Slightly Overwhelmed

[channant]

Hello MMM crew! Looking for some input here...

I'm 30 years old and began saving for retirement a few years ago with a Roth IRA through Vanguard thinking I'd work hard until becoming a happy millionaire at age 59.5. I'm self employed and make about $75k/year before taxes and have since been maxing out the Roth where I currently have about $27k 100% in VTSAX. I've also been stashing some away in a high-yield online savings account. Right now I have about $40k in there. I owe $209,000 on my home with a $1400/month mortgage with no other debt.

I have one other source of income: this year I started to Airbnb my house and projected earnings at this time are in total $15k. Next year I should be able to get around $30k in rental income alone.

Just last week I discovered the exotic and exciting world of early retirement/financial independence and I've been obsessing over the concept and scanning the blogs of Mr. Money Mustache, Go Curry Cracker, Mad Fientist, and the like. Holy crap, this is all so for me. I'm willing and able to limit my spending and cram as much money into investments as I can.

At first I thought this would be as simple as continuing to max out my Roth and moving over my $40k savings into a taxable Vanguard account, and then just throwing as much as possible into that. It's going to be so easy! Not...

As I read through these blogs, I realized how much more complicated and nuanced this world actually is. For one, being I'm currently in the 25% tax bracket, maybe even 28% next year, it would actually be far more wise for me to be using a Traditional IRA instead of the Roth. And then come the (rhetorical) questions: Should I open a Traditional and relocate those funds? Or should I keep the Roth and let that $27k cook and open a Traditional to fund instead? Wait...what's this Solo 401k for the self employed?? Should I have that too?? How much should I be putting into each? What about the taxable account?

Not sure if I should even open the can of worms on how confused I am at the best effort to minimize taxes...input is welcome on that too.

But what it really boils down to here is this:

I've got $27k in a Roth
I've got $40k to invest (I'm totally down with 100% VTSAX)
I am unsure on how to now allocate between Roth, Traditional, Solo 401k, Taxable.
I'm hoping to be putting away $20-$30k ever year after this.
Would love to be financially independent by 45, long enough to get me to 59.5.

And, finally, should I even be thinking about it that way? I sort of see it in two stages. Stage 1: Save for 15 years and then live off those investments until Stage 2: begin withdrawing from IRAs/401k. But I also have been reading about ways to withdrawal from an IRA early. What the heck is the best move here?

If you can't tell, I'm slightly overwhelmed!

[grandep]

One thing I strongly advise you to look into first: make sure that your income doesn't disqualify you from Traditional IRA deductions. The traditional IRA is popular around here, but if your income exceeds a certain threshold set by the IRS then it's a moot point because you can't deduct your contributions. In that case, Roth is the clear way to go.

Here's the link to the IRS page: https://www.irs.gov/retirement-plans/ira-deduction-limits

Let those Roth funds just brew in there. Down the road having income that is completely tax-free could be very useful, especially since the benefits of a traditional IRA only apply if your total taxable income is indeed low enough to put you in a low tax bracket. Having money in a Roth account will allow you to make distributions without bumping you up into a higher tax bracket, leaving more room for other forms of taxable income such as your rental income. Not to mention that I am pretty sure you cannot retroactively move funds into a traditional IRA and claim the tax deduction.

Another reason to keep the money in the Roth is that even if you fund your traditional IRA, you will need a source of funds to live off of while you're waiting for the 5 year period to elapse during the conversion ladder. This is where Roth and taxable account contributions really come in handy.

Absolutely open up a Solo 401k if you can. You should be using every tax advantaged account available to you.

Make sure you consult the "investment order" stickied post if you haven't already.

[wirednuke83]

Quick tag-along question: If you're sitting right at the IRS income limit for the traditional IRA, would it still be beneficial to start it as a traditional and then convert later? Or just start the Roth now?

[channant]

Grandep, thanks so much for your response! I had not considered disqualification from a tax deferred account and it certainly looks like that is the case for me. No bother as it seems to only simplify my situation...

How does this sound:

Stop contributing to Roth and let current funds marinate till 59.5.
Throw my max amount of $30k/year into VTSAX in a solo 401k.
Begin Roth conversion ladder at an age I have yet to determine.

This leaves nothing in any taxable accounts - is there any reason to not move forward with this plan? I'm trying to wrap my head around any issues that being in the 25%-28% tax bracket for the next 15 years might cause with any part of this.

On another note - is there any worry anywhere of The Man switching up any of these laws? What if they decide to disallow conversions to a Roth account?

