Early Retirement Withdrawal Strategies for the Long Haul

A strong woman is climbing a steep rock face while roped in.

(Image credit: Getty Images)

published 6 July 2024

Editor’s note: "Early Retirement Withdrawal Strategies for the Long Haul" is part six of an ongoing series focused on how to retire early and the FIRE ("Financial Independence, Retire Early") movement. The introduction to the series is How to Retire Early in Six Steps. To see all early retirement articles, jump to the end.

You’ve reached the summit of your financial independence journey — now what?

Without a plan, you might find yourself financially “rim rocked,” as rock climbers stuck with no way out.

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Many assume climbing is about finding a way up and simply taking the same route down, but the truth is that accidents often happen during the descent. A 2006 study found that over half of the 192 deaths above base camp on Mount Everest from 1921 to 2006 occurred on the way down. As mountain climber Eric Arnold, who tragically died descending from his fifth summit, noted, “Two-thirds of the accidents happen on the way down. If you get euphoric and think, ‘I have reached my goal,’ the most dangerous part is still ahead of you.”

Early Retirement Withdrawal: How to Plan

Achieving FIRE (financial independence, retire early) status is similarly ambitious, and drawing down assets over a much longer period than a traditional retirement brings unique risks. Market conditions and life circumstances can change dramatically over these withdrawal years. One wrong move could prove costly — penalties, taxes, or worse, running out of money. This is reflected in a recent Schroders retirement study that found the major concerns for retiring Americans include: “not knowing how to best generate income and/or draw down assets” and “outliving assets.”

That’s why Brett Spencer, founder and lead advisor of Impact Financial, emphasizes the importance of creating a plan and “diligently monitoring it.”

The FIRE movement is broad, with individuals achieving it in a variety of ways, leading to an array of strategies for spending down assets. While one way is not best for all, many of the dangers on the way down are the same. Here are some strategies for overcoming them.

Sidestepping early withdrawal penalties

The IRS means well. To discourage premature use of retirement funds, it imposes a 10% tax penalty on early withdrawals from certain retirement plans before age 59 ½. However, this guardrail becomes an obstacle for those who actually save diligently but then retire early.

Fortunately, there are ways to access retirement accounts before age 59 ½ without penalties.

One option is Substantially Equal Periodic Payments (SEPP), also known by its low-budget cyborg movie name, 72(t). This allows penalty-free withdrawals from IRAs or 401(k)s at any age, provided you take a series of substantially equal periodic payments for a minimum of five years or until you turn 59 1⁄2, whichever is longer. Spencer notes that “rules need to be followed for withdrawals to qualify.” For instance, payments must be calculated using one of three IRS-approved methods and cannot be altered once started.

Another possible strategy is a Roth conversion. Here, you transfer traditional IRA or 401(k) funds into a Roth IRA. After five years, these converted funds (but not earnings) can be withdrawn penalty-free and tax-free. This requires careful planning to manage tax implications during the conversion years.

For those with a 401(k) or 403(b) and who aren’t exactly rushing out the door by FIRE standards, the Rule of 55 is another exception. This IRS rule allows individuals who leave their job during or after the year they turn 55 to withdraw funds from their 401(k) without the 10% early withdrawal penalty.

Navigating taxes and investment costs

A towering figure casting a shadow over the spending down of your assets is none other than Uncle Sam. While you can’t avoid them, you can minimize taxes on account withdrawals.

An early retiree client of Spencer’s illustrates this point. His client structured his FIRE plan with passive income investments, generating more portfolio income than needed. As a result, he paid taxes on unused investment income, which was then re-invested. Spencer says, “We’ve improved this client’s tax efficiency by moving some income investments into his tax-deferred retirement accounts. This way he is more in the driver’s seat on the income he realizes.”

A Roth conversion could also help lower your tax burden, as converted funds can be withdrawn tax-free. However, since you pay taxes on the conversion, the decision depends on whether your tax rate is higher now or when you start withdrawing funds.

For a taxable portfolio, Spencer suggests two strategies: tax loss harvesting and tax gain harvesting.

Tax loss harvesting allows you to sell investments at a loss to offset gains and reduce taxable income. Losses can offset up to $3,000 of ordinary income per year and be carried forward to future years.

Meanwhile, tax gain harvesting involves realizing gains when you’re in a 0% or low tax bracket. You sell and immediately buy back investments (from a taxable account) that have increased in value to reset the cost basis and take advantage of low capital gains tax rates.

Spencer cautions, “These strategies take a lot of monitoring and careful planning with the right software and tax knowledge.”

Investment costs are another potential drag on your retirement savings. A Vanguard paper even calls the failure to plan for investment fees, such as mutual fund expense ratios, a retirement risk for FIRE investors. After all, investing costs reduce net returns. Therefore, consider investing in lower-cost funds to help you keep more of your returns, increasing the probability of success.

Keeping your portfolio financially sustainable

Arguably, the biggest challenge among early retirees is portfolio sustainability.

Many FIRE proponents use the famous 4% rule to determine their spending plans. This guideline suggests saving 25 to 30 times your annual spending, then withdrawing 4%, adjusted for inflation, annually. However, the 4% rule is based on a shorter drawdown period of 30 years, not the 50-year period of someone retiring early at 40. Therefore, the 4% guideline might be too generous.

When considering a potentially 50- or 60-year time frame, predicting portfolio sufficiency is difficult. Retirement planning often assumes relatively static spending, but many variables, such as healthcare costs, can dramatically alter your financial needs.

The 4% rule can be a good starting point, providing a target for saving and spending. However, the earlier you retire, the lower your withdrawal percentage may have to be. A safer rate might be around 3% to sustain your portfolio for 50 years. Alternatively, you could save more before reaching FIRE status.

Market downturns also pose a risk to portfolio success when withdrawing funds as prices drop. A dynamic withdrawal rate can help mitigate this risk. With this strategy, you adjust your withdrawal rate based on market conditions: withdraw more during good years and less during bad years, allowing better recovery.

Additionally, Spencer recommends diversification. “A properly diversified portfolio reduces the level of downside potential, which becomes really important once you are living off of your portfolio,” he says. While bonds are a common diversifier, keep in mind they fell alongside stocks in 2022. Therefore, diversify broadly across all asset classes, such as international securities.

Planning is the ultimate lifeline

A noticeable feature of the FIRE community, evident in blogs and Reddit forums, is a deep commitment to planning. Some manage their finances and retirement planning on their own, which is possible but challenging. Given the potential pitfalls, working with a financial advisor may benefit most.

Spencer points out: “While the thought of retiring early can be very attractive, it is very important to plan and stress test your plan.” Advisors can use simulation models to assess the success rate of your portfolio under various scenarios. While not a guarantee, it provides a good idea of your plan’s sustainability and strength.

Ultimately, the potential dangers should not deter those inspired to retire sooner rather than later.

Achieving financial independence, even in the most aggressive scenarios, typically takes about a decade or more. This is enough time to learn, grow and adjust strategies, as many FIRE advocates do.

As Beat writer and outdoor enthusiast Jack Kerouac wrote, “Because in the end, you won’t remember the time you spent working in an office or mowing the lawn. Climb that goddamn mountain.”