Author Topic: Ignoring TIRA for Flexibility?  (Read 585 times)

desert_phoenix

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Ignoring TIRA for Flexibility?
« on: August 12, 2017, 02:10:58 PM »
It seems sacrosanct that one should max out tax-advantaged accounts before taxable ones.  But I wanted to look at things the other way. 

If you have a match in a 401k/TSP, then I think it 100% makes sense to contribute to that amount.  But what about beyond it?  Has anyone ever made the argument that taking the tax hit now to keep your funds fully liquid is worth it?  Example below:

I can contribute up to $18,000 a year to a TSP as a federal employee.  The match tops out around $4,000.  So let's say I only do the 4k to get the match.

If I took the other 14k, I'd be taxed at the 28% rate due to my earnings level.  But once that money is in VTSAX, I can use it whenever.  Obviously I'd want to wait at least a year to pay long-term capital gains instead.  I am unsure how many years of "average" returns I'd need to get back what I lost in taxes, but I am sure there are calculators for that.  But rather than having to thread the needle on rolling over to a Roth, it is just already in taxable accounts and if things get crazy, can be used without a huge penalty.

But a post that the Mad Fientiest had about how maybe just paying the 10% penalty to access TIRA funds can make sense in some scenarios.  But you still pay tax on that.

So, I don't know.  What do you all think?  I feel like there have to be early retirement scenarios where hitting your FIRE # through brute dollars contributed to taxable funds can be worthwhile due to the increased flexibility.

Otherwise, say I need $500,000 and I have $150,000 in a TSP/401k/TIRA rather than everything but the match in a taxable account + Roth IRA.  It seems to muddy up the actual FIRE number a bit.  Just throwing this out for discussion as it seems a lot of topics get repeated and this one seemed new :)

seattlecyclone

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Re: Ignoring TIRA for Flexibility?
« Reply #1 on: August 12, 2017, 02:15:19 PM »
Once you leave work, retirement funds are hardly less flexible than taxable funds. See this sticky thread for a summary of the ways to get most of this money out without penalty. Even if you pay the penalty, it's only 10%. If you plan to drop at least 10% in your tax brackets when you retire, taking the penalty still leaves you better off than a taxable account.
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desert_phoenix

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Re: Ignoring TIRA for Flexibility?
« Reply #2 on: August 12, 2017, 02:23:10 PM »
Once you leave work, retirement funds are hardly less flexible than taxable funds. See this sticky thread for a summary of the ways to get most of this money out without penalty. Even if you pay the penalty, it's only 10%. If you plan to drop at least 10% in your tax brackets when you retire, taking the penalty still leaves you better off than a taxable account.
Damn. So much for thought provoking. I will try harder next time, haha.

Financial.Velociraptor

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Re: Ignoring TIRA for Flexibility?
« Reply #3 on: August 12, 2017, 02:32:58 PM »
It seems sacrosanct that one should max out tax-advantaged accounts before taxable ones.  But I wanted to look at things the other way. 

If you have a match in a 401k/TSP, then I think it 100% makes sense to contribute to that amount.  But what about beyond it?  Has anyone ever made the argument that taking the tax hit now to keep your funds fully liquid is worth it?  Example below:

I can contribute up to $18,000 a year to a TSP as a federal employee.  The match tops out around $4,000.  So let's say I only do the 4k to get the match.

If I took the other 14k, I'd be taxed at the 28% rate due to my earnings level.  But once that money is in VTSAX, I can use it whenever.  Obviously I'd want to wait at least a year to pay long-term capital gains instead.  I am unsure how many years of "average" returns I'd need to get back what I lost in taxes, but I am sure there are calculators for that.  But rather than having to thread the needle on rolling over to a Roth, it is just already in taxable accounts and if things get crazy, can be used without a huge penalty.

But a post that the Mad Fientiest had about how maybe just paying the 10% penalty to access TIRA funds can make sense in some scenarios.  But you still pay tax on that.

So, I don't know.  What do you all think?  I feel like there have to be early retirement scenarios where hitting your FIRE # through brute dollars contributed to taxable funds can be worthwhile due to the increased flexibility.

Otherwise, say I need $500,000 and I have $150,000 in a TSP/401k/TIRA rather than everything but the match in a taxable account + Roth IRA.  It seems to muddy up the actual FIRE number a bit.  Just throwing this out for discussion as it seems a lot of topics get repeated and this one seemed new :)

This is exactly the path I took to FIRE (5 years come October 5th).  I used some leverage early on which I couldn't have done in a tax advantaged account.  I am still in the same 25% tax bracket as when I was employed so it wouldn't make sense to pay the penalty.  But if you are going to use the 4% rule, section 72(t) distributions get you most of the way there already.

