If you read FAQ #1, I already know what your next questions is. Here’s what’s going through your mind:
“Gee Ed, I think the way you funnel all of your paychecks into your various savings accounts is awesome, but what the heck do you live on? How do pay for rent, groceries, utilities, etc.? Do you and your family live in a cardboard box?”
Come on and admit it, I just read your mind, didn’t I? This question is a fair one because as you can imagine, we usually don’t have much money at the end of the month after stuffing our various accounts (see Edwina’s paycheck above). In 2016 from January to August, we received combined paychecks of 26¢: 7¢ for Edwina and 19¢ for me. Naturally, we need money to live on, so in order to work our financial plan, we set up two sources of income to cover our living expenses. (For the record, we don’t live in a cardboard box.)
Here are the referral links for the credit cards we currently use:
I. 72t Distributions from IRAs
Before I proceed with this explanation, grab a cup of black coffee or go get some fresh air first because it can be BORING. A 72t distribution is an IRA distribution taken before age 59.5 that is NOT subject to the normal tax penalty of 10%. Such distributions must be part of a series of “substantially equal periodic payments” based upon the life expectancy of the individual. Essentially, a 72t distribution allows you to take IRA distributions before the age of 59.5 without penalty. Did you get that? In other words, you can tap your IRA before you’re old and gray. However, be aware that calculating your 72t distributions can be a bit confusing, so do your research or get some professional help to determine your distribution numbers. (Fun reading: #1, #2, #3, and #4)
In 2013, Edwina and I each had rollover IRAs at Vanguard with a combined balance of about $500,000. Since the money was trapped in IRA accounts, it just sat there waiting for us to retire. However, when we learned of our 72t distribution options, we realized that we could use some of our IRA money to cover current living expenses. After doing my research, I calculated our 72t distributions and set them up with Vanguard. My distribution was $10,404 and Edwina’s was $7,971 for a grand total of $18,375 a year. While that’s not a lot of money, $1,500 a month is enough to cover many of our living expenses. Because 72t distributions must be taken until the age of 59.5, we plan on taking out $18,375 until we turn age 60.
II. 457 Distributions from “Old” Accounts
Those of you who read my “Crappy Jobs” posts (#1, #2) knew that this trusty account would be part of our income plan. We love 457 accounts for the following reason: as long as you have separated service from your employer (i.e. quit), 457 distributions are NOT subject to the normal 10% penalty for pre-59.5 withdrawals. Wow, do you understand what that means? Your formerly untouchable 457 “retirement” money can now be used as a current income stream without a tax penalty. What. A. Deal. (This is the reason that I advise teachers to fund their 457 accounts before their 403b accounts.)
We have four 457 accounts from our previous employers; these accounts have a combined balance of $90,000. Here’s how we’ll use our 457 funds this year. In 2017 we estimate that we’ll need $30,000 to cover our living expenses in Mexico and the U.S. Since we already have $18,375 from our 72t distributions, we plan on taking a 457 distribution of $12,000 later in the year. At a withdrawal rate of $12,000 a year, we should have enough money for seven years of distributions (until 2023). At the end of seven years, I’ll start receiving my Georgia TRS pension of about $24,000. Then, three years later Edwina will receive her pension of about $18,000.
Putting It All Together
Suddenly, I feel a rumbling in my bowels…could it be last month’s chili that I had for breakfast? No, it’s everybody’s favorite: a table! Here’s what we plan to live on over the next seven years.
While $30,000 isn’t big money, it’s enough for us to enjoy a decent and relaxed lifestyle. Here are a few final thoughts on our streams of income:
- Our estimated income falls well within our 2017 free money + 10% amount of $43,500. This means our tax bill will be low.
- Keep in mind that our $30,375 is much more than the same amount at your job. Why? Because your wages have not run through the taxman’s gauntlet yet. Mr. FICA, Uncle Federal, and Mrs. State all get a crack at your paycheck before you do (unless you feed your starving 457 and 403b accounts first…hint, hint). Sure, I have to pay taxes, but at a very low rate thanks to my tax planning. (Nota bene: We don’t pay FICA tax on our income because it’s derived from retirement distributions, not from wages.)
- With the dollar-peso exchange rate at $1 U.S. = 22 Mexican pesos, $30,000 is a considerable amount of money in Mexico these days. I’m sure we could live very well on $2,500 a month in Cancun or Merida.
- If we decide that we need more money, we can always take another “crappy” job and turn it into a golden-egg-laying goose. Like I said in FAQ #1, we can save at least $100,000 a year. If necessary, we could suck it up and teach for nine months. We’re not buttercups or cupcakes here!
