Reader Case: Retiring Early With a Pension

Wanderer
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Wanderer

The Wanderer retired from his engineering job at a major Silicon Valley semiconductor company at the age of 33. He now travels the world, seeking out knowledge from other wealthy people, so that he can teach people how to become Financially Independent themselves.
Wanderer
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It’s Friday, so you know what that means…another reader case!

Hello Wanderer and Firecracker,

I’ve always been a fairly frugal person, and my wife a little less so, but we always lived on less than we made and always disliked debt.

I first saw the CBC article about you guys and thought, well… good for them. We could probably do that, but… hey, look something new and shiny in the news. I didn’t look further into that. What got me interested was the follow-up article that talked about the rash of comments from the first article. That piqued my interest and I went through your blog. I loved it and started looking at MMM, Mr 1500, and other linked blogs from yours. That opened my eyes and that gave me purpose… so now I have a lot more focus and want to work on retiring as early as possible.

OK, so about our situation (for this, it’s simpler to take us as a family I imagine, as all my budgets are for the family).

This year, (up to July) our take home was $6340 and cost of living was $3630.

I work for the federal government and my wife is staying at home until both our kids go to school. She will be putting her name back on the priority list to start working again for the government in October so we expect our income to increase significantly. But as far as our planning, we budget to keep the same costs and income as now and everything she makes will be a bonus.

A little more about our finances:

Debt: $0, nada, nil, zilch

Fixed assets: house (paid off, worth approximately $350K, taxes are approximately $4K/year included in our living expenses), Car (2010 Mazda 5, completely paid)

Investments and savings:

His RRSP: 50K

His TFSA: 25K

Her RRSP: 2.5K (we pulled out most of it while she was staying at home and had little income to take advantage of the low tax bracket)

Her TFSA: 35K

Other investments: 30K

Emergency fund: 28K

We both have government pensions mine was worth approx $250K last year (can’t get more recent numbers) and my wife’s is worth approximately $150K

As far as retiring, I’d like to retire at 45, my wife is more pessimistic, and wants to retire by 50, but she definitely won’t mind if we retire earlier. We’re both 37. I’m sure we can make it, but it never hurts to double check. My main questions are regarding our pensions.

As far as our pension, we can’t start withdrawing from it until 50 (with a penalty) or until 55 (with no penalty). Since I would like to retire earlier, do you think it would be better to defer our pension for 5-10 years or would it be better to withdraw the money as a lump sum? I realize a pension is a pretty stable investment, but if I retire early and manage it myself it will start paying me a lot earlier. Judging from how the government is spending and that they have previously dipped in the pension surplus to pay for their debt… I’m not sure I like that.

I appreciate any suggestions you can provide (or the whole FI community).

Thanks!

Retireat45

OK so where do we start. First of all, we know that Retireat45 has purchased a house. My stance on housing isn’t exactly enthusiastic, but in this case Retireat45’s done all right. At his age of 37, a paid off house costing $350k ain’t bad at all. It’s decimated his savings somewhat, but him and his wife both have those gold-plated defined-benefit taxpayer-backed pensions millennials only dream about. Worth $250k and $150k respectively, he should be sitting pretty.

But he’s worried that too much of his wealth is locked away inside these DB pensions, as he should be. So let’s do what we do here on Millennial-Revolution.com and MATH SHIT UP.

So first, we’re going to do a total-net-worth analysis. Meaning, we’re going to ignore all age-based restrictions, pretend that Retireat45 has access to everything, and figure out when he can retire.

Category Amount
Income $6340 net per month, $76,080 per year
Expenses $3630 per month, $43,560 per year
Debt $0
Investible Assets (including pension) $570,500

I don’t know about you, but at first glance I like them odds. No debt, good amount of assets (though most of that is in a pension which we’ll deal with later), and a healthy savings rate.

Retireat45 spends $43,650 a year, which means he’ll need $43,650 x 25 = $1,091,250, as per the 4% rule, to retire.

Now, I know Retireat45’s wife intends to go back to work, but since I have no idea what she does or how much she’d earn, I’m going to assume she earns bubkis. So where does our analysis lead us?

