How to Retire Early with a Locked-In Pension

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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.
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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.

Until now…

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.

Year Balance ROI Total
1 $250,000.00 $15,000.00 $265,000.00
2 $265,000.00 $15,900.00 $280,900.00
3 $280,900.00 $16,854.00 $297,754.00
4 $297,754.00 $17,865.24 $315,619.24
5 $315,619.24 $18,937.15 $334,556.39
6 $334,556.39 $20,073.38 $354,629.78
7 $354,629.78 $21,277.79 $375,907.56
8 $375,907.56 $22,554.45 $398,462.02
9 $398,462.02 $23,907.72 $422,369.74
10 $422,369.74 $25,342.18 $447,711.92

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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48 thoughts on “How to Retire Early with a Locked-In Pension”

  1. Ditto to Frosty Fire’s comment above. This is the article I’ve been waiting for because I do plan to retire before my pension become available to me. Now I know how to figure out when I can actually go. Thanks very much, Wanderer!

  2. If I’m reading this tool right, and I’d like to think I am: if we can accumulate $400k in after-tax dollars by 2030 while stashing just enough to get company matches in 401k accounts, we’ve got a 96.6% chance at successfully retiring in twelve years… given that our mortgage will evaporate at the same time. Which FIRECalc also takes into account.

    Thanks for giving me cause to revisit this thing! I hadn’t futzed around with all the options before now. It’s perfectly comprehensive for my needs.

  3. Long-time fan. First time commentator (second time maybe?).
    I would like to point out a minor issue I see above (not as a complainypants but just trying to add value, so please don’t punch me in the face). 🙂

    When you run FIRE Calc for $40,000 of annual spending off of a $1,000,000 portfolio, without a locked in portion, you get a 94.9% success rate.

    So I was scratching my head a bit when I saw the 100% success rate of the portfolio on this post, since it is made up of the same spend of 40,000 and same assets of 1,000,000. How could a locked in portion bring the success up to 100%?

    The 100% success rate of the above scenario is mainly due to the fact that you take away sequence of returns risk from the first 10 years of the $250,000, by setting it to grow at 6%. Which is definitely a conservative estimate, no arguments there. But if we are going to compare apples to apples, then all of the portfolio (1,000,000) has to be subject to the sequence of returns, not only the 750,000 that is not locked in.

    For the example on this post, I think the fact that 250,000 is locked away is a mute point and you can just run the regular FIRE Calc scenario. This is for two reasons:

    1. The time horizon to unlock the funds, 10 years in this case, is short enough that it doesn’t matter. Because…
    2. Money is fungible. The 4% rule does not care that $250,000 can’t be touched. In fact, there are 250,000 that are probably not going to be touched anyway in the first 10 years, whether they are locked in or not.

    Long-story short. I think the above example overestimates the success rate of the hypothetical portfolio. Do you agree? Am I missing anything?

    1. I’d say the better success rate is caused by the fact that we are treating the $250,000 as a seperate portfolio that will have likely have a higher equity allocation than the rest, which will mean it outperforms the rest of the portfolio over the time period where you can’t touch it.

      If you want to be more conservative, you can always do 2 analysis: one big pot and two seperate portfolios and take the lower success rate. This process allows you to identify situations where you have way too much money in a locked in account and therefore can’t retire because you have an access issue.

  4. This is just what I need to assess what I was calling my franken-retirement, since I’ve got a (CDN) gov job with defined benefit pension and I need to sort out how much full time I need to do, how much part time I can manage, and what else needs to fit together along the road to create the perfect monster retirement scenario! If you ever want more fun math calculators to create, let me know 🙂

  5. This is something that I thought about a while ago as I will have a LIRA from a commuted pension when I pull the retirement trigger in a couple more years (mid 40s fingers crossed) and which I can only access at age 55.

    I consider the RRSP and the LIRA as the same block of funds. I just pull funds from the RRSP (I’m thinking it will be in the range of $10-20k a year). All other funds in the RRSP and LIRA continue to grow tax free in the meantime. When I hit 55, I can choose to start to pull funds out from the LIRA if I need it.