I'd do it the same way again.  It might not be optimal down the penny but it has loads of flexibility.  If my planned side hustle (next year) works out, I'll contribute the max to SEP and convert to Roth as I don't need anything above what my taxable already generates.
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dandarc

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Re: Ignoring TIRA for Flexibility?
« Reply #4 on: August 12, 2017, 02:38:32 PM »
The thing to do is all of the above - $18K to the 401K, $5.5K to a Roth IRA (via the back-door method if necessary), and anything more to a taxable account.  In the 28% bracket, you oughta be able to make all of that happen, right?  You're on the MMM forums, after all.

I'm curious what you think is going to come up that you'll need a six-figure amount on short-notice?

alexpkeaton

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Re: Ignoring TIRA for Flexibility?
« Reply #5 on: August 12, 2017, 06:50:28 PM »
I may be able to contributed to a non-qualified deferred comp plan out of my bonus. The cap for the plan is something like $1 million/year in contributions and a $10 million lifetime cap. Obviously I couldn't even come close to that.

But the reason I'm torn is exactly this. I'll probably actually want access to the money before I retire to buy a bigger apartment. But on the other side, having my deferred comp arrive in regular installments might be a nice bridge between retirement and when I'm eligible to start taking distributions from my 401k.

teen persuasion

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Re: Ignoring TIRA for Flexibility?
« Reply #6 on: August 13, 2017, 09:16:27 AM »
It really depends on your exact tax/income scenario, and the intersection of various tax brackets and credits.

We are relatively lower income with lots of kids (deductions), so we have a relatively low tax burden.  Conventional wisdom says contribute to Roth accounts to lock in low tax rates and owe no future taxes.  However, I've discovered that it makes more sense to contribute as much as possible to our HSA and DH's traditional 401k, to increase the refundable credits like EITC.  The phaseout rate on the EITC is 21%, our state matches EITC at 30% (for an additional 6.3%), and our state bracket is 4% and federal is 10%.  So contributions to traditional 401k accounts save/earn us a 41.3% return (HSA contributions also save us 7.65% FICA for 48.95% return).  So I turn around and put our refundable credits into Roth IRAs for both of us.  I've changed a relatively low tax burden into refundable credits, that will now be growing tax free and tax free at withdrawal, and contributions are accessible in an emergency. 

The retirement sheltered assets are better than taxable assets on the FAFSA, too, as is the reduced AGI if it drops you below certain test thresholds.

desert_phoenix

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Re: Ignoring TIRA for Flexibility?
« Reply #7 on: August 13, 2017, 09:43:17 AM »
The thing to do is all of the above - $18K to the 401K, $5.5K to a Roth IRA (via the back-door method if necessary), and anything more to a taxable account.  In the 28% bracket, you oughta be able to make all of that happen, right?  You're on the MMM forums, after all.

I'm curious what you think is going to come up that you'll need a six-figure amount on short-notice?
Thank you for your follow-up.  The phrasing of your question actually made me recognize my premise may be flawed.

For simplicity's sake, let's say I had $400,000 in taxable account and $100,000 in a TIRA and planned to draw $20,000 for 4%

My thinking was that having money in the TIRA was bad because 20k out of 400k is 5%, and thus over my comfort limit by 25% (4 versus 5 withdrawal rate).  I guess I have always thought of money I can't spend initially as somehow counting differently, so that money in a TIRA should somehow count less in terms of figuring out when I hit FIRE.  But I suppose if I have a similar asset allocation in both taxable and non-taxable, then it doesn't matter that the pull from my taxable is 5% since it is 0% in my TIRA.

I guess it just becomes a matter of paying attention to the conversions from TIRA to Roth or taxable to make sure it doesn't get to the point where I am drawing down the principle on the latter two at a rate that is unsustainable due to a max on how much I'd want to move from TIRA due to tax implications.  So, basically, thanks for your question to my question :-)  I think this is one less thing to worry about, and once I hit my personal magic number, it isn't a huge deal how it is spread between the different accounts.

dandarc

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Re: Ignoring TIRA for Flexibility?
« Reply #8 on: August 13, 2017, 01:46:09 PM »
The thing to do is all of the above - $18K to the 401K, $5.5K to a Roth IRA (via the back-door method if necessary), and anything more to a taxable account.  In the 28% bracket, you oughta be able to make all of that happen, right?  You're on the MMM forums, after all.

I'm curious what you think is going to come up that you'll need a six-figure amount on short-notice?
Thank you for your follow-up.  The phrasing of your question actually made me recognize my premise may be flawed.