Year Balance Savings ROI Total
1 $570,000.00 $32,529.00 $34,200.00 $636,729.00
2 $636,729.00 $32,529.00 $38,203.74 $707,461.74
3 $707,461.74 $32,529.00 $42,447.70 $782,438.44
4 $782,438.44 $32,529.00 $46,946.31 $861,913.75
5 $861,913.75 $32,529.00 $51,714.83 $946,157.58
6 $946,157.58 $32,529.00 $56,769.45 $1,035,456.03
7 $1,035,456.03 $32,529.00 $62,127.36 $1,130,112.39

Apparently, slightly over 7 years. And given that they’re currently 37 and want to retire at 45, their numbers suggest that they’ll be able to retire at exactly that age. Clearly, Retireat45 is no stranger to mathing shit up himself.

BUT, and this is a big but, what about those age limits on that pension? Let’s work through that stuff now.

As we discussed in this post, once we do a total-net-worth analysis, in order to do a two-portfolio analysis, we split Retireat45’s money into two camps: the one he has access to and the one he doesn’t. In this case, of his total starting net worth of $570,000, he has access to $170,000, and is locked out of the other $400,000.

In 8 years, how much will that $170,000 grow to, taking into account his savings rate?

Year Balance Savings ROI Total
1 $170,000.00 $32,529.00 $10,200.00 $212,729.00
2 $212,729.00 $32,529.00 $12,763.74 $258,021.74
3 $258,021.74 $32,529.00 $15,481.30 $306,032.04
4 $306,032.04 $32,529.00 $18,361.92 $356,922.97
5 $356,922.97 $32,529.00 $21,415.38 $410,867.35
6 $410,867.35 $32,529.00 $24,652.04 $468,048.39
7 $468,048.39 $32,529.00 $28,082.90 $528,660.29
8 $528,660.29 $32,529.00 $31,719.62 $592,908.91

$592,908.91.

Super. And that $400,000 pension amount? Since we have no idea how Retireat45’s pension system works, we will be extremely conservative and assume no furth contributions. Instead, we will just assume it compounds at the conservative 6% we use for other investments. And we know that at his current age of 37, he can’t access these funds until that age of 55, or 18 years. How much will this pension be worth by then?

Year Balance ROI Total
1 $400,000.00 $24,000.00 $424,000.00
2 $424,000.00 $25,440.00 $449,440.00
3 $449,440.00 $26,966.40 $476,406.40
4 $476,406.40 $28,584.38 $504,990.78
5 $504,990.78 $30,299.45 $535,290.23
6 $535,290.23 $32,117.41 $567,407.64
7 $567,407.64 $34,044.46 $601,452.10
8 $601,452.10 $36,087.13 $637,539.23
9 $637,539.23 $38,252.35 $675,791.58
10 $675,791.58 $40,547.50 $716,339.08
11 $716,339.08 $42,980.34 $759,319.42
12 $759,319.42 $45,559.17 $804,878.59
13 $804,878.59 $48,292.72 $853,171.30
14 $853,171.30 $51,190.28 $904,361.58
15 $904,361.58 $54,261.69 $958,623.28
16 $958,623.28 $57,517.40 $1,016,140.67
17 $1,016,140.67 $60,968.44 $1,077,109.11
18 $1,077,109.11 $64,626.55 $1,141,735.66

$1,141,735.66

So we now have two numbers. In 8 years, Retireat45’s accessible net worth will be $592,908.91, and in 10 additional years, his pension will become accessible when it will be worth $1,141,735.66. Plugging this into FIRECalc, how does his retirement look?

 

Pretty good, actually. With these inputs, FIRECalc is predicting a 99.2% success rate.

So for all intents and purposes, Retireat45 is absolutely free to retire at 45.

And of course, keep in mind that I’m making big assumptions in order to be conservative. First of all, Retireat45’s pension is likely to grow faster than just a straight 6% since he’s contributing to it as he’s working. $0. Also, if his wife goes back to work, a whole other income stream opens up, but again, I have no idea what that might be so I assumed $0 to be safe. So in many ways, my analysis is super-duper conservative. However, there is the caveat that Retireat45 could increase his costs over the next 8 years, so before he retires he’ll need to redo this calculation with his latest updated numbers.

So what do you guys/gals think? Can he retire at 45? Or can he retire much, much sooner? Let’s hear it below in the comments!



