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For some odd reason, we’ve gotten a recent flood of emails asking us about how to pull off this whole FIRE thing if they have some kind of locked-in retirement account (eg. pension), so I thought I’d use today’s article to address this.
What is a Locked-In Account?
A Locked-In account is the catch-all term for any retirement account that has an age limit on when you can withdraw.
Note that there is a distinction between an actual Locked-In Account versus a supposedly Locked-In Account that you can access using some form of loophole. The American 401(k)/403(b)/TSP is a good example of the latter. These 3 types of retirement accounts (though notably, not the 457) have an age-based withdrawal restriction that tacks on a 10% penalty if you withdraw from them before the age of 59 1/2. However, if you build a 5-year Roth IRA Conversion Ladder as we wrote about here, you can access those funds penalty-free at any age (though you still have to pay taxes when you do each conversion).
Actual Locked-In Accounts are relatively rare in the US and Canada, but they do exist. When FIRECracker quit her job, for example, she had a company pension that she elected to receive as a lump-sum commuted value. However, as a Federally regulated pension, it had to be received inside a Locked-In Retirement Account, or LIRA, which prevents her from withdrawing from it until the age of 55.
In other cases, age restrictions may be artificially placed by whoever runs the retirement plan of your specific company. During my decade working for a Silicon Valley company, we switched retirement plan administrators. The old one had no age restrictions on withdrawals, but the new one did. So sometimes it can be completely arbitrary.
And if you live in another country, Locked-In Accounts are far more common. In the UK, for example, Private Pension Schemes are provided by employers, and contributions are pre-tax. However, withdrawals can’t be made until the age of 55, barring some extraordinary circumstance like being diagnosed with a terminal illness. Australians have a retirement account that combines employee and employer contributions called a Superannuation, commonly referred to as a “Super”, and Supers have a withdrawal age of 60. New Zealanders have a system that combines employee, employer, and government contributions all into one account hilariously named KiwiSaver. KiwiSavers can only access their money once they turn 65.
Why Is This a Problem?
If you’re planning on retiring at or near the “normal” age of 65, then none of this matters. Just wait until you hit whatever age the account wants you to be at, and then just withdraw normally.
But if you’re much, much younger? Then yeah, this could be a problem.
Now, I’m of course putting quotation marks around the word “problem.” Having extra money coming from your employer or the government, or being able to invest tax-free is never a bad thing, even when there are strings attached like age restrictions.
However, if you’re trying to retire early, it does complicate the math.
For example, the 4% rule no longer applies. You can’t just take your annual spending and multiply it by 25 and use that to figure out when you can retire. The 4% rule assumes you have access to your entire portfolio, so if that’s not true, you need a new methodology. A new methodology that takes into account the age-based restrictions of your various retirement accounts. A new methodology that doesn’t really exist.
Can People With a Locked-In Accounts Retire Early?
Yes. But the analysis does get more complicated.
The math can no longer be simplified into an easily quotable rule like “The 4% rule.” Now, the math has to take into account the current age of the person, the age restriction of their Locked-In Account, and the amount of money that’s restricted and not restricted. Suffice it to say, this math will never be picked up by some reporter looking for a pithy quote. But it does work.
So without further ado, let’s MATH SHIT UP, shall we?
First of all, let’s say you’re 45. Your annual spending is $40,000, you have a $1,000,000 portfolio, so as per the 4% rule, you should be good to go. BUT $250,000 of it is in a Locked-In Account that can only be accessed at 55. Can you retire?
So how we do this analysis is that initially, we only count the amount of money you have access to as part of your portfolio. So rather than a $1,000,000 portfolio, at the age of 45 this person actually has $750,000.
However, we can’t just ignore the locked-in portion. That would be crazy. So we need to project what that locked-in portion would be worth if it were invested in a low-cost Index-hugging ETF portfolio. Given that this imaginary person is 45, and the Locked-In Account is accessible at 55, we can see what this amount would be worth assuming a conservative 6% growth rate.
So now at the end of these 10 years, our $250,000 has grown to $447,712. Super. So how do we reconcile this with our retirement math?
Well fortunately, FIRECalc once again comes in to save the day.
I am constantly amazed by how many features a free tool like FIRECalc has. At this point I’ve met and become friends with most of the major players in the FIRE community, but I have no idea who created this wonderful tool. If I ever get to meet him/her, I’m totally buying them a drink.
So how we use FIRECalc to handle this situation is by using the “Portfolio Changes” tab.
This tab allows us to add or subtract lump-sum changes to your portfolio, as if you fell into an inheritance or something. Well, this extremely useful feature can be used to model the sudden addition (or more accurately, sudden availability) of funds stored in Locked-In Accounts.
So how we would use this tab is we would click “Add” a lump sum to your portfolio in the amount that we calculated in the above table. Namely, $447,712 in 10 years. And since the current year (as of this writing) is 2018, we would enter 2018 + 10 = 2028 as our year of the lump sum addition, like so.
Them on our home screen, we make sure that we include an accurate living expenses number and only the part of the portfolio that’s accessible at the beginning of our retirement period.
And what do we get when we hit “Submit”?
We can clearly see the initial 10-year period in which our fictional early retiree is living off of the portfolio they have access to. And then at the end of that 10 year period, a whole whack of money becomes available to them, which makes their situation super-easy. As we can see here, this retirement plan has a 100% success rate, so this fictional retiree is absolutely good to go.
So yes, it’s absolutely possible to retire if a significant portion of your money is locked away by one of these Locked-In Accounts, but you have to math shit up a little differently from everyone else. If you find yourself in a situation where too much of your assets are in a Locked-In Account and your FIRECalc simulations indicate that those restrictions are actually holding you back from retiring early, you may want to reduce your contributions to these Locked-In Accounts, even if that means paying more taxes up-front.
It all depends on your age, the rules of these Locked-In Accounts, and the math.
What do you think? Comments or questions, let’s hear that below in the comments!
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