Smart but Not Smart Enough - Completed Post

[savedough]

First, thank you for your time and consideration.  I appreciate all the comments, ideas and input.
Second, I'm not sure why it messed up the first time.  Fixed now.


We are a dual career family with 3 kiddos. Two of our children are in school and one will be in daycare for 2.5 more years.  Hubs and I both enjoy working but want to work because we choose to, not because we have to.

The Smart: 
1.  We've done a decent job of saving since we started our careers.  We are in our mid-30s and just reached the two comma net worth milestone through a combination of good fortune and hard work. 
2.  We have no debt other than our mortgage.
3.  Our house is a fairly small portion of our net worth.
4.   I have a pension that will pay 50% of my current salary when I am 65 if I work for 15 more years.   If I don't, it will pay less than that proportionally.

The Not Smart Enough
1.  Most of our savings is tied up in retirement accounts that we cannot access until we are 59.5 withour penalty.
2.  Our cash savings is fairly small.
3.  We've let some lifestyle inflation creep in, so we are working on reducing expenses. (One note:  We do have one special needs child so our medical expenses are what they are but not high enough to deduct.)

The Breakdown
PreTax Income:  $170,000

Annual Expenses last year:  $90,000

• $25,000 Mortgage ($10,000 extra on the mortgage principle)
• $12,000 in daycare (Cheaper now that two are in school)
• $12,000 Medical Expenses (insurance doesn't cover a lot of the treatments bc they aren't approved by FDA for his age)
• $41,000 on everything else (We are working on reducing).  Side Note:  We spent A LOT on vacations last year.  We took 2 driving weeklong vacations, and 5 trips for our family of five via airline.   This is unusual for us and we'll have to revisit our family FOMO because, holy buckets, did those trips bleed money.

Annual Savings last year:   $53,000

• $18,000 401k me (Company matches up to 3%)
• $18,000 457b Hubs
• $11,000 Roth IRAs (me and Hubs)
• $6000 529s (Max for State Tax Deduction)

Net Worth: $1,065,000
Cash $38,000
Retirement Accounts: $887,000
Home Equity: $83,000
Stock Assets: $1000
Education Savings: $57,000

To make FIRE a realistic option (because I know we are secure for retirement age if we stay on our current path), I don't really understand the next steps.   I've been approaching our finances with a plan to pay as little tax today as possible.  Is that the right approach?   

[dandarc]

This will change your life:

https://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

Yes, you can withdraw from your retirement accounts before 59.5 without penalty.

[savedough]

I need to save the cash to pay the taxes for making the conversion, right?

[Ricksun]

I need to save the cash to pay the taxes for making the conversion, right?

Or convert enough to pay the taxes with it, or better yet, convert so little that you don't pay taxes and use a little of your after-tax savings to supplement what you need.

Ricksun

[dandarc]

Does Hubs have access to a 457B?  A lot of times, places that have a 403B will also have a 457B.  Public schools and universities, for example, often offer both.  457B is another 18.5K you can defer taxes on.  And the criteria for avoiding penalty on early withdrawals is "separation from employment".  Very handy for an early retiree.

My point is - you have many options to withdraw money from "retirement" accounts before 59.5 without paying the penalty.  And quite often, just paying the penalty works out in your favor too.  So, taking issue with your "Not Smart Enough" items 1 and 3.  The exact mechanics shouldn't worry you until you're closer to the withdrawal phase.

While accumulating, you want to max out tax-advantaged space first, then if there is still money to invest, consider a taxable investment account.

[savedough]

Ahh - I made a typo.  He has a 457b, not a 403b.   Fixed.  But only about $50k in it, but I could use that to pay taxes!

[merula]

You can also make early withdrawals from IRAs for qualified education expenses, and it looks like you'll probably have some of that, based on 3 kids. (Although you probably can't double-dip expenses between the IRA and the 529.)

Let's say, hypothetically, that your post-FIRE spending plan involves a paid-off house, no daycare costs, roughly equal medical spending and slightly lower general expenses. That brings you to roughly $50-$55k per year (depending on how much you reduce expenses and how much your property taxes will be). Meaning you'll need ~$1.25-1.38M in savings (outside of your house) if you go by the 4% rule. (And this doesn't even count your pension or SS.) You're ALMOST THERE! Without even targeting FIRE, you've made it most of the way. Nice job!