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59 thoughts on “Reader Case: Retiring Early With a Pension”

  1. I think their chances of having a long successful retirement are great. I think one thing that people pursuing FI tend to underestimate is the fact that retiring while you are still young and healthy makes it virtually impossible that you wont at some point in time earn some kind of income doing something that you enjoy. So I think they will ultimately need even less than the $1,091,250 due to unplanned income in early retirement.

  2. The crystal ball says the future is murky, check again in 5 years. Their lives are changing a lot so it’s really difficult to forecast. Just keep saving and investing. Once things are more stable, check again. Good luck!!

  3. Wow Guys! Thanks for the analysis… I’m slightly stars truck 🙂

    Regarding the questions above, my wife returned to remunerated work in January (her salary is about the same as mine), but it also increased our living costs to about 4K$/mo. Still, our saving rate is around 60% now. We are looking at having one of us go to 75% FTE to be able to spend more with the kids, but we are still on track.
    The question that wasn’t answered, (and I don’t know that there is “one” answer), is when I retire, should I take the lump sum value of the pension and place it in low cost index funds and manage it myself (at age 45), or should I defer my pension (to reduce any penalties) and start getting my payments when I’m 55?
    Thanks again for this!
    Retireat45

    1. I’m guessing for them to start answering it you’d need to explain your pension better, i.e. is it say 70% of your best 5 years salaries (which currently would be X, expected to be Y), indexed or not, how much are the penalties to your pension for early withdrawal.

      That said, doing crazy simplified math – it costs you ~ $44k to live annually – you want to retire 10 years early, you’d need (ignoring inflation) ~ $440,000 to end up cover you to 55 and then live off your pension. You hit that in year 6 above, so your 8 year plan gives you a 2 year better cushion (cause going to 0 perhaps isn’t the best strategy).

      Also – you’d need to double check whether there are penalties at 55 as a lot of gov’t think 55 = OK to retire, but pensions vary. You may think you can’t retire until age 55 without penalties (which is typically true for most), but that doesn’t necessarily mean that you CAN retire at age 55 without penalties as there may be other criteria (like age + years of service = a certain number, so retiring early may push your pension drawdown date later).

      If your pension is one of those defined benefits where its’ 70% of your salary, given you’re saving 60% of your salary now, I’d say as long as the defined benefit > expected costs AND you’ve saved enough to cover between early retirement date and pension drawdown date, pull the trigger and live.

    2. Wow, your situation sounds surprisingly like mine, except that I am you in the future. I am 45, three kids still at home, house paid off, federal government job with the same salary as you, husband same salary as your wife with same pension arrangement… and we both retired this year, pulling out our lump sums. If you know what you are doing investment wise (and it sounds like you do), then I say do it! Take the lump sum and run!!!!

    3. Hi, I have a provincial dB pension like you, NO don’t take the commuted value, you will get a HUGE tax hit. They don’t give it all to you, find out with your pension provider what that will be (I did it provincially and it is a whopper). I would save and live off your own savings and add the pension at 55. Maybe both drop to part time before then? I am considering going to part time to continue my pension contributions. Best of luck!

        1. Here’s an email I got back from the pension board:
          The Income Tax Act may not allow the full Commuted value to be tax sheltered. You may receive a portion in cash, which will be taxed at source. Any cash payment over $15,000 is taxed at source at a 30% withholding tax rate. If you receive a portion in cash, you will receive a T4A for those cash payments and you will be required to report the amount as income in the year the payment is issued. While OPB will withhold tax from any cash payment and remit it to CRA, you may be required to pay additional tax based on your total income for the year.

          However, if you have unused RRSP eligible room, you can explore the option regarding withholding tax at source. Please contact Canada Revenue Agency for further information. You could apply to Canada Revenue Agency (CRA) using their form T1213 to reduce withholding tax at source. If your request is approved, Canada Revenue Agency would send you a letter and you would need to provide the Ontario Pension Board with the Canada Revenue Agency approval letter.

      1. You still pay taxes taking the annuity. (Monthly payments)

        With what we saw with Sears (slashing their annuity after Sears went bankrupt) we should be cautious of keeping our pension in the hands of government.

        I for one am deciding to take the lump sum and be responsible for my future. I can get a better return in the markets too since pension only keeps up with inflation.