I hope that answers your question about what we live on. If you have any questions, leave them in the comments section. Now, I’m going to tackle our next FAQ:
FAQ #3: How Do You Invest Your Money?
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Hi Ed,
Quick question for clarification. Did the school pull out the FICA % before you money goes into 457? and 403?
Chris,
Mr. FICA always gets paid unless you work a job that does not participate in Social Security. In that case, you’ll still pay Medicare.
That’s what I thought… Just was wondering if you knew something I didn’t.
Your next crappy job should be consulting! 🙂 I’m so glad you’re doing this FAQ series.
I’m confused, what is the advantage to draining pre-tax accounts to fund similar pre-tax accounts?
Steve,
Accessing our 457 money allowed us to ramp up our savings rate in the other pre-tax accounts. Instead of sitting in a fixed account earning 2%, that money provided a cash flow that helped us maximize savings for 3 years. While we were better than average savers, we had never saved that much before. Another consideration was that by quitting our jobs we could move our 403b money to Vanguard and lower our investment costs. I know the conventional wisdom is to never take money out of retirement accounts. However, because our distributions were from 457 plans, there was no 10% penalty. Plus, our money ($30k for 3 years) was used to cover basic living expenses, not increase our lifestyle.
So drain a crummy 457, got that. Are the IRA distributions funding non-retirement accounts? Otherwise, it seems like recycling.
I never claimed my plan was “pure.” My goals is to have money in my bank account while keeping my taxes under control. So far, so good.
I just listened to your podcast on ChooseFI as well.
Is seems to me, if you have after tax money say from the sale of your house this works perfectly. But if you are doing a 72T and then maxing out everything, it seems to me like taking money from your left pocket and putting it in your right pocket. You aren’t saving FICA or Medicare, or State Taxes since those come out anyway. Just curious if in 18 months you have change this strategy at all.
I love the tax free savings, that has been my strategy all along as well, to max as much as I can.
Hi Chris,
We’re still taking $18k of 72t distributions every year. We also take distributions from our 457 accounts as needed. This strategy seems to drive many people crazy for a multitude of reasons: it’s inefficient, it sub-optimal, it’s…
I view it like this: Every year we start the year in the black about $30k. That financial tailwind allows us to A.) spend the year in Mexico if we choose, or B.) front load all of our accounts if we choose to work. This year we’re working and saving all of our money; that means were building another substantial money buffer. Depending on how long we work, our second million dollars is right around the corner thanks to our high savings rate.
Prior to using these streams of income, we never saved as much money as we now do, so we have no plans to change our ways. It’s working for us.
Ed,
Amazing articles…very eye opening! One question – if you want to live off your Roth IRA before age 59.5, can’t you just withdraw your contributions tax free? That seems easier to me than 72t distributions unless I’m missing something.
Thanks!
Coast2Coast,
Our 72t distributions provide us with over $18k a year for living expenses. Our Roth IRA balances were never high enough to provide that amount of income, so we opted for 72t distributions. If I could go back in time, I might consider doing a Roth IRA conversion ladder instead. Thanks for the question. Ed
Assuming your pensions aren’t indexed to inflation, how did you figure out how much to save to compensate for inflation erosion? Thanks!
Laura,
I can’t honestly say that I have a grand plan to fight inflation erosion. My pension does have a COLA provision, but it’s not automatic. I guess my plan is to grown my portfolio to $2-5 million dollars, continue to live my awesome frugal lifestyle, and develop a side hustle that might help off set decreasing purchasing power. If that doesn’t work, please save me a spot in the bread line. Thanks for the question.
Ed,
I love your blog! I have a question about this strategy, and I o ow you stated above this strategy might not be the most optimal. Why did you do a 72t and use your old 457 both? If your 457 was a crappy investment only earning 2%, is there a particular reason why you didn’t just take $30k a year from your 457 until it was drained and then start the 72t withdrawals? I’m asking bc my wife is a teacher, and we’re hoping to FIRE in a few years, with over 500k in a Roth IRA, and I am trying to figure out how to prepare for this with our ‘buckets’ now.
Hello Joe,
When I started the 72t back in 2013, I knew that I’d have to take annual withdrawals until to age 59.5. That’s the catch with the 72t provision, so I don’t plan on making any changes to that because a 72t misstep can be (retroactively) costly. I don’t know that I’d do a 72t again if I had a do-over, but it has provided us with $1,500 a month without tax penalty. Best of luck with your FIRE plans, G