Asset Location - Less to Retirement? Feedback on plan

[APBioSpartan]

Hey All -

My wife and I at a bit of an inflection point in my life (new [to us] house, new job, 2nd kid on the way, etc.) and as a result have been rethinking our approach to finances.  Currently, we are following the traditional recommendation to max 401k, Roth, then contribute remaining amount to Brokerage.  My wife and I have been very fortunate with our incomes which has helped us to get to where we are today. 

Age: 33/34
Location: MCOL
Income: ~$330,000/yr
Mortgage: $580,000 [3%]
Investments: $622,000 [12% brokerage, 85% retirement, 3% UTMA/HSA]
Cash: $30,000
Net worth: $652,000 [I don't include home equity, just assets]

I'm still new to "early retirement math", but I believe our retirement accounts are at "CoastFI" status.  Meaning, if we stop contributing to retirement, and those assets continue to grow at ~7%, then those accounts will grow to $4-5mm by traditional retirement age.  That is much more than we will need.  With that in mind, I've been considering reducing my retirement contributions in favor of growing other less-efficient accounts [see below].  I'm sure this approach is less favorable "by the numbers", but the thought is to bulletproof our finances, mitigate any risk, and achieve piece of mind.  Especially, since our income may not always be this high.   

1) Reduce retirement contributions to only employer match
2) Increase cash holdings to 50k, perhaps higher?
3) Increase brokerage contributions, get account to 500k?
4) [Only after 2+3] reduce brokerage contributions and pay off mortgage
5) Back to brokerage until we retire

All feedback is welcomed [positive or negative].  Is it better to stay the course?  Or pivot for financial security?  Any changes to the above?

Thank you in advance. 

[Tasse]

What risks are you trying to insulate yourself against, exactly? And when do you want to retire?

Your steps 1-2 seem reasonable to me if you would feel safer with a bigger emergency fund. (You don't say what your spending is, so it's hard to assess whether it's big enough from here.)

But after that, you are increasing your tax burden for no clear reason. If you want to retire at 60+, why would you need extra money in brokerage? You'll be able to access all your retirement money when you need it, so you're just paying extra taxes for no benefit.

If you want to retire sooner than that, it's true that it's possible to over-contribute to a 401k and not be able to access your money when you need it, but the same concern does not apply to Roth: you can always access the principal. If you want to access more retirement money than that, there's always the Roth conversion ladder: https://www.investopedia.com/how-roth-conversion-ladder-works-5214808 In other words, you can still avoid the taxes if you plan carefully.

Whether or not you should pay off the mortgage early is a long-standing and spirited debate on this forum, but generally it's considered financially suboptimal to do so, especially at a rate of only 3%. I'm no expert in this, but I'm sure you'll get some advice on the topic, and in the meantime, you can search for previous threads to read the reasoning.

[APBioSpartan]

What risks are you trying to insulate yourself against, exactly? And when do you want to retire?

I guess general uncertainty.  I work in tech, which always has a baseline of uncertainty, and my wife will likely want to reduce her hours soon to spend more time with the kids.  I have no way of guaranteeing our income in the future which makes think more about what I can control.  My current goal would be to have the option to fully retire at age 50 with a fat fire lifestyle.  Though, who knows.... we may want to cut it early, or we may keep going beyond and upgrade our lifestyle. 

[lhamo]

Do you have a Roth 401k option?  I would take that first if you do.  I had a Roth 403b that I converted to a Roth IRA when I FIREd.  I have over 100k in contributions I can tap in that if I need to, but if I don't that money is growing tax free.

Also, money in traditional retirement accounts can always be tapped before age 59.5 penalty free via SEPP withdrawals.  They are a pain to set up, but might be worth it to avoid the 10% penalty.  And in the grand scheme of things, a 10% penalty on top of a lower tax bracket is probably not going to be a major hit.

In terms of the bigger picture, I have learned I feel most comfortable with a big cash cushion so I would probably:

1)  Keep maxing retirement accounts, with a tilt toward Roth options if you have them

2)  Increase EF to 2-3x annual expenses -- gives you plenty of cushion if the job goes away for some reason

3)  Build brokerage with the aim of getting well past where you could use those funds to pay off the mortgage as you get closer to FIRE.  RIght now paying off the mortgage doesn't make sense as you have such a good rate.  But as you pay it down and as the brokerage balance becomes weighted with LTCG, you could probably pay it off with 2-3 years of chunking from that account without taking too much of a tax hit. Not having a mortgage in FIRE helps minimize costs in other important ways (health insurance, financial aid for kids college, etc.)

