Q. My wife and I are in our mid 30's with one child and another on the way. We've been very lucky and have quite a nest egg put away in qualified plans--- about $220,000. Over the past 3 years we've been continuing with adding qualified funds on a consistent basis ($10,000 a year for each of us). We are focusing any additional funds in non-qualified investments (now about $75,000) to bridge the early retirement gap, college, and weddings.

Our plan is for me to retire at age 53. My question is should we consider reducing or eliminating our qualified plan contributions for the next three years or so and redirect these funds to a 529 plan or any other non-qualified fund activity. The plan is to use non-qualified funds to bridge to my 59- ½ money.

One of my first concerns is the increased tax liability with this strategy and if I have enough money already set aside to keep my retirement standard of living, estimated at $90,000 a year, net. Do you think this is a sound strategy?

---T.A., Dallas (by e-mail)


A. You may need to rethink this in several dimensions. First, if you actually plan to retire before age 59  ½ you can avoid the penalty for early withdrawal simply by taking a series of substantially equal payments. The people who have to pay penalties are people who make one-time or short-term withdrawals. So your need for "bridge" money may not be as large as you expect.

Second, you may not understand the magnitude of your project. To retire at 53 with $90,000 of after-tax income you will need to be able to sustain a withdrawal rate of about $109,300. You'll pay about $20,000 in Federal Income Taxes. To do that on a sustainable, lifetime basis you'll need starting capital of 20 to 25 times that much. That's somewhere between $2.2 million and $2.7 million.

How do you get there? You continue saving $20,000 a year. You grow the nearly $300,000 you have in financial assets at a rate of at least 8 percent a year. That's quite possible, providing you've factored in problems like the high cost of medical insurance. Rates for people their fifties are now so high many people that age look for part time jobs with medical coverage simply to get the coverage.

College savings would have to be in addition to your yearly $20,000 retirement savings. They are likely to be nearly as high as your retirement savings if you have children that opt for an expensive private college. The required savings rate means that you will spend the next twenty years living for the future.

Twenty years is a long time.


Q. In an effort to expand the Couch Potato approach to encompass my retirement 401k accounts (in addition to non-retirement accounts), would it be wise to try to make all bond investments in the retirement 401k accounts and all stock investments in non-retirement accounts, since redemption of stock gains (hopefully) from a 401k retirement account will be taxed at one's tax bracket rate, whereas the same gains will be taxed at potentially a lower capital gains rate in a taxable account.

---M.D., Dallas (by e-mail)


A. What's most important is the amount of money we have to spend, not the amount of money we spend in taxes. Miami financial planner Harold Evensky has shown that we are almost always better off by using tax deferred vehicles to the max because the benefits of tax deferred compounding will overcome the difference in tax rates.

What that means in practice is that we invest as much as possible in our qualified accounts. We have them contain both stocks and bonds. Then we invest any surplus that goes into taxable accounts in tax efficient vehicles such as tax efficient index mutual funds and tax-free bond funds. Remember, yields on tax-free bonds are now highly competitive with yields on taxable Treasury obligations.