Tax-advantaged retirement accounts like 401(k)s, IRAs, pensions, and more all restrict access by age or have penalties for accessing funds early. This may not be a problem if you plan to retire at a “normal” age – most allow penalty-free access starting at age 59.5 – but not everyone plans to retire at a “normal” age. If you plan to retire early, you may need to build what is commonly called a bridge account.

What is a bridge account?

Not just any type of account can be considered a bridge account. Traditional retirement accounts like Roth IRAs and 401(k)s have age limitations on penalty-free access, which creates the need for bridge accounts in the first place. Bridge accounts are most often taxable brokerage accounts.

Taxable brokerage accounts are one of the investment “buckets” in the three bucket strategy, and building taxable assets falls into Step 7 of the Financial Order of Operations, hyperaccumulation. If you follow the FOO, you may find yourself building taxable brokerage assets even if you don’t plan to retire early. Or if you never reach Step 7 you may not build any taxable assets, even if you plan to retire early. Who exactly should worry about building a taxable account and when should you start?

Do you need a bridge account?

Let’s start with the question that’s easiest to answer: if you don’t plan to retire early, but reach Step 7 of the Financial Order of Operations, should you still invest in a taxable account? The short answer is yes, for several reasons. For starters, reaching Step 7 of the FOO means you are already maximizing your Roth IRA, HSA, and employer-sponsored accounts. It might be better for you to contribute more dollars to tax-advantaged accounts, especially if you don’t plan to retire early, but you no longer have that option. 

Taxable brokerage accounts have more benefits than just early access. Taxable accounts provide another level of tax diversity in your retirement plan. These accounts are not tax-free, and are not tax-deferred, but subject to short-term or long-term capital gains tax. Unlike all tax-advantaged plans, there are no contribution limits for taxable accounts. Unlike many employer-sponsored retirement plans, investment options in your taxable account are almost unlimited.

Can you retire early without a bridge account?

Now for the tougher question: what if you plan to retire early but will never reach Step 7 of the Financial Order of Operations (and never contribute to a taxable account)? If you follow the FOO to a T, you wouldn’t contribute to a taxable account until you reach Step 7, hyperaccumulation. That means you are already maximizing your Roth IRA, HSA, and employer-sponsored retirement account. In 2024, the combined contribution limit for those accounts, for a single individual under 50, is $34,150.

Unless you have a high income, it’s likely you may never get past investing in your Roth IRA, HSA, and employer-sponsored account. That is totally fine. You can consider Step 7 of the FOO completed as long as you are investing 25% of your income, even if you never contribute to a taxable brokerage account. But for those planning to retire early, not having taxable assets could complicate early retirement.

There are ways to access tax-advantaged retirement accounts early that may negate the need for a taxable brokerage account. For a Roth IRA, you can withdraw contributions at any time without penalty. Gains are still limited to age 59.5, but accessing contributions early could give you some flexibility in your retirement plan. Additionally, the Rule of 55 may allow you to take distributions from your 401(k) and other employer retirement accounts as early as the year you turn 55 if you become unemployed.

If you plan to retire early, it may not be necessary to build a taxable account if you have access to enough assets in other accounts that you can access before traditional retirement age. Every situation is different, though, and you may need to contribute to a taxable brokerage account “out of order” in the FOO in order to retire early. A fee-only financial advisor can help create a personalized plan for you and make sure you develop a plan of action to achieve your retirement goals.

Depending on what your retirement accounts look like, a bridge account may be necessary for early retirement or early access to Roth IRA contributions and your 401(k) may be enough to retire early. Making decisions like whether or not you need a bridge account and how much to contribute, if you do, is extremely stressful and not easy. If you get it wrong, you may not be able to retire when you want – or even worse, you may run out of money in retirement. You only get one retirement and we want it to be as successful as possible. We’ve helped clients navigate hundreds of successful retirements and would love to chat about how we can work with you.

If you are one of the fortunate Americans with a defined benefit pension plan, how should you think about saving for retirement?

How certain is your pension?

