If throughout your career you maximized savings into your tax-advantaged retirement accounts and diligently socked money into after-tax savings, you may be able to retire early — well before you’re old enough to collect Social Security or pensions.

Now the challenge is how to manage money in early retirement: specifically, figuring out how to withdraw income from your investment portfolio to support you until normal retirement age, while still allowing for growth to supplement expenses down the road. You need a retirement income bridge — a stream of income from your portfolio to last until pensions and Social Security help fill in the gaps.

Lots of money locked in US retirement accounts | Lock: © Kitch Bain/Shutterstock.com, Money vector: © KennyK/Shutterstock.com

We asked three experts to help us with tips on how to manage money for a hypothetical 55-year-old couple who plan to retire early. Their money is split evenly between after-tax and pretax accounts. Their goal is to maximize tax benefits in their retirement accounts for as long as possible, maintain investment growth and withdraw a steady stream of income.

Determine how much you’ll need

From the start, you’ll need to plan for the next stage of life and potentially 40 years in retirement. “The first step is to take inventory and see what your allocation is. Look at all the pieces,” says Jason Flurry, president of Legacy Partners Financial Group. “Second, you’ll need to plan for a long time frame. We usually figure age 92 for women and 90 for men.”

Before taking the early retirement leap, couples will need to get a handle on how much they actually spend and how much they expect to spend in the years ahead. “Every person is going to be different in what their true budget is,” says Leslie Corcoran, founder of Family First Financial Planning. “What is this number — is it $35,000 or $150,000 per year? That’s going to be a big key to your portfolio lasting 40 years.”

Flexibility is essential

The order of withdrawal should be taxable accounts first, allowing the tax-deferred accounts to grow. To ensure that a couple doesn’t run out of money, approximately 3 to 4 percent would be considered a safe range for annual withdrawals, the experts agree. That leaves room for inflation and some growth in your investments during most years.

But, as with most rules of thumb, there are no guarantees and early retirees have to be flexible, allowing for market swings and accounting for personal spending habits. “The first few years of retirement matter a lot,” says Scott Keller, investment specialist and principal at Truepoint Wealth Counsel. “You have to calibrate your withdrawals to your expenses, with 3 percent as the average over the retirement period. In reality, we often see it higher in the beginning and then it drops down.”

Have a cash cushion

If a high withdrawal rate is paired with a market downturn, early retirees who are spending a lot in the beginning could be in trouble. To mitigate losses in such an event, Keller suggests to his clients that they maintain a minimum of five years of living expenses in short-term bonds and cash. “Then we feel comfortable with them taking risk,” he says.

“We had a pretty quick recovery in the market after the 2008-2009 recession,” he says. “In a typical business cycle, it’s a five-year period. You don’t ever want to be forced to sell stock at a depressed level.”

Your cash cushion should cover anywhere from two to five years of living expenses, according to our experts, depending on how much risk you can stomach and how expensive you anticipate the first few years of retirement will be. Once you establish a comfortable cushion, think of your investments in terms of buckets, says Corcoran.

Fill the buckets

See how a 55-year-old couple uses the bucket system to invest $2 million

The first bucket is for your cash reserves. It’s designed for easy access and safety and contains an after-tax mix of liquid cash and short-term fixed-income assets. Yield is difficult to find, so you’ll have to shop around for the best rates, Corcoran adds.

The second bucket is for intermediate-term needs, within five to 10 years, and ideally is also part of your after-tax portfolio. Here, you’ll err more on the side of safety but allow for some investment growth.

The third bucket is for pretax investments that you would prefer not to tap into for 10 years or more. That’s your bucket for growth because any market dips will likely have some time to recover. However, you won’t want to take on too much investment risk.

As with the years leading up to retirement, the years in early retirement will require the right asset allocation.

The right investment mix: Risk versus income

Back in the days when interest rates were higher, early retirees seeking income could begin reallocating their portfolios toward bonds to gain safety and a healthy stream of income. In today’s low interest rate environment, it’s not so simple to find yield and there’s interest rate risk with bonds, so early retirees will need to maintain a percentage of their overall portfolio in equities.

Keller suggests looking at both pretax and after-tax accounts together and focusing on total return when planning the right investment mix. “At the very top level, we want to address overall allocation in both accounts. Optimally, allocate interest and nonqualified income (such as short-term capital gains, which are taxed as ordinary income) in the pretax accounts where income is sheltered in the near term,” he adds. After-tax accounts can hold exchange-traded funds and domestic stocks.

An alternative strategy

For the after-tax account, Flurry likes 30 percent equity spread among large-, medium- and small-cap stocks, plus U.S. and international stocks. “We lean more toward value companies with good dividends,” he says.

The remaining 70 percent should contain stable, high-quality bonds and other fixed-income assets, especially those that can offer guarantees on your principal and income. He would stay away from long-term bonds and instead tilt toward short-term, with durations of one to three years and ultrashort-term, with durations of less than a year. He also suggests avoiding high-yield bonds, which have a similar risk level to equities.

Another possibility for the fixed-income part of the portfolio is a bond alternative strategy, like a merger fund, which owns stocks of companies undergoing mergers and acquisitions. These funds generally provide additional diversification and low volatility compared with the market. “They act like a bond but with a higher rate of return,” Flurry says.

Lessen exposure to stocks

The pretax account that you won’t dip into for a number of years can contain a 50-50 mix of equity and fixed-income-type investments. Although the fixed-income assets won’t provide a lot of growth, they can help stabilize the portfolio from market fluctuations and offer safety to your nest egg. “This part of your portfolio is more for income tomorrow,” Flurry says. “You still have 10 to 15 years of growth.”

All-in-one funds that combine a mix of fixed-income assets and equity could be beneficial for pre-retirees who don’t want to constantly monitor and rebalance their portfolios, says Corcoran. These funds maintain their balance so you don’t have to. Look for the ones with high-quality, dividend-paying equities and high-quality corporate bonds. “I like these because most people will invest and never have to look at them,” she adds.

Time to reap what you’ve sown

After you’ve diversified your portfolio, it’s time to develop a strategy for pulling out income. Some early retirees might prefer to use a portion of their after-tax investments to purchase an annuity for guaranteed monthly income, but be sure to understand the fees and terms, says Corcoran.

Otherwise, you’ll be earning income from your investment portfolio in several different ways — through payment of quarterly dividends, interest and long-term capital gains.

One way to harvest long-term capital gains is to rebalance your portfolio. This is how it works: When one area of the portfolio — say, growth stocks — has outperformed and exceeded your optimum allocation by a certain percentage, take that percentage excess, redeploy some of it into underweighted asset classes and use the rest to beef up your income stream or cash bucket.

Keller suggests that rather than rebalance on a set timetable, do it whenever your portfolio positions are getting off-kilter from your target allocation.

Managing investments in early retirement is not difficult when you realize that you’re now shifting from being performance-driven to safety-conscious, says Flurry. The goal now is to maintain and realize reasonable growth, rather than reach for new investment highs. “Don’t get caught up in returns,” he says. “If you need 6 percent of your portfolio to live on and meet your goals and you try to get a higher performance, chances are you’re just taking on unnecessary risk.”

That can lead to unnecessary, and painful, losses.

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