

I would like to sell some of the VTSAX to a more conservative option but the shares were purchased in mid-January after waiting out a 30 day wash sale period.  I sold my VTSAX in late 2018 to take advantage of the market drop and do some tax loss harvesting.  Selling now will mean that the gains I have seen this year will be taxed at my marginal income tax rate and not the 15% long term capital gains tax rate.  I will make a note in Quicken to consider making a trade next January.

Still more waiting

My current plan is to start working toward this phased approach.  If I am successful, I shouldn’t have to worry about withdrawal penalties or ever running out of money.  Their plan is very conservative though, a withdrawal percentage under 3% likely means that a person could have quit full time employment a year or more before they actually did.  I may end up not being so conservative with my own plan, 2.5 years seems like a long time to me right now.  We will see have to wait and see what the road ahead has in store for us.