Will your pension still be there when you retire? Nearly one million Americans are currently receiving income from the PBGC, or Pension Benefit Guaranty Corporation, because they were enrolled in one of over 5,000 failed pension plans. It is not very uncommon for a pension plan to fail, but fortunately the PBGC covers most plans. They do not cover government pensions, military pensions, those associated with religious institutions, or small professional practices with less than 25 employees. While government pension plans aren’t covered by the PBGC, they are generally considered low-risk since governments can raise taxes to overcome a funding shortfall. Private companies don’t have this luxury.

If you have a government pension, it is worth reading up on the federal or state laws that apply to your pension and outline what steps will be taken if there is a funding shortfall. In general, most pension plans can be considered safe, but it is important to understand the protections in place if something were to happen to your own pension plan.

How much should you invest outside of your pension?

How much money should you invest for retirement if you expect to receive a pension? Before you completely factor your pension into your retirement need, make sure you will absolutely be eligible to receive your pension payments. There may be service requirements you need to meet before becoming eligible, so if there’s a chance you will leave your job before you meet the service requirements, it may be best not to count that pension just yet.

If you are certain you are eligible to receive benefits in retirement, how do you determine what you should invest outside of your pension? There are many factors involved, but at the end of the day, it is a simple math equation. If you reduce your expected retirement expenses by a conservative estimate of your pension income, you can calculate how much you need to invest to fund that goal.

If that sounds complicated, don’t worry! We created our Know Your Number course to help you determine your retirement number and how much you should be investing to reach that goal. The course includes a nifty spreadsheet where you can adjust different variables like your expected expenses in retirement, age at retirement, life expectancy, and more to see if you are on-track to meet your retirement goals. 

How to think about investment allocation

If a pension plan is a safe investment that provides a certain amount of income in retirement, does that mean I can be riskier with my other investments? Not necessarily. There is no one-size-fits-all answer to risk in your investment portfolio. Everyone has different goals and risk tolerance that factor into how aggressive or conservative you may want to invest. In general, if you have a very large and safe pension plan, you may be able to invest more aggressively in other retirement accounts. If your pension plan is smaller and not as safe, it may be unwise to invest so aggressively in outside accounts.

What if something happens after you retire?

After you retire and start receiving income from your pension plan, you may feel like you’re in the clear. However, something could happen to your company after you retire that may affect your pension plan, like bankruptcy or underfunding. Most private pensions are covered by PBGC insurance, which would cover your pension income up to legal limits if something happened to your plan. It is important to research whether or not your pension plan is covered by PBGC and what would happen if your company went bankrupt or could no longer fund the plan.

What about your loved ones?

If both you and your spouse are dependent on your pension income, they could be in quite the pickle if you were to die before them. That’s why it’s so important to understand survivorship options available in your pension plan. Many plans have the option to choose a joint or survivor option, which will likely decrease your monthly benefit, but would provide income for the life of both you and your spouse. Without this option, your pension income would stop when you died, which could be very bad for a spouse that depends on that income to live.

Pension plans have become more uncommon in the US, but there are still tens of millions of Americans that will likely receive pension income in retirement. They are very different from 401(k) plans, and knowing whether or not you can depend on your plan, how much to invest outside your pension, and how to change your investment allocation, if at all, can help you reach your more beautiful tomorrow in retirement.

How do you prioritize investing for retirement and making memories and experiences now? It can feel difficult to prioritize all of life’s needs and have enough left over to lead a fulfilling life.

Are you ready to take your finances to the next level? Check out our Financial Order of Operations resource that outlines the nine steps anyone can take to build wealth and reach financial abundance.

Did you know that there are perfectly legal strategies you can use to AVOID paying taxes in retirement? Contributing to these accounts can minimize your tax burden when it comes time to hang ‘em up.

Ever wonder what the highly trained professionals use to tax plan? Wonder no more! We’ve assembled the ultimate tax guide you can download and reference as you prepare your taxes this year.

If you Know Your Number for retirement and reach that goal, does it make sense to continue investing even when you don’t need to be anymore?

Find out how much wealth you need, when you’ll get there, and ways to speed the process. Own your time with the Know Your Number course.