    In my case, my current balances are as follows:

    LIRA $140k (if I quit today – this can fluctuate on a go forward basis though)
    RRSP $260k
    TFSA $ 60k
    NonReg $560k (includes a bit of cash)

    I’m not dependent on the funds in the LIRA. When applying the 4% rule in general terms, that would mean I should be able to pull $16k annually from the RRSP/LIRA on a combined basis although I will weigh annual rebalancing of the portfolio before I decide how much I actually draw from the RRSP/LIRA combined balance. If I need to rebalance heavily in a specific year for some reason, then I may withdraw less from the combined RRSP/LIRA balance and compensate with capital gains in the non-registered account.

    On the other hand, if someone only has a LIRA, well, they’re a little more SOL and will need to be a bit more patient. Considering the crowd who congregate here, I don’t think that type of situation may arise too often as the hope is that most readers will have a higher than average savings rate and therefore, multiple types of investment accounts.

    My piece of advise is that if the LIRA is your one and only saving grace, be a bit more patient and save a bit more before pulling the fire trigger. Even with the balances I currently have, I still don’t feel comfortable enough to do it. On the other hand, if you’re really confident regardless, by all means, pull the trigger anyways. 🤪

      1. Locked in retirement account. When you commute a pension, that’s where most if not all of it will go. If you have more than the allowable amount, that portion will be taxed as income in the year you quit/get laid off.

      2. Locked In Retirement Account. In Canada, if you have defined benefit pension, you have 2 options when you leave your employer: Take a lump sum cash payment or wait to receive your earned monthly pension benefits at 55. If you take the lump sum, that cash will be in a LIRA. You can manage the investment yourself but you still can’t access it till 55 (some provinces have different ages cut offs).

    1. Right, FC has a LIRA too but as a percentage of our total retirement portfolio it’s not big enough to require a seperate locked-in analysis. You look like you’re in the same boat, just treat it as one big pot and you’ll be fine.

  6. Long-time fan. First time commentator (second time maybe?).
    I would like to point out a minor issue I see above (not as a complainypants but just trying to add value, so please don’t punch me in the face). 🙂

    When you run FIRE Calc for $40,000 of annual spending off of a $1,000,000 portfolio, without a locked in portion, you get a 94.9% success rate.

    So I was scratching my head a bit when I saw the 100% success rate of the portfolio on this post, since it is made up of the same spend of 40,000 and same assets of 1,000,000. How could a locked in portion bring the success up to 100%?

    The 100% success rate of the above scenario is mainly due to the fact that you take away sequence of returns risk from the first 10 years of the $250,000, by setting it to grow at 6%. Which is definitely a conservative estimate, no arguments there. But if we are going to compare apples to apples, then all of the portfolio (1,000,000) has to be subject to the sequence of returns, not only the 750,000 that is not locked in.

    For the example on this post, I think the fact that 250,000 is locked away is a mute point and you can just run the regular FIRE Calc scenario. This is for two reasons:

    1. The time horizon to unlock the funds, 10 years in this case, is short enough that it doesn’t matter. Because…
    2. Money is fungible. The 4% rule does not care that $250,000 can’t be touched. In fact, there are 250,000 that are probably not going to be touched anyway in the first 10 years, whether they are locked in or not.

  7. Great article, and from what I have seen it is unique in the FIRE blogs. I wanted to highlight the option, in Canada, of converting your LIRA to a Life Income Fund (LIF). Check out the details here:
    http://www.osfi-bsif.gc.ca/Eng/pp-rr/faq/Pages/lif-frv.aspx
    For the first couple of years of having a LIRA I thought I could only start withdrawing at a standard retirement age, but then I had a Eureka! moment when I learned about the LIF.
    I then called the trustee of my LIRA, who confirmed that they could convert my self-directed LIRA into an LIF and all assets will seamlessly move over.
    The benefit of a LIF is that you can withdraw a certain amount of it annually, no matter how old you are. For example at my age (36), the maximum withdrawal rate is 4.0864% of the start of year balance of the account, payable monthly. This is great because it is essentially lets you withdraw your 4% safe withdrawal rate.
    The older you are, the more you can withdraw, up to 100% at age 89. See the chart at link above.
    So, to go back to the example in this post of a person having $250,000 in a locked in account, at the age of 36 one could withdraw up to $10,216 over the year ($851/month).
    This could be a great supplement to other available portfolio income and speed up one’s ability to retire early.
    I have not yet converted my LIRA because I still have some months before I am leaving my full time job, and right now it would be disadvantageous from a taxation perspective, but I definitely plan to take advantage of this when I stop full time work next year. There are also minimum withdrawal rates once you make the conversion.
    I hope this helps someone find freedom sooner than they thought!