So appreciative of this forum and those willing to toss their advice around.

[Financial.Velociraptor]

...Would love to be financially independent by 45, long enough to get me to 59.5.
...

Another wrinkle for you.  You don't necessarily have to wait until 59.5 to withdraw from tax advantaged accounts without the penalty.  Please read: https://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

[DavidAnnArbor]

Definitely do the Solo 401k and also you'll be able to do megabackdoor Roth contributions on top of the maxing out your tax-deferred contributions.
So in this way you can still make your Roth contributions but by a different means.

https://forum.mrmoneymustache.com/taxes/anyone-execute-a-mega-backdoor-roth-in-solo-401k/

On top of all that I would still do the traditional IRA.

[channant]

Taking all this in, thanks so much for your responses!

Quick side question - by putting money into a taxable account, I'm paying tax upfront but when I withdraw it (assuming I am FI at this point with no other income source) I won't be taxed as long as I keep it in that first 0% bracket, right? That would be almost $40k withdrawn tax free assuming no other income.

Megabackdoor roths, tax lost harvesting, conversion ladders; it's hard to wrap my head around how to achieve maximum efficiency and profit and worry I'll misplace some decimal point and get it all wrong anyway.

To me, maxing out the Roth and stuffing the taxable account sounds so clean and simple. I get it's not the most optimal, efficient machine but hey, I went to art school. I like clean and simple!

Opinion time: am I just totally blowing it and throwing away hundreds of thousands of dollars by taking the clean and simple route?

[grandep]

Taking all this in, thanks so much for your responses!

Quick side question - by putting money into a taxable account, I'm paying tax upfront but when I withdraw it (assuming I am FI at this point with no other income source) I won't be taxed as long as I keep it in that first 0% bracket, right? That would be almost $40k withdrawn tax free assuming no other income.

Megabackdoor roths, tax lost harvesting, conversion ladders; it's hard to wrap my head around how to achieve maximum efficiency and profit and worry I'll misplace some decimal point and get it all wrong anyway.

To me, maxing out the Roth and stuffing the taxable account sounds so clean and simple. I get it's not the most optimal, efficient machine but hey, I went to art school. I like clean and simple!

Opinion time: am I just totally blowing it and throwing away hundreds of thousands of dollars by taking the clean and simple route?

Hundreds of thousands of dollars? No.

A couple thousand? Maybe. There is always a trade off between complexity and performance. You have to determine for yourself how much complexity you are willing to take on in exchange for eking out a little bit more performance.

Mustachians are dyed-in-the-wool index fund investors. That means that most of us are more than happy to sacrifice some performance for simplicity. That is the nature of index funds. The point of Mustachianism is not to get as rich as possible, but rather to learn how to take control of your finances to serve you in leading a good life.

To answer your taxable account question: long-term capital gains are taxed at 0% as long as you are in the bottom two tax brackets (i.e. 10% or 12%), including the standard deduction. If you are single in 2018, then if your total taxable income (including capital gains) is less than $50,700 ($38,700 is the top of the 12% tax bracket plus $12,000 for the standard deduction), then you will pay no taxes on those capital gains. If you are able to pull that off, then it is equivalent to a Roth IRA (better in fact, since you can withdraw at any time without penalty).

[robartsd]

Quick side question - by putting money into a taxable account, I'm paying tax upfront but when I withdraw it (assuming I am FI at this point with no other income source) I won't be taxed as long as I keep it in that first 0% bracket, right? That would be almost $40k withdrawn tax free assuming no other income.

You'll owe taxes on investments in your taxable account whenever gains are realized. Most of the gains should be long-term capital gains or qualified dividends which are taxed at a lower rate than your ordinary income.

To me, maxing out the Roth and stuffing the taxable account sounds so clean and simple. I get it's not the most optimal, efficient machine but hey, I went to art school. I like clean and simple!

Opinion time: am I just totally blowing it and throwing away hundreds of thousands of dollars by taking the clean and simple route?

I'd max tax deferred investments first. If you have Roth space beyond what you can tax defer use that next. The silly truth is that tax advantaged accounts are both simpler to use for investing (no need to track cost basis; trades and dividends don't trigger tax events) and likely save money over taxable investments (as @grandep pointed out sometimes taxable gains can be tax free making them as good or better than Roth). For most situations traditional tax deferred accounts are the simplest, most tax efficient way to save for retirement. I'd let whatever you already have in a Roth marinate and focus on figuring out the best way for you to save as much as possible in traditional tax deferred retirement accounts. If you want to save a couple of bucks on taxes this year, you can figure out what it would take to re-characterize your Roth contributions already made in 2018 as traditional contributions.