If Roth accounts are so good that the government limits who contributes and how much they can contribute, then why do we have “loopholes” like the backdoor Roth and mega backdoor Roth that allow people to contribute when they shouldn’t be able to?

Learn why Roth IRAs are so powerful and why they might be the perfect next step on your wealth building journey with our Roth IRA Guide.

If you are under the age of 40, you might find it difficult to believe that pensions were previously the dominant retirement plan in America. They outnumbered defined contribution plans, like 401(k)s, by a ratio of over 2:1. Today, they are not nearly as popular, and there are less than 10,000 pension plans with 100 or more participants.

Still, pension plans aren’t going anywhere anytime soon. 21% of Americans have pension plans, and 83% of state and local government employees working full-time participate in a pension plan.

How much should I save if I have a pension?

One of the most difficult questions to answer is how much you should be investing for retirement outside of your pension plan. To start, if you don’t already know, find out how much both you and your employer are contributing to your pension. You may always include your own pension contributions in your savings rate, and can include employer contributions in your savings rate if you make under $100,000/single or $200,000/married.

Here’s an example: Jill is single and is required to contribute 5% of her annual pay to her pension, and her employer contributes another 5%. If Jill makes under $100,000, her savings rate would be 10%. If she makes over $100,000, her savings rate would be 5%.

That might give you an idea of what you should be aiming to save outside of your pension, but depending on your retirement goals, age, and how far ahead or behind the curve you are, you may need to save more or less. Our Know Your Number course can be a great tool for factoring a pension into your retirement number. I’ll show you how it works.

First, let’s look at someone without a pension. They are age 30 and want to retire at 55. They expect to spend $6,000 per month in retirement, using today’s dollars (pre-inflation adjustment), already have $200,000 invested, and invest $30,000 per year. They are currently on-track to meet their goal to retire at 55, based on their assumptions.

Now, what if they had a pension? Let’s assume they have a PBGC insured pension, and they will conservatively receive $2,200 per month starting at age 50 (which means they will more than likely receive more; it’s almost always better to be more conservative when it comes to estimating retirement needs). Here’s what their number looks like now with the same assumptions.

To account for the pension, expenses in retirement were reduced to $3,800. They are now able to retire just before age 50 based on the assumptions used. This means if they still would like to retire at age 55, they could save less per year or explore spending more in retirement (blossoming memories come to mind with travel and visiting family). Here’s what an updated calculation would look like.

To retire at age 55, with the assumptions chosen, they would need to invest just $11,500 annually outside of their pension plan. It’s incredible how such a “small” detail can significantly impact your retirement plan and how much you need to be investing. Investing 20% to 25% is a great place to start, but knowing your retirement number can help you know exactly how much you should be investing each month to be on-track to achieve your retirement goals.

What if I won’t get Social Security?

Some workers with pensions, including teachers in a handful of states, don’t pay Social Security taxes and won’t receive benefits unless they have enough credits from a different job. If you do have a pension and won’t be receiving Social Security benefits, consider including a much more conservative estimate of your pension in your retirement plan or not including it at all. It is not uncommon for teachers to transition to another school system or profession to build enough credits to qualify for Social Security after they meet the years of service requirement and their top three years of income are used in the pension calculation. A “best of all worlds” approach to optimize their retirement.

How does a pension affect my asset allocation?

A pension should not be viewed in isolation, but as part of your larger retirement plan and portfolio. Defined benefit pensions provide just that: a predetermined retirement benefit that doesn’t fluctuate with the stock market. Your pension can be viewed as a more conservative piece of your portfolio, which may allow you to take more risk with the rest of your portfolio.

Saving for retirement can seem more confusing when you have a pension plan, but it doesn’t have to be. Use our tools and resources to help you determine where your pension fits in your overall retirement portfolio and how it affects the other parts of your retirement plan. While you only have one retirement, our advisors have helped hundreds through the transition into retirement. If you would like to complete the Abundance Cycle to land the plane of your retirement journey, please do not hesitate to check out our “Work With Us” page at AboundWealth.com or MoneyGuy.com. Our ultimate goal is to help you live your best financial life so that your money works harder than you do with your back, brain, and hands.