[Tasse]

So, the risks and goals you cited are:

• Risk of uncertainty in tech, which I take to mean the possibility of job loss. A big emergency fund is probably the best hedge here.
• Goal for your wife to reduce her hours. Ensuring that you spend less than one income would be a great way to prep for this, plus would further insulate you against job loss.
• Goal to be able to Fat FIRE at 50. This is going to be best facilitated by following the investment order and using the tax-advantaged space you have.

I just don't see how ignoring your tax-advantaged space for taxable investments serves any of these goals or mitigates any of these risks. All it does is reduce the amount of money you are saving to be able to draw on later in a pinch.

[APBioSpartan]

In terms of the bigger picture, I have learned I feel most comfortable with a big cash cushion so I would probably:

1)  Keep maxing retirement accounts, with a tilt toward Roth options if you have them

2)  Increase EF to 2-3x annual expenses -- gives you plenty of cushion if the job goes away for some reason

3)  Build brokerage with the aim of getting well past where you could use those funds to pay off the mortgage as you get closer to FIRE.  RIght now paying off the mortgage doesn't make sense as you have such a good rate.  But as you pay it down and as the brokerage balance becomes weighted with LTCG, you could probably pay it off with 2-3 years of chunking from that account without taking too much of a tax hit. Not having a mortgage in FIRE helps minimize costs in other important ways (health insurance, financial aid for kids college, etc.)

I agree with this approach, but my concern was mainly time to achieve.  Building ~$200k-$300k in cash, ~$550k in a brokerage, all while maxing retirement accounts will take some time.  Even with our high income.  The thought behind suppressing #1 was to help speed up the process of #2 and #3. 

So, the risks and goals you cited are:

• Risk of uncertainty in tech, which I take to mean the possibility of job loss. A big emergency fund is probably the best hedge here.
• Goal for your wife to reduce her hours. Ensuring that you spend less than one income would be a great way to prep for this, plus would further insulate you against job loss.
• Goal to be able to Fat FIRE at 50. This is going to be best facilitated by following the investment order and using the tax-advantaged space you have.

I just don't see how ignoring your tax-advantaged space for taxable investments serves any of these goals or mitigates any of these risks. All it does is reduce the amount of money you are saving to be able to draw on later in a pinch.

Valid points.  I do plan on building our emergency fund as you mentioned.  I think the goal was to keep things simple.  I am aware of Roth conversion ladders and SEPP withdrawals, but having a sizable brokerage just feels "easier".  We can access the money sooner if we need it, use it to pay off the house if we want, use it to retire early, etc. etc.  Though, as you mentioned, "easier" comes with a cost which may not be worth it.  Partly why I wanted to get community feedback and experiences here. 

[index]

You are saving yourself 24% in taxes for every dollar you put in a traditional 401k. Say your retirement/job loss budget is around 100k, you could take the full amount from your 401k and pay a combined tax rate of 12.87% plus the 10% penalty and pay less than the 24% marginal tax rate you would be paying now by contributing to a Roth or brokerage. As pointed out earlier, there are ways to get around the 10% penalty.

I'm actually not a fan of Roth's for this reason. If you are in the 22%+ tax bracket, you should always opt for a traditional IRA/401k unless you are above the income limits to utilize the account.   

[Freedomin5]

I agree with 1, 2, and 3, but would swap 4 and 5. Build up your brokerage, and then, a few years before you plan to retire, start stashing up enough money to pay off your mortgage before you retire, or if you want, use money in taxable accounts to pay off mortgage. No point paying off the mortgage earlier than necessary, especially with your nice interest rate.

This way, you can take advantage of compounding while still ensuring you can cover your mortgage and not lose your home in the event of job loss.

Also, since you’re still working, I would recommend the standard 3-6 month emergency fund. When you’re almost ready to FIRE, then bulk up your EF to 2-3 years expenses or use other means to mitigate for SORR.