Frankly, if the goal isn't total FIRE but "work on my own terms", you're probably there already. If you and your husband are roughly equal earners, one person could quit entirely and the other could work 60% of the time and you'd cover all of your current expenses (except daycare and the mortgage).

You might want to try this out in FIRECalc or something similar: Take your ~$900k and subtract what it'd take to pay off your house and fund your children's education to the level you're planning to. Then take your planned annual expenses minus what a pension would pay (throw in SS if you're feeling up to it). How long would you need to wait for the first number grow at your preferred asset allocation to get to 25x the second number? That's how long you'd need one person to work part-time before you could both quit work forever.

[Laura33]

Ahh - I made a typo.  He has a 457b, not a 403b.   Fixed.  But only about $50k in it, but I could use that to pay taxes!

I think you are misunderstanding how the Roth pipeline works.  First, you cannot access that new Roth until 5 years after you open it, so you need 5 years' expenses in something accessible -- that can be the contributions to your existing Roth, post-tax funds, 457b money, or whatever.

The point of the Roth pipeline is that you convert a little bit each year after you retire, specifically to keep your taxes low.  So the first thing you do when you retire is roll over your 401(k) into a traditional IRA.  And then each year, you convert part of that tIRA into a Roth.  How much?  Well that is based on how much you will need to live on in 5 years + tax implications.  But under the new US tax law, you will have a $24K standard deduction at the very least.  That means that, if the Roth conversion is your only "income" that year*, you can convert $24K of your 401(k) money into a Roth every year and pay no taxes on it -- and even if you need to convert more than that, that first $24K is tax-free.

So basically, at a minimum, you want to be setting up Roth conversions to take maximum advantage of that $24K standard deduction.  If you can live on $24K or have other sources of income, you can basically convert $24K/yr indefinitely and pay no taxes on that money, ever.  But even if you need to convert more than that every year, you will still be paying significantly lower taxes on that conversion than you think, because that first $24K is free, and the next chunk is then at the lowest tax rate.

*This is too simplistic, because (a) most people have some other income, even if it is just interest on a bank account, and (b) how much you convert into a Roth will also be counted as income for figuring out your capital gains tax rate, so if you have a lot of capital gains from your non-tax-protected investments, doing a $24K Roth conversion could push you into a higher CG tax rate.  But for illustration purposes I am ignoring all that.

[Ben Kurtz]

My usual starting point for a young-ish family looking to FIRE is $1,000,000 in investments plus a paid-off house -- because $40,000 per year ($1m at the 4% rule) without having to pay rent is a secure, comfortable, non-extravagant lifestyle for a family. By that metric, you are perhaps 3/4 of the way there -- just need to build up a bit more home equity.

Day-care expenses will disappear quickly enough once the child is old enough for school (or once the parents are home enough of the time to watch the kid themselves), so I don't make too big an issue of those. But your special needs child requires a bit more planning. You haven't said much about the child's condition. It's not just the additional $12,000 per year in medical costs to consider, but the broader longer-term unknowns: Will the child need lifetime support and have trouble living independently? What are the long-term medical costs and medical insurance implications? You may want to carry more life insurance than most, and leaving behind a high-quality employer health plan might pose a lot more downside for you than for the average family.

If you were an average family I'd say that you were within spitting distance of FIRE -- 3-5 years, and most likely on the earlier side of that, with very little risk in taking a radical pay cut immediately if you really didn't want to keep doing what you're doing. But the better course of action now, until you provide more detail about the long term financial impact of having a special needs child, would be to plan on at both parents continuing work at current rates until you reach the basic threshold ($1m plus the paid-off house) and then have one parent continue work for several more years after that, at least.

Having a one-income transition period can also help with the positioning of your money, given how little you have in taxable accounts: The conversions to create a Roth IRA ladder, described by Laura33, are best done during years of no earned income, so you keep the taxes due on the conversion low or non-existent. But then you need a good sized taxable nest egg to tide you over until the 5 year waiting period is over. The next-best time to do conversions are when your income keeps you in a low tax bracket. Married filing jointly has some pretty large low-rate brackets these days, so there will be plenty of opportunity to get money into Roth accounts and favorable rates during the one-income phase. And it pays to continue to max-out your tax-deductible accounts while you are still a two income family, rather than stint on contributions to a 401k in favor of building up a taxable account, because even if you convert the year after contributing, when you step down to one income and pay taxes on the conversion, you will to a mathematical certainty have taken a deduction at a higher rate and then re-included the income at a lower tax rate, which puts you ahead.