        Not to mention you can pass on your lump sum to your kids and wife in full. If you dies only half goes to your wife, nothing to your kids.

        1. You and your employer can contribute more to a DB Pension than you can to an RRSP. When it comes time to roll the DB into a LIRA you are only allowed to roll over about the same amount that you could have contributed to the RRSP. The remainder is paid out as taxable income, you can put that income in an RRSP but if you don’t have room, you get taxed.

  4. Just recently retired, or semi-retired a couple months ago. We decided to sell our house and move to Mexico. I say semi because I am starting my own business soon so I don’t plan to live entirely off my investments. However, with the proceeds from the sale of our house we’re debating investing it in case of another stock market crash in the near future. I just tried out the FIRECalc and it says we have 100% success rate (assuming we’ve added the proceeds to our portfolio)… should we just take the plunge and invest it then?

    Retireat45 definitely sounds like he’s on track! Especially once his wife returns to the workforce, they’ll have no problem meeting their goal.

    1. Part of investing is sleeping at night. Consider different splits between asset classes and keeping some liquid funds to your taste until the next downturn. If you’re already in a good spot, stay diversified, manage risk, and develop strategies like the MR “yield shield” if it suits you!

      1. Thanks for the replies! It’s 100% only if we keep our spending consistently low which means living in Mexico indefinitely (no complaints there), but it would be nice to have the opportunity to travel or move elsewhere if we desired. I’ll have to take a closer look at those yield shield strategies.

  5. A lot can happen in 7 years, but yeah — on the surface the numbers look good.

    It doesn’t take a genius to save money, but it does take discipline to do so consistently for many years.

  6. Hmmm. You have a pension that you can just cash out as a lump sum??!

    The only pensions I know usual pay out an annual amount that is a certain percentage of your salary.

    1. Yes, if I RE my pension allows me to do two things: leave with all the money in my pension (some would be locked in a LIRA) and if I have RRSP room, I could put money there. but I would be taxed on the remaining amount (there would not be any other penalty for that option). Otherwise, I could defer payment of the pension. The pension would pay 2% per year of service times the best 5 consecutive years of my tenure starting at 55. If I RE at 45, that would be about 23 years of service, so approximately 46% my salary (90K$). If I start taking my pension earlier, the penalty would be a reduction of approximately 10% per year. (so if I delay to 53, I would receive 46% of 90K$ = 41.4K$, with a 20% reduction, that would be 33.1K$)

      1. Whether to take the commuted value or not requires deep analysis of your total situation at the time of making such an irreversible decision. I’m a pension rep on a DB plan, I have a wife and kids, and right now, I have no intention of taking the commuted value. Sure, on paper it looks like I can do better, but as I don’t actually need to do better because of other savings, and later, CPP and OAS, why should I take the risk of doing worse!

        With some DB plans there are other benefits, such as group health, dental and life coverage; even comprehensive travel coverage. These won’t necessarily be free, but could be a lot cheaper than if they were individual plans.

        When it becomes time to make your decision, pay at least one fee only adviser to give you their opinion. The best thing you can do right now is as suggested here and focus on stashing away as much as you can.

        On a related note. If I were to take my commuted value, my unrecoverable tax bill would be in the region of $200.000!

        1. Thanks, Completely agree. we are considering taking the commuted value for one of us, and staying in the pension plan for the other exactly for that reason. We could keep a cheap health and travel insurance, but I think we will have to do a full assessment of our finances 2 year before RE to make sure it makes sense.

    2. It sounds as though Retireat45 has done the research and that is indeed a possibility in his situation. You are right though, I have a DB plan through my job with a state government in the U.S., and there is no lump sum option, which IMHO does somewhat spoil an otherwise sweet deal. I guess it was originally conceived without accounting for people who might choose to do other than work their lives away!

    3. You can cash out a pension as a lump-sum known as a commuted value. It’s meant to be a chunk of money that you manage that could, theoretically, produce the income stream that the pension manager could. If you know how to manage it properly, you could even beat the DB amount.

  7. I don’t see anything in here about savings for higher education for the kids … but maybe that won’t be in the cards in any event

    1. yes, thanks for mentioning that. We opened up a RESP at the beginning of the year. we’ve maxed out our contribution at this time. With my wife at work this year, we had a lot more savings to put in various pots 🙂

  8. These are amazing numbers. Not to mention that if the math made sense, they could sell the house which they own in the clear, and put those funds toward their retirement funds. It would obviously impact their monthly expenses, but depending on where they live or plan to live, that could be worthwhile.