1. Healthcare

According to Fidelity, an average single person retiring in 2023 will need approximately $157,500 saved, after taxes, to cover all of their medical expenses in retirement (for a married couple, the number is simply double, $315,000). This estimate assumes you retire at age 65 and are eligible for Medicare coverage. More importantly, it does not cover health-related expenses like most dental services and long-term care.

The Fidelity estimate is a good jumping-off point for estimating your medical expenses in retirement if you expect to retire at age 65 and are in good health. However, if you have a family history of illness or expect to retire early, you will need to plan for more medical expenses in retirement. Those who retire early will also need to plan for the extra cost of paying for their own health insurance before they become eligible for Medicare. Healthcare is often one of the scariest unknown costs for early retirees, but at the end of the day it is an expenditure that can be estimated like anything else.

The Health Savings Account, or HSA, is one of our favorite retirement savings vehicles for a reason. Not only do you get a tax deduction when you make contributions, withdrawals used for eligible medical expenses are entirely tax-free. Eligible medical expenses include a wide range of expenditures, including many related to long-term care (coming up next).

2. Long-term care

Paying for long-term care can potentially be one of the costliest expenses in retirement. The average stay in a care facility is around 22 months, and depending on the amenities and level of care provided, the average cost ranges from around $5,000 to $10,000 per month. If you do the math, long-term care could easily end up costing you hundreds of thousands of dollars in retirement. What’s so frustrating about estimating long-term care is just how drastic differences in costs can be. It is estimated that one-third of 65-year-olds today will never need long-term care, however the rest will; and 20% of all 65-year-olds will need care for longer than five years.

Knowing your family history can be extremely helpful in estimating potential long-term care expenses. It is worth weighing the costs and benefits of long-term care insurance as opposed to self-insuring. Medicare doesn’t cover long-term care, but Medicaid provides coverage for lower-income people whose assets are exhausted. Paying for your own care, through self-coverage or insurance, is obviously preferable (it means you still have assets remaining in retirement, for one, and you likely have some choice of where you’d like to stay). However, Medicaid provides a safety net for those who have no other options.

3. Housing

We like for everyone to enter retirement debt-free, but you may be renting, and even if you own your home, you have other housing-related expenditures. These shouldn’t be extremely difficult to estimate if you have an idea of where you’ll be living in retirement. If you own your home, housing costs are even more fixed and increase only as your property tax, utilities, homeowner’s insurance, and other housing expenses go up. Historically, rents increase about the same percentage as inflation overall.

4. Taxes

Just how much will your assets be taxed in retirement? Will your Social Security income be subject to taxation? If the majority of your assets are in pre-tax retirement accounts or pensions, what you end up with, after taxes, could be significantly less. Conversely, if a large percentage of your assets are in tax-free accounts like Roth IRAs and HSAs, your taxes in retirement may be very low.

Adding to the uncertainty of how much taxes you will owe in retirement is the possibility that tax rates will change or you will end up in a higher or lower tax bracket when retired. Historically, we are currently in a period of low tax rates. When planning for the future, it’s better to err on the side of caution and assume tax rates may go up or be higher in retirement.

5. Other living expenses

Housing, healthcare, long-term care, and taxes are some of the greatest “unknown” expenses in retirement, but there are plenty more you need to be thinking about. They can vary greatly from person to person. How much do you want to travel in retirement? Do you want to spend a lot of time at nice restaurants or do you like cooking at home? Do you have hobbies (or anticipate developing hobbies) that might be costly? Do you want to leave money to relatives or charitable causes? Only you can answer these questions, but a fee-only, fiduciary financial advisor can help you determine what’s important to you and how to plan for those goals.

Estimating what your expenses will be in retirement is daunting, more so the further away you are or the longer you plan to be retired. Our Know Your Number course can provide additional clarity on both your expenses in retirement and putting all of the pieces together to make sure you’re on track for retirement. Through video lessons, worksheets, and spreadsheets, Know Your Number will help you better understand where you’re going, where you want to be going, and how to make sure the two align.