[seattlecyclone]

Are you making Roth IRA contributions currently (possibly through the back door as needed)? If so you're already putting away $11k annually that could be withdrawn at any time with no tax cost.

At your income level I'd expect you would be able to max out your retirement accounts and also have a fairly substantial amount left over to put in taxable investments, especially since you don't live in a HCOL area. Yeah the ~$60k/year you put in your retirement accounts annually if you both max out 401(k)s and IRAs will slow you down a bit on achieving your $500k taxable goal, but by how much? Maybe a year or three? Is getting there a bit quicker worth losing the opportunity to shove money in a tax shelter while you're in a high bracket? That's a decision only you can make, but for me personally I haven't regretted maxing our retirement accounts one bit on a similar/lower income.

Re: mortgage paydown, as long as money market accounts are paying more than 3% it's strictly better to put cash in there than your mortgage. You get a better guaranteed return and you retain access to that liquidity if necessary. If and when interest rates go back down, or you're retired and trying to keep your cashflow down for ACA purposes, you can re-evaluate shoving all that money into your mortgage at that time, but for now it makes little sense at all.

[ixtap]

Are you familiar with SEPP and Roth conversion ladders? These are two ways to access your traditional accounts before 59.5. Moreover, any Roth contributions you make now and any conversions you make now will be available immediately or within five years. We are not in the least bit concerned about the size of our taxable account growing because we have several years' expenses in Roth contributions and MBR conversions. These now save us a few thousand dollars every year over having the same amount in taxable, since dividends aren't taxed. It was even more dramatic before downshifting, as dividends were also subject to NIIT.

[Radagast]

At your income level I'd expect you would be able to max out your retirement accounts and also have a fairly substantial amount left over to put in taxable investments, especially since you don't live in a HCOL area. Yeah the ~$60k/year you put in your retirement accounts annually if you both max out 401(k)s and IRAs will slow you down a bit on achieving your $500k taxable goal, but by how much? Maybe a year or three? Is getting there a bit quicker worth losing the opportunity to shove money in a tax shelter while you're in a high bracket? That's a decision only you can make, but for me personally I haven't regretted maxing our retirement accounts one bit on a similar/lower income.

+1
$330k income.
$70k spend in a MCOL city giving a nice standard of living, maybe you need to trim this if more?
$70k in retirement accounts should leave
$140k to brokerage which is a lot
$50k taxes

No way I'd trim my measly $70k tax advantaged investing. Also, I don't get why you consider an emergency fund separate from a brokerage account. Once you get to a certain point (2X annual spending?) they are basically the same. With a two earner household and a high savings rate you have double security. Either of you alone could work part time and still meet household spend, with enough left to get a 401k match. The need for an emergency fund, in addition to quadruple redundant incomes and a loaded brokerage account, is greatly exaggerated.

[APBioSpartan]

+1
$330k income.
$70k spend in a MCOL city giving a nice standard of living, maybe you need to trim this if more?
$70k in retirement accounts should leave
$140k to brokerage which is a lot
$50k taxes

No way I'd trim my measly $70k tax advantaged investing. Also, I don't get why you consider an emergency fund separate from a brokerage account. Once you get to a certain point (2X annual spending?) they are basically the same. With a two earner household and a high savings rate you have double security. Either of you alone could work part time and still meet household spend, with enough left to get a 401k match. The need for an emergency fund, in addition to quadruple redundant incomes and a loaded brokerage account, is greatly exaggerated.

Our situation unfortunately isn't that straight forward.  Just our mortgage [$38,400/yr] and the avg cost of daycare in our area [$30,000/yr] puts us at your threshold of nice standard of living.  We also have a second kid on the way which doesn't make childcare any cheaper.  Colorado ain't New York or San Fran, but it ain't cheap neither :P. 

I've thought about considering my Brokerage as a emergency fund, and I kind of do, but tech usually performs layoffs when the market isn't great and I would hate to be in a position to pull discounted assets.  That's why I want to maintain a decent cash buffer, and then the brokerage is the icing on top. 