  9. Hi Wanderer. Amazing post as usual. This one made me especially excited since it’s similar to my situation. When you did the calculations for the pension, were you assuming that he took out the $400,000 or is the assumption is that it was left in the pension. Thanks so much!!

    1. I’m assuming that the $400k commuted value grows on its own at 6%, which is pretty conservative since they’ll be contributing into the pension over time and I didn’t model that. At the time of retirement, I’m assuming they then take the commuted value of the pension out as a LIRA and manage it themselves.

  10. I’ve inquired at my defined benefit pension as to whether I will see an investment growth in my pension if I put it on hold, retire at 50 then decide to pull out the lump sum versus taking the deferred pension at age 55. The answer I received was sufficiently vague and disconcerting to lead me to think, they would indeed not pay me a dime of the growth on the vested value in the 5 years holding time. If I opted for the deferred pension, I would be paid a severely penalized amount equivalent to just 3.8% yearly of the original lump sum payout (no accounting for any increase in value over the 5 years it would be on hold) and I would never see the principal. So I am leaning towards withdrawing the lump sum as other commenters have noted and investing it rather than taking the deferred pension. This decision seems best despite the massively prohibitive and unfair tax snatch unique to us defined benefit people taking the payout. Section 8517 of the income tax act actively restricting one’s right to portability of defined benefit pension benefits. https://www.benefitscanada.com/pensions/governance-law/a-tale-of-two-tax-rules-902

    1. For this exact reason, I decided to take it out as a commuted value so I would have control over it. DB pension administrators don’t know what to make of us early retirees, so the rules often aren’t favourable towards us weirdos.

  11. I would consider doing an each way bet and withdraw one of the pensions as a lump sum while leaving the other one in. That way you have insurance.

  12. CBC radio Vancouver did a short review of the FIRE movement

    it was pathetic .. they dissed the fact that its frugal …( erm . we have a planet to take care of … ) and we don’t need to be frugal on everything .. anyway

    and that if the stock markets tank then people are screwed .

    never mentioned the fact that anyone can do some PT work again or as you say move to a cheaper place or that many of us live off dividends / have a small nest egg .

    and worst case …… its ok to even sell a FEW stocks at a bad time IF absolutely needed .

    it wouldn’t kill the portfolio

    1. I’m not expecting Vancouver to understand how money works. Every single one of them will be in debt until they’re in their 70’s. Never take financial advice from poor people.

    2. The funny thing about people using the ‘you can’t retire early because the stock market could tank’ argument is that they don’t seem to realize that by their logic, no one (other than defined-benefit types in the short-term) could ever retire since that risk always exists….

    1. Funny you should mention that. I figured out how FI math by talking to an Australian at our last Chautauqua. I learned so much about Superannuation from him that I gave him the nickname “Superman.”

      Good times.

  13. What pension surplus? The unfunded federal liability for civil servants is $250 billion! The beleaguered Canadian taxpayer is on the hook for the liability in addition to funding the pensions that 70% of the taxpayers don’t have. DB pension holders should be funding the liability and for that matter DB pensions must be replaced with DC pensions before this country goes broke. And this is coming from a non-federal government employee who receives a DB pension.

  14. Lots of thoughts:
    Get those RESP’s established immediately! Take advantage of the CESG as that is free money. Wanderer wrote a great article on this.
    I have a DB with Alberta teachers and I love getting my monthly pension deposit for my entire life and my wife’s entire life. Love that security. If I live another 20 years I will take out over 4 times what I contributed. I retired from full time teaching at 56. Our gross income will be around $60 000. Consider pulling the wife’s pension and topping up the RRSP and TFSA accounts when the time comes. You will take a one time substantial tax hit when you do. Since she appears to have lots of RRSP room you may get a good chunk back. Your pension group should be able to give you accurate numbers. Leave your pension alone, you will be glad you did. Establish a unregistered account if you don’t already have one, put some money in there and split it between quality index ETF’s and some Blue Chip Dividend payers. Set it and forget it and just collect those payments.
    Think about taxes. By keeping one of pensions you can income split with your spouse and get the pension tax credit of $2000 each when you collect your pension. You can do this at any age as long as you are collecting a pension. You can’t do this with RRSP money until age 65. Seek some professional tax help.
    Each year you work you add to both your Gov’t pension and CPP pension.
    Bottom line-doing great. Work another 5 years and reassess.

