The Comfort of a Big Nest Egg… for Later

Something we get asked about semi-regularly is our two-tiered retirement plan, which has us living primarily off of our taxable investments for the first ~18 years, and then shifting to our tax-deferred investments (401ks) for all of our years after age 60, with some rental income sprinkled in here and there. Here’s the clearer breakdown:

What this chart doesn’t show is the huge difference in how much money we expect to have to spend in each phase. A lot depends on how our 401ks do between now and when Mr. ONL turns 60, but — worst case — we expect to have at least 50 percent more per year to spend once we hit 60. With returns more in line with historical averages, we should easily be able to double our annual spending once we hit 60.

The reason for this is that our 401ks have a lot more in them than our taxable accounts, and while we’re working fast and furiously to fill up the taxables, that head start that came from (mostly MR. ONL) maxing early and often is hard to beat.

A lot of people, when planning for early retirement, view their money as being all in one big pool. And with tools like the Roth conversion ladder, that’s a perfectly reasonable way to view it all. That approach lets you apply the 4 percent rule in a more straightforward way than our more complicated math allows, at least assuming you can get enough of your tax-advantaged dollars converted by the time you need them. And it lets you live at a more level standard of living over the long term, which could certainly be appealing.

But, despite all that, we don’t view our taxable and tax-deferred investments as one big pool of money. And the logical question is:

Why not?

We may have started the post with a chart and a graph, but we’re about to talk about emotions, y’all, along with some  financial reasons.

Fact is: we find it super comforting to back-load our retirement. To save the biggest part of our nest egg for later. To know that we may need to scrimp in the early years, but we’ll be able to live more comfortably in the later years.

This for sure outs us as still having some inherent discomfort with the whole idea of early retirement, despite having done all of our homework, understanding the math, knowing the history of the stock markets, and all the rest. It still feels a little scary to us, and it’s possible it always will. But that’s not going to stop us from going through with it, because the bigger risk to us is that we spend our whole lives working, and we end up missing out on the chance to do the things we really want to do in life.

But here’s why we take comfort in reserving so much of our nest egg for our age 60+ years:

The financial reasons

On the financial front, our most important reason for thinking of our retirement savings in two distinct buckets, for two separate periods in our lives, has everything to do with health care. Both to maximize our health benefits in our earlier years, and to protect ourselves in our later years.

Health Insurance in our 40s and 50s

As Justin at Root of Good has covered expertly, subsidies under the Affordable Care Act are not on a sliding scale. The subsidy cliff is a very real thing, and there are scenarios in which earning literally $1 over a particular tier could end up costing you hundreds of additional dollars in health care costs. However, Medicare doesn’t have this same structure, and people with higher incomes aren’t penalized nearly so harshly. Since we plan to rely on Obamacare for health insurance during our pre-Medicare years, we want to keep our income as low as possible to max our subsidy, which we will achieve by living off of our taxable funds, supplemented by rental income, in the first phase.

Of course, we expect our taxable funds to carry us through age 60ish, while Medicare doesn’t kick in until 65. What about that five-year gap? We figure that by that point, almost 20 years into retirement, the index fund shares we sell will be largely capital gains, with a comparatively small cost basis (unlike our early years, when we could theoretically sell lots and lots of shares and still have only a small income, because most of the value is still our cost basis, or what we initially invested to buy the shares, with minimal capital gains to count as income). And therefore, we figure it will be unavoidable to register a higher income by then anyway, making our ACA subsidy minimal, and taking away the incentive to keep our income small. Plus we’ll be able to access our 401ks penalty-free by then, so it feels like the right time to go for it.

Anticipating higher health care costs in our 60s and beyond

I’m sure we have all heard plenty of heartbreaking tales of seniors going hungry because of high health care bills. While we will do everything possible in retirement to stay healthy and active (including getting lots more exercise than our work schedules allow currently!), odds are that we’ll need more medical care in our 60s and in the decades that follow. (And I hope there are a lot of those — I’m pretty set on making it to 100.) We don’t want to let money stand in the way of us getting the care we need, especially if it’s something costly like in-home care or even nursing home care. And we also don’t want to let stress about medical costs affect our health. That’s something a lot of seniors cope with. So having the larger pool of funds waiting for us at age 60 gives us enormous comfort on that front, too.

The emotional reasons

Is it weird to say that it just gives us a sense of peace to know that we have this big nest egg sitting there, growing and waiting for us? Because it absolutely does. We know that no matter how badly we screw things up in the first phase of our retirement, we won’t burn through all of our money. We’ll still be okay in the years when it’s tougher to earn an income. And if that makes it sound like we don’t trust ourselves to manage our money well in early retirement, that’s kinda true. After all, we’ve never done it before! It will be our first time being retirees, and we expect there to be a steep learning curve. Just check out the comments on this post for proof, from actual retirees.

We don’t actually expect to screw everything up, but we still think of our later-years nest egg as our safety net. And it’s sure a lot easier to walk out onto that tightrope if you know there’s a net somewhere down below you.

Beyond that, we think saving the biggest part for later also helps us with our pacing. If we know we’re living on a low-ish income forever, we might at some point get frustrated with that fact. We might get the urge to splurge (possibly the worst rhyme ever). We might just want to take a trip that we can’t afford. And that could breed all kinds of resentment, or even rattle our marriage. Instead, we love knowing that we only have to follow the low spending plan for less than two decades, and then we’ll have the reward of getting to up our standard of living, potentially by a lot. We don’t envision starting to buy a lot of stuff when we hit our 60s, but maybe we can stay at nicer hotels, fly first class once or twice, or just donate a whole lot more to charity. That will feel like a nice upgrade from the dirtbag-style travel we plan to do between now and then — staying in hostels and camping as much as possible.

Which camp are you in?

Do you think of your savings in one pool or two? Are you building anything into your plan to ensure that you’re covering higher health care costs in your later years? Are you structuring any parts of your plan for greater peace of mind, like us with the bigger nest egg for our later years? Share it all in the comments!