[Radagast]

+1
$330k income.
$70k spend in a MCOL city giving a nice standard of living, maybe you need to trim this if more?
$70k in retirement accounts should leave
$140k to brokerage which is a lot
$50k taxes

No way I'd trim my measly $70k tax advantaged investing. Also, I don't get why you consider an emergency fund separate from a brokerage account. Once you get to a certain point (2X annual spending?) they are basically the same. With a two earner household and a high savings rate you have double security. Either of you alone could work part time and still meet household spend, with enough left to get a 401k match. The need for an emergency fund, in addition to quadruple redundant incomes and a loaded brokerage account, is greatly exaggerated.

Our situation unfortunately isn't that straight forward.  Just our mortgage [$38,400/yr] and the avg cost of daycare in our area [$30,000/yr] puts us at your threshold of nice standard of living.  We also have a second kid on the way which doesn't make childcare any cheaper.  Colorado ain't New York or San Fran, but it ain't cheap neither :P. 

I've thought about considering my Brokerage as a emergency fund, and I kind of do, but tech usually performs layoffs when the market isn't great and I would hate to be in a position to pull discounted assets.  That's why I want to maintain a decent cash buffer, and then the brokerage is the icing on top.

Yeah my knee jerk mustachian responses are always based on my dink years. I should examine my own spending first because our housing and daycare expenses are similar (actually housing has been notably less but that swill change soon).

Still you are looking at brokerage investments of around 6 figures now, and still likely larger than tax sheltered investments. I would not be cutting into tax advantages to enlarge an already gargantuan investment stream.

I include savings bonds and high yield municipal bonds (VWALX) in my asset allocation just so I have more stable assets available in taxable. I occasionally use VWALX to fund big movements of money and have ibonds as an e-fund of last resort. I do rebalance with them for example to buy stocks in 2020 because they are a regular part of my allocation. Just eliminate any bonds in tax advantaged accounts and hold your bond allocation in taxable as a mix of those two. You could even add a taxable bonds allocation. But keep the total to the level you would ordinarily keep a bond allocation for example 20% of investments.

[LightStache]

Interesting, when you said "bulletproof our finances, mitigate any risk" I thought you'd be asking something like "should I pay a bunch of capital gains tax in my brokerage to fully fund my solo 401K?" The reason being that your 401K is protected from bankruptcy with no limit, thus deterring lawsuits from slip-and-falls, car accidents, etc. Your IRA is protected up to $1.5M, a limit that increases every year. It doesn't get much more bulletproof than that. In Colorado, only $189K of your home equity is protected.

You already acknowledge that it's not financially optimal for you to shift from tax deferred contributions and it would actually increase your risk. From a liquidity perspective, you can already tap those retirement funds in the unlikely event that you burn through your savings and taxable brokerage.

I think the real crux is simple, in your words: "having a sizable brokerage just feels 'easier.'" Lots of things in life are easier if you're willing to waste a bunch of money on them.

[VanillaGorilla]

I somewhat see where you're coming from - having the majority of your assets tied up in tax advantaged accounts isn't amazing in terms of liquidity.

A few thoughts:

Your mortgage rate is very low, low enough that it's arguably safe to keep in retirement, and certainly efficient to keep as long as possible. If you go play with cFIREsim you can easily model a fixed expense that's not inflation adjusted (ie your mortgage) for 30 years. When not inflation adjusted, a 5% withdrawal rate is about as safe as a 4% inflation adjusted rate. Your P&I costs at 3% should be 4% of the balance. Very safe. So you might consider not worrying about the mortgage at all, and focus on investing until it's time for a big life change.

Full disclosure: I paid down a cheap mortgage and mildly regret it.

I also work in tech, and I feel that having a big buffer against professional upheaval is well worth it and is the responsible thing to do. I personally dislike cash because it's a guaranteed loss and keep a minimal amount of cash on hand. I prefer to consider my entire taxable portfolio my emergency fund. Adjust asset allocation as desired.

You're in a pretty good position no matter what you do. Taking advantage of retirement accounts is very important in the long run, but if you wanted to reduce 401k contributions to beef up your taxable account that's understandable. Maybe get 100k in taxable and then let it run, or something like that. Even better: buckle down on frugality and fully fund the retirement accounts AND invest more in taxable. You have a great income and modest housing expenses. Now's a great time to invest!

In a nutshell, I'd keep the mortgage as long as possible, keep as little in cash as reasonable. If you wanted to beef up taxable that's justifiable, if you wanted to optimize your taxes that's also justifiable.