To reduce this to steps:

1. Spend the next 3-5 years doing what you are doing: Earning a good six figure family income, maxing out all available tax advantaged savings, and pay off the mortgage aggressively beyond that.

If we assume this phase lasts 4 years, and assuming flat investment markets, you will have:
-Nearly $1.1m in retirement accounts.
-$81,000 in educational accounts.
-Around $165,000 in home equity.
-Around $68,000 in mandatory yearly cash-flows ($41,000 plus basic mortgage plus special needs child)

2. At this point, one parent retires and the other keeps working. This provides, I assume, a good health plan and at least $68,000 in after tax cash flow.

3. Even if nothing more is contributed to retirement accounts, you will still be improving net worth by probably $10,000+ per year given principal paydown on your mortgage (I'm assuming you'll still have one of some about at this point), apart from any investment dividends and market-based movements in asset prices.

4. You start a Roth pipeline during the first full tax year with only one income.

5. Keep going as a five-figure, one-income family for about 5 years. Then assess the situation and FIRE if you can.

At that point, about nine years from the present, if we assume average market returns instead of a flat investment environment, you'll probably have $1.5m+ in retirement savings, a paid-off house (or enough equity to relocate to a fully owned house), and hopefully a lot more clarity on the future prospects of your special-needs child.

There are also 72t / SEPP withdrawals which you can take from tax-deductible retirement accounts which allow you to avoid the 10% penalty on early withdrawals. They are discussed elsewhere on the forum. But I wouldn't counsel going straight to those in your circumstances. There have been family and friends of mine who have had special needs children, so I know up-close how much more complicated life can then become. For that reason I urge an bit of extra conservatism. Perhaps at the end of 9 years, when Step 5 is complete, you will be in a position to set up SEPP withdrawals.

Good luck!

[savedough]

Thank you Laura and Ben.   

We are very fortunate that our child will be able to live independently, attend college and earn his own income.   The doctors expect the medical costs and impact will decrease with age because then he'll be in an age group approved by FDA and insurance will pay, but there is no guarantee.  The vast majority of the needs are in his youth and traditional treatments were not successful.   I will not need to plan to support him in his adult life unless we chose to supplement his medical costs.

We would like to pay for our children's undergraduate degrees so they graduate with no debt.  Both Hubs and I had scholarships and jobs that paid the bulk of the costs for our degrees at public state schools (we each paid the equivalent of less than one years cost total) and we are doing well, so I will guide our kids to a similar set-up.  Obviously, we are not planning for scholarships to pay for everything/anything.  If we end up passing the 529s on to them for our grandchildren or graduate school, that's fine.  We are not saving for education at the expense of saving for retirement so I don't think it is going to cost us more than a couple years of additional working and if it does, it is a sacrifice we are are willing to make to give our children the gift of choice.

I'm so pleased that I posted because I had read about Roth Conversion ladders, but wasn't sure when they would apply to us. Now I better understand.   My goal for the next 4-5 years is to max out our tax advantaged accounts and pay off our mortgage.   If I can save a little more in cash or a taxable account along the way, that would be ideal as well!

[Dicey]

Where are you based and what is the interest rate on your mortgage?

[savedough]

Home base is moving.  We are currently in the mountain west and moving to the Appalachian south this summer (expect that relo costs will be covered by company as they have been in the past, but it's been a while since we moved and I'm sure the relo policy has changed).

Our current mortgage rate is 3.275%.   When we move, it will go up based on current rates and we'll probably do a 15 year loan to lock in a lower rate.   

I see the mathematical reasons not to pay our house off and we've not paid extra in years past when we purchased cars with cash or I took extended maternity leaves (6 months), though we continued to max out our tax advantaged accounts.   But it is a milestone I really, really want to reach.   We made it to millionaire status last year.   I want to own my own home outright.   I want to have $1.5 million in investment/retirement accounts.  Then I want to pay for my kids education.    I'm not dying to retire, but I like options and I want FIRE to be an option too.   I know I can't have my cake and eat it too, but I like to have goals.    Somehow just having them makes me find ways to reach them.