A senior O-4 approached me the other day to talk about his personal finances. He was excited because he had just passed the $250,000 mark in his TSP -- no easy feat to be sure! As we chatted, he told me he couldn't wait to achieve FIRE. So, I asked him how much he had saved outside of TSP.
Our conversation instantly ground to a halt. He seemed confused -- he'd been saving every penny to max out his TSP contribution and thought he was good. And he is.... once he reaches age 59-1/2 and can pull that money out penalty-free. But in order to retire before the official government retirement age, you need money saved in other, more accessible places.
My O-4 friend isn't alone; in fact, even with all our strategic thinking and saving, Mr. FIRE and I had the same ah-ha moment only a couple years ago. We were so focused on maxing out our 401ks and TSPs, getting employer matches and tax benefits, that we forgot that money is fenced off for decades without incurring a massive penalty. And in fact, most FIRE websites will talk about achieving your "FIRE number" -- the total amount you need saved to be able to retire -- but they don't remind you that you need to be able to, you know, ACCESS that money during both phases of retirement.
So Mr. FIRE and I developed a new approach we call "Two Buckets."
The basic concept is that you shouldn't give up on the benefits associated with retirement account contributions, but you need to balance that against saving into accounts you can tap between your FIRE retirement and official government-sanctioned retirement age. So you need to plan and track your savings according to two buckets: we call them FIRE and RETIRE.
Early in your career, the most important thing is to contribute to the RETIRE bucket. First, you want to give this money a chance to grow over the decades you're working. Second, contributing to TSPs and 401ks reduces your overall taxable income, giving you a nice break during tax season. Third, retirement fund contributions often have some kind of matching contribution from your employer (this is especially true if you're under the Blended Retirement System) and that free money shouldn't be passed up. Finally, this kind of contribution is easy to make because it can be pulled straight from your paycheck, requiring no willpower whatsoever!
Once you have a steady contribution going into your RETIRE bucket (or if you're getting closer to your planned FIRE age) it's time to focus on the FIRE bucket. This is money in the stock market, real estate, CDs, high-yield savings accounts, wherever that is NOT in a designated IRA or retirement fund. This is also the money that you will live off during the gap between your FIRE retirement (for us, 42 years old) and age 59-1/2.
Though this money won't have to last as long, it also won't have as much time to grow... so don't wait too long to start filling this bucket. You may also find yourself in a position, like us, where you stop maxing out your retirement contributions so you can pour more money into your FIRE bucket. We gave up contributing to a Roth IRA years ago and instead put that money into a normal investment account so we can tap it in our early retirement.
Balancing your contributions to the FIRE and RETIRE buckets is just the first step. You also need to identify your magic retirement numbers for each portion of retirement and invest to achieve them. For the RETIRE bucket, you can use the standard retirement math: 25 x annual expenses OR enough money to withdraw and live off 4% annually. Assuming a conservative 5% rate of return, this money should last you from age 59-1/2 to the end of your life.
For the FIRE bucket, the math is a little different. You only need enough to get you to age 59-1/2 (or whenever you plan to tap into your retirement accounts). One way to look at this is to look at your total FIRE bucket and see how long it will last you based on your planned annual spending -- 2 years? 5 years? 10 years? 59-1/2 minus that length of time tells you when you can afford to retire early.
You can also go the reverse direction: identify when you want to reach FIRE and how much you want to spend each year. Your FIRE bucket number is Annual Spending x Years between FIRE and RETIRE.
Not all of this FIRE bucket money needs to be available the day you hit retirement and not all of it needs to be liquid. For example, some could be in real estate assets that you plan to sell sometime after you reach FIRE. Moreover, any income you plan to have during the FIRE portion of your retirement -- pensions, part-time work, rental income -- offsets the amount you need in both the FIRE and RETIRE phases.
The two bucket approach helps clarify not just how much money you need in retirement but when you may need it. Imagine if you had saved all your planned retirement money, but some of it was tied up in retirement accounts....and you realized too late that you would run out of FIRE funds before age 59-1/2. You'd be forced into either giving up on FIRE and going back to work or taking a major penalty to tap into retirement funds.
So start planning now: identify your FIRE and RETIRE buckets, calculate your FIRE and RETIRE numbers, set some goals and strategies, and start saving! You'll be happy that you have planned for both phases of retirement and can reach and sustain FIRE successfully.
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