    1. Thanks! already on my way on some of those recommendations! My wife and I actually have have no RRSP room. That is the disadvantage to the DB pension is that it severely cuts into your RRSP potential. I think we will keep on track and reassess in a few years definitely!

  15. What I noticed was no verbal disdain for actual working just a goal of leaving the workplace when he made enough to be able to. From the Math, it looks like he’s on target for reaching that at age 45. Way to go, you! For him, and his reluctant wife, it seems like this is a good place to be. I am excited to see what they will do with the options afforded them before they were too desperate to imagine them!

  16. The one thing that I’d like to see done in your calculations is putting a number to rising costs of living.

    The reader may spend 42k now, but in 10 years, assuming no changes that 42k will be a bit over 50k at 2% inflation…

    While they still look in good shape, it’s still something to consider.

    1. Hi GPA and welcome to the blog. We’ve addressed this question in previous reader cases. Since we don’t include any promotions or inflation-adjusted pay raises in the estimates and we assume a conservative 6% ROI, the numbers are real dollar values and inflation is accounted for. As with each case, the reader should redo the calculation each year on their way to FI, to account for any lifestyle inflation or deflation.

  17. Ok Wanderer and retireat 45. I called my provincial benefits plan, and they said, “The Income Tax Act states that anything above the rsp limit must be paid in tax.” For example you would max out the LIRA amount, perhaps if your commuted pension value was 500k, you could lock in 300K, and above that anything would need to be paid in cash, and anything above 15K would have an immediate 30% withholding tax up front. This is a Canadian example, so not sure if this is the same for others.

    I had to make this call ducking into a boardroom during office hours. Perhaps someone has a moment to dig into the income tax act? Wanderer, Bueller, Bueller?

    1. Thanks,

      That’s what I managed to find as well. I contacted my pension group and that was the gist of it. I’ll have to figure out if it’s worth it closer to FIRE. I think when we get to that point it will be a clearer picture and we’ll be able to make the real calculations with the values at the time. I will focus more on filling my TFSA than my RRSP moving forward and try to see if I can leave myself some room when we pull the trigger, but with the limited RRSP room we get, I don’t think that will work.

      One interesting point is that the commuted value of the plan is dependant on current interest rates, and since rates are so low now, the value is a lot higher. Something to keep in mind.

      1. Thanks retireat45. I am hoping our Premier gives us factor 80, which would be about four years away for me………or something even sweeter.

  18. Hi Wanderer

    I did not read this specific reader case but would like to make a general comment on the tables used in most if not all of your cases.

    The table showing how many years to get to a net worth number able to cover expenses with the 4% rule and its conclusion do not take into account the cash cushion.

    Let’s say someone needs 10% of his total net worth in the form of a cash cushion so they are able to live on it for 3 years when the market crashes (which if I’m not wrong is a safety net you have also implemented for your lives). It seems to me that this needs to be accounted for as it may well add several years to the time shown in the tables of your reader cases just to gather that cash cushion.

    Or am I missing something?

    1. Yeah I don’t account for building up a cash cushion in every reader case in order to keep the analysis relatively simple. In practice, once the reader gets to their FI number, the amount of time to save up the extra cash cushion usually takes just a few months, so it doesn’t change the answer in any major way.

  19. Things look really good especially since the wife will add another income stream. I think he/they can retire even earlier (maybe at 42 or 43) if their expenses don’t increase. But as some people pointed out in the comments, retireat45 needs to figure out what kind of taxes his money will have to deal with down the road plus add inflation to the mix. This calculation probably needs a yearly redo so that changes are taken into account.

  20. Hi all, looks like a solid plan. Very conservative asssumtions. I would stick with the db plan. Fed govt pension is pretty much bulletproof as they will just keep taxin us to pay for it. If you wait till 45 there should be a large safety cushion which will easily get you through till the pensions start. Personally I would redo the math and aim for an earlier date…

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