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3 Reasons Why This Couple Is Ignoring Their 401(k) Accounts In Early Retirement

3 reasons why this couple is ignoring their 401(k) accounts in early retirement

We are planning a two-phase retirement: a more basic lifestyle in phase one (what the Elephant Eaters have dubbed “dirtbag millionaires”), supported by our taxable investments and rental income, followed by a more traditional retirement, funded by our more gold-star worthy 401(k)/tax-advantaged funds.

One of the things we consistently get questions about is why we’re taking the two-phase approach, especially with well-funded retirement accounts already in place, instead of starting to tap those funds now, and already being able to retire. Of course, what they’re really asking is “Isn’t it all just one big pool of money?” You can certainly choose to see it that way, but I’ll be crystal clear on where we stand on the question:

No. We don’t think it’s a good idea to see taxable and tax-advantaged funds as one big pool of money.

And we definitely don’t think it makes sense to apply the 4% rule to your total balance to figure out what you can spend in your early retirement years, before you can access your tax-advantaged funds without penalty. (We don’t think you should be using the 4% rule at all, actually, but that’s another post.)

I know them’s fighting words for some, and I can already hear the imaginary retorts about all the ways someone can access tax-advantaged funds early. “But the Roth conversion ladder!” And “But the substantially equal periodic payments in rule 72t!” Yep, those are things. But we have three big reasons why we aren’t relying on them to fund the early part of our early retirement:

We massively disagree with the conventional wisdom that people naturally spend less as they get older.

Or even that it’s a fine idea to plan on level spending over your lifetime.

While it’s true that research shows people do spend less in older age, that research never asks if that’s by choice or if they are forced to spend less because of financial hardship. That’s like asking Irish people during the potato famine if they find themselves eating fewer potatoes, and assuming that they must just be avoiding carbs. Matt at the Resume Gap wrote an excellent post where he makes the great point that many people in their 70s and beyond simply can no longer afford their pre-retirement lifestyle, which skews the scale.

But in addition to that, the cost of health care in the future is a huge unknown, and not just in the U.S. Most of the countries that provide free health care are also facing demographic challenges that may force greater cost-sharing in the coming years, as more people age out of the workforce and fewer young people enter it to support them. (So don’t get too comfortable, all you folks feeling smug about your better-than-America health care. Or do. Because we’re still totally jealous.)

But we think it’s a mistake to sell out our future selves to escape the workforce a little earlier, and we’re leaving our true retirement money alone so we can both have a less-dirtbag lifestyle and have a bigger safety net for health care expenses and whatever other unknowns might be lurking out there.

Tax rules can and do change, which could spoil your early withdrawal plans.

The backdoor Roth, for example, has been targeted for years as a loophole that needs closing. This applies to the “mega backdoor Roth” too. Given how little people save for retirement, even when they have tax-advantaged vehicles like IRAs and 401(k)s available to them, and especially given the ethnic and racial disparities in savings rates and the ways some say 401(k)s really just help the rich get richer, it’s not at all unthinkable that Congress might rethink our tax laws that pertain to retirement, especially over a long time horizon like many of us have in our early retirements.

The current system isn’t actually working, after all, to prepare Americans for retirement, so a responsible Congress (I know, I know) would take a long, hard look at this. For those of us who are the lucky few benefiting from IRAs and 401(k)s, it’s dangerous to be wholly dependent on rules that could change.

Relying on Roth conversions and rule 72t increase the temptation…

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