      1. I noticed that most of the calculators on bank web sites that I initially looked at (which are often “silly and misleading”) only showed calculations for after the age of 50 or 55, but I have not seen any written rule anywhere for an age restriction. Have you seen one? What I am referencing is the OSFI rules and chart (linked above) that shows ages as low as 20 withdrawing from a LIF. Also good is this site that describes some differences between provincially and federally regulated locked accounts and LIFs. https://www.taxtips.ca/pensions/rpp/minmaxwithdrawals.htm

        1. I should add…the trustee/bank I spoke to about my conversion was Canadian Western Trust, where we hold most of our registered accounts.

  8. You assume that the locked-in-pension appreciates at constant 6% while the portfolio is exposed to actual historical returns. But in the cases where the accessible portfolio would have dropped in the past simulations so would have the non-accessible portion. That means the locked account would have been worth less than $447,712.
    The proper calculation would have been to do FIREcalc with the entire $1,000,000 right from the beginning and to check if after 10 years you still had more than enough to satisfy withdrawals from the accessible portion only. (which you would have, so you came to the correct answer but with a faulty calculation).

  9. I didn’t know you could use firecalc with the additional lump sums. This is very helpful as I hadn’t projected the CPP + OAS amounts to the equation either. Did you also add those amounts in your retirement planning? How reliable is it to use social security in FIRE plans? I’m don’t feel 100% secure in adding these amounts because that assumes the funds will be there in the future … One question is how can we find out the age limits + penalties for early withdrawal from RRSP and/or LIRA accounts? Thank you!

    1. Oh we’re way to young to assume anything about CPP/Social Security. I just assumed 0 from those sources so anything I get will be bonus.

      As for age limits, there are generally no age limits for RRSPs, and LIRAs usually restrict withdrawals until 55, but check with your provider.

  10. All this talk about LIRA…. Can anyone speak to any loopholes regarding removitng them as a non resident? Can’t really find reliable info regarding what happens if we declare residency for another country and then remove them? Different tax rate?

    My wife and I will retire in 4 years and she’ll be 37, so waiting 18 years to pull it out seems ridiculous.

    Thoughts?

    1. That’s an excellent question for a tax attorney.

      My understanding is that after become tax-non-resident for 24 months, you would be allowed to unlock the LIRA, but it would be taxable income that you’d have to report in your new tax jurisdiction. But again, I haven’t tried it myself so check with an attorney or your plan provider.

  11. Really interesting article! Thanks so much. I work for a state government in the U.S and luckily have access to a 457. The flip side to that is that the defined benefit pension also on offer–in which you are vested after 8 years of service– is only available as a monthly pay-out when you reach the magical “rule of 90” number. I don’t even know whether to count this! Thanks also for the link to the FIREcalc resource. Looks like I may need to avail myself. I wonder if it can cope with my 1950s era pension “problem!”

  12. I’m basically reiterating what everyone is saying but I can’t thank you enough for posting this. I had done the calculations myself which took a great deal of time, and I was very unsure of the accuracy basically assuming I was being too positive with my outlook. I had no idea FIRECalc was able to do this. I have a 100% success rate with my current plan to retire in 15 years at age 50. I wish I had figured all this out 10 years ago but not much I can do about that now. Thank you so much for taking the time to do posts such as this!

  13. Another good article. While not very pertinent (but somewhat) for my case, feedback suggests a warm welcome on the topic. 🙂

    But, I did want to thank you for giving FIREcalc a plug! It was THE tool that told me I was free to live life on my terms. I have fixed and cola’d pensions, SSI (later), and something similar to a LIRA, as well as a modest portfolio. Ergo, my retirement planning was more complex than most free tools could handle. FIREcalc crushed it. I made a modest donation to FIREcalc on my retirement anniversary (and intend to do so annually). I play with FIREcalc often to model different retirement strategies.