For simplicity's sake, let's say I had $400,000 in taxable account and $100,000 in a TIRA and planned to draw $20,000 for 4%

My thinking was that having money in the TIRA was bad because 20k out of 400k is 5%, and thus over my comfort limit by 25% (4 versus 5 withdrawal rate).  I guess I have always thought of money I can't spend initially as somehow counting differently, so that money in a TIRA should somehow count less in terms of figuring out when I hit FIRE.  But I suppose if I have a similar asset allocation in both taxable and non-taxable, then it doesn't matter that the pull from my taxable is 5% since it is 0% in my TIRA.

I guess it just becomes a matter of paying attention to the conversions from TIRA to Roth or taxable to make sure it doesn't get to the point where I am drawing down the principle on the latter two at a rate that is unsustainable due to a max on how much I'd want to move from TIRA due to tax implications.  So, basically, thanks for your question to my question :-)  I think this is one less thing to worry about, and once I hit my personal magic number, it isn't a huge deal how it is spread between the different accounts.
I think I actually misunderstood your point earlier - for some reason, I was thinking you were worried about needing a substantial amount of money while you were still in the accumulation phase.  Re-reading and with this post, I understand it is more of a "how do I get from 35 to 59.5?" question.  And seattlecyclone and others covered that well.  I personally don't think a taxable account is strictly necessary to make the early part of FIRE work, but it does give you some additional options for bridging the 5-years to get the Roth Ladder rolling, and other tax-optimization techniques.

And important to realize that no one account has to last for your entire retirement, so long as your total portfolio does, which you've pointed out with your example.

desert_phoenix

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Re: Ignoring TIRA for Flexibility?
« Reply #9 on: August 13, 2017, 02:59:19 PM »
The thing to do is all of the above - $18K to the 401K, $5.5K to a Roth IRA (via the back-door method if necessary), and anything more to a taxable account.  In the 28% bracket, you oughta be able to make all of that happen, right?  You're on the MMM forums, after all.

I'm curious what you think is going to come up that you'll need a six-figure amount on short-notice?
Thank you for your follow-up.  The phrasing of your question actually made me recognize my premise may be flawed.

For simplicity's sake, let's say I had $400,000 in taxable account and $100,000 in a TIRA and planned to draw $20,000 for 4%

My thinking was that having money in the TIRA was bad because 20k out of 400k is 5%, and thus over my comfort limit by 25% (4 versus 5 withdrawal rate).  I guess I have always thought of money I can't spend initially as somehow counting differently, so that money in a TIRA should somehow count less in terms of figuring out when I hit FIRE.  But I suppose if I have a similar asset allocation in both taxable and non-taxable, then it doesn't matter that the pull from my taxable is 5% since it is 0% in my TIRA.

I guess it just becomes a matter of paying attention to the conversions from TIRA to Roth or taxable to make sure it doesn't get to the point where I am drawing down the principle on the latter two at a rate that is unsustainable due to a max on how much I'd want to move from TIRA due to tax implications.  So, basically, thanks for your question to my question :-)  I think this is one less thing to worry about, and once I hit my personal magic number, it isn't a huge deal how it is spread between the different accounts.
I think I actually misunderstood your point earlier - for some reason, I was thinking you were worried about needing a substantial amount of money while you were still in the accumulation phase.  Re-reading and with this post, I understand it is more of a "how do I get from 35 to 59.5?" question.  And seattlecyclone and others covered that well.  I personally don't think a taxable account is strictly necessary to make the early part of FIRE work, but it does give you some additional options for bridging the 5-years to get the Roth Ladder rolling, and other tax-optimization techniques.

And important to realize that no one account has to last for your entire retirement, so long as your total portfolio does, which you've pointed out with your example.

Indeed.  I think that I am running into that "newbie enthusiasm" issue where I want to plan everything out today, haha.  Even investing 82% of my take-home pay as of last month, I still have a minimum of 4 years to go.  I think I should probably wait on "practical questions" until I am 70-80% of the way to my personal goal number.  It is really too easy to get wrapped around the axle on all this stuff.

Anyway, I appreciate your time!

alexpkeaton

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Re: Ignoring TIRA for Flexibility?
« Reply #10 on: August 14, 2017, 07:38:25 AM »
HSA contributions also save us 7.65% FICA for 48.95% return

Correct me if I'm wrong, but I didn't think HSA contributions saved you from FICA?

seattlecyclone

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Re: Ignoring TIRA for Flexibility?
« Reply #11 on: August 14, 2017, 10:15:43 AM »
HSA contributions generally don't get charged FICA if they're payroll deductions. If you contribute outside of your paycheck, you must pay FICA on that money.
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The Roth IRA was named after William Roth, who represented Delaware in the US senate from 1971-2001. "Roth" is a name, not an acronym. There's no need to capitalize the final three letters.