Self employed at $75k/yr and an understanding of personal finance - for having gone to art school, you seem to be doing quite well. Congratulations.

There is a simple way to throw away hundreds of thousands of dollars in personal finance - keep a large portfolio with a financial adviser who charges a 1% of Assets Under Management fee - $10,0000 a year for every $1,000,0000 in the portfolio. Taxes are a higher percentage, but they should only happen once for each dollar gained.

[channant]

Mustachians are died-in-the-wool index fund investors. That means that most of us are more than happy to sacrifice some performance for simplicity. That is the nature of index funds. The point of Mustachianism is not to get as rich as possible, but rather to learn how to take control of your finances to serve you in leading a good life.

Excellent point, Grandep, thank you for this!

I'm still a little confused on how long term capital gains are taxed - is this separate from or in addition to any other income I acquire? So if I make $75,000 one year but only sell $10,000 of my long term investments...am I paying taxes on those capital gains?

I'd max tax deferred investments first. If you have Roth space beyond what you can tax defer use that next. The silly truth is that tax advantaged accounts are both simpler to use for investing (no need to track cost basis; trades and dividends don't trigger tax events) and likely save money over taxable investments (as @grandep pointed out sometimes taxable gains can be tax free making them as good or better than Roth). For most situations traditional tax deferred accounts are the simplest, most tax efficient way to save for retirement. I'd let whatever you already have in a Roth marinate and focus on figuring out the best way for you to save as much as possible in traditional tax deferred retirement accounts. If you want to save a couple of bucks on taxes this year, you can figure out what it would take to re-characterize your Roth contributions already made in 2018 as traditional contributions.

I like this plan a lot. However, I would love to be FI by 45, which means no access to this money for another 15 years without penalty. I've read up on getting this money out early using a conversion ladder but that is already beginning to trespass into complex territory. Does anyone here keep a chunk in a regular 'ole taxable account for pulling out pre-59.5? Or is the Roth conversion ladder just the way to go?

[pecunia]

I understand about being overwhelmed.  It is my firm belief that it is one of the few conspiracies in this life that is real.  The money people really do NOT want you to understand all of the ins and outs of finance.  Why?  They make their living from it.  If folks did all this finance stuff themselves, we wouldn't need them.  (And maybe we don't need a lot of them.)

Check out J. R. Collins website.

http://jlcollinsnh.com/

This stuff can be sooooo complicated.  For some of us it is both boring and confusing at the same time.  Mr. Collins explains things in an entertaining manner and down to earth manner.

[MDM]

I'm still a little confused on how long term capital gains are taxed - is this separate from or in addition to any other income I acquire?

Both, depending on what you mean by "separate from" and "in addition to".

So if I make $75,000 one year but only sell $10,000 of my long term investments...am I paying taxes on those capital gains?

Yes.

How do you do your taxes each year?

[channant]

Check out J. R. Collins website.

Love his site - and just picked up his book!

How do you do your taxes each year?

I'm a sole proprietor - schedule C.

At 75k per year he can still receive the tax deduction for traditional IRA contributions. The phase out for singles starts at $118k this year.

https://thefinancebuff.com/401k-403b-ira-contribution-limits.html

Looking at that (I'm single) I don't think I can get deductions if I'm over $64,000 starting next year

Even still, is the best option of reaching FI before 59.5 using a Roth Conversion ladder to withdrawal until hitting that mark? My goal here is 45, but that of course leaves 15 years to be pulling income from somewhere.

Again, really appreciate all the input, fellas! Doing a lot of reading, but nothing beats getting so many well rounded opinions all in one place. Not to mention it's all up to date!

[MDM]

So if I make $75,000 one year but only sell $10,000 of my long term investments...am I paying taxes on those capital gains?

How do you do your taxes each year?

I'm a sole proprietor - schedule C.

The question wasn't so much about the forms included with the return as it was the mechanics used.  E.g., do you do them by hand, or using tax software, or handing them off to a CPA, etc.?

While there may be some complexity in what you can and can't claim as expenses on schedule C, once you get back to form 1040 the return is probably simple.  If so, you could use something like the "what if?" worksheets of TurboTax, TaxAct, etc. or the case study spreadsheet to give you a good answer.

[channant]

The question wasn't so much about the forms included with the return as it was the mechanics used.  E.g., do you do them by hand, or using tax software, or handing them off to a CPA, etc.?

Ah, I have a family friend who's a CPA who takes care of my taxes for a super modest fee.