    So, thank you!

    To the fans Millennial Revolution, I would encourage you to add FIREcalc to your favorites (and use it often as you chart your dreams).

  14. Australian here. Plan to build up our portfolio outside of super. Worse case means extra tax during the working and building up portfolio years roughly 10-15 years. Once retired early couple has roughly $18,000 each ($36,000) income tax free. I’m 29 and my super currently has $105,000 ticking along in vanguard index funds

  15. THANKS for the FIRECalc – such a cool tool! Is that what you guys always use when mathing shit up?

    I’ve been playing with a bit over the last few days – my work pension is indexed defined benefit (assuming I leave it there when I leave my job, or I can do the LIRA thing but that’s a more complex question I’ll get more professional assistance with closer to my FU date) so it’s been interesting to play around with the numbers to figure out how close I am (or to suddenly panic like WTF then realize I totally didn’t enter something right lol)… CPP/OAS really is just bonus money that I’m ignoring as well – who knows what will change between now and gov’t retirement date.

    Something for the “to write later pile” – RESP’s investment strategy given the shorter timeframe to withdrawal. In Canada it seems crazy not to put money in the RESP to get the gov’ts sweet cash contribution to your kids’ university tuition!

  16. Getting into the specifics:
    Financial Hardship Form 1 – Medical Expenses
    Financial Hardship Form 2 – Rent or Secured Debt (Mortgage) Arrears
    Financial Hardship Form 3 – First and Last Months’ Rent
    Financial Hardship Form 4 – Low Expected Income

    Looks like the magical amount is…. drumroll please: $37,267.00 (per person?)

    In 2018, if the amount you enter in box 2 is greater than $37,267.00, your application must be refused.
    https://www.fsco.gov.on.ca/en/pensions/Forms/Pages/2016-user-guide-fhu4.aspx

    https://www.fsco.gov.on.ca/en/pensions/Forms/Documents/1299E.5.pdf

    Q69. How can I determine whether an amount should or should not be included as expected total income?

    A69. The Regulation sets out certain amounts that are not included in an owner’s expected total income from all sources before taxes.

    The following amounts should be included in determining your expected total income for the next 12 months:

    wages, salaries, casual earnings and amounts paid under a training program (gross amount, before taxes);
    income from self-employment (excluding expenses but before taxes);
    rental income (excluding expenses but before taxes);
    payments received under an annuity, pension plan, registered retirement savings plan, registered retirement income fund, superannuation scheme, or earnings replacement program;
    insurance benefits;
    spousal support payments;
    capital gains arising from the sale or disposition of an asset;
    cash payments received under a government program (except for those excluded below), such as Canada Pension Plan, Old Age Security, or Ontario Works;
    interest and dividend income on any investment; and
    income from any other source.
    The following payments should not be included in your estimate:

    the amount you expect to withdraw under the low income category;
    a refund or repayment of taxes;
    a refundable tax credit;
    a refund of tax paid under the Ontario Child Care Supplement for Working Families program (under section 8.5 of the Income Tax Act);
    the payment to you of an Ontario child benefit (under section 8.6.2 of the Income Tax Act or under section 104 of the Taxation Act, 2007);
    a payment received by a foster parent under the Child and Family Services Act; or
    child support payments received under a court order or an agreement. -03/14
    https://www.fsco.gov.on.ca/en/pensions/financial_hardship/Pages/applicants-owners.aspx#part2

  17. Financial Hardship rule in Ontario is an easy way to withdraw from a Locked-In account before 55. I will be using this method next year when I fire at 45. Will be withdrawing from Locked-In accounts first, RRSP second and TSFA 20 year from now. In that order. 🙂

  18. Question:
    The Portfolio tab says to enter the amount in TODAY’s dollars. You entered a number that is the future value of the pension, not the pension value today. Seems like a mistake. All the numbers you entered were in today’s dollars, except this one. Why is that? What am I missing?

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