Author Topic: 10% Penalty vs Taxable  (Read 1678 times)

millennialonfire

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10% Penalty vs Taxable
« on: February 20, 2017, 11:39:24 AM »
I plan to become a SAHP in 6 years. My spouse's income only will be able to cover all our expenses with the exception of our mortgage. Our mortgage has 15 years left at 2.8%. Rather than pay it off with the next 6 years, I would like to invest the money in either taxable brokerage or 401k and use that account as needed to pay for the mortgage. I am struggling with the math to determine which type of account would have the best tax benefits. We currently have a combined income of $100k and would drop to $50K after I quit my job. My 401k has good investment options with low ERs. In my mind, the initial tax savings and tax free growth of the 401k might outweigh the 10% penalty. Thanks!

boarder42

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Re: 10% Penalty vs Taxable
« Reply #1 on: February 20, 2017, 11:56:55 AM »
do the actual math both ways.  but i'd include a 3rd option which will 100% beat the 10% penalty.

you likely could do Roth conversions to avoid the 10% penalty after the first 5 years.  so you'd only need a 5 year bridge not the full 15 years worth of payments.  my guess is this will come out far ahead.  at 50k you can convert alot of money over to roth and pay just 15% or less tax on it. with no penalty.

boarder42

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Re: 10% Penalty vs Taxable
« Reply #2 on: February 20, 2017, 11:57:31 AM »
this is a really fun problem that i'd probably enjoy doing the math on but its probably best you do it and understand it yourself so if things change you can make the right decision.

aceyou

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Re: 10% Penalty vs Taxable
« Reply #3 on: February 20, 2017, 12:27:04 PM »
do the actual math both ways.  but i'd include a 3rd option which will 100% beat the 10% penalty.

you likely could do Roth conversions to avoid the 10% penalty after the first 5 years.  so you'd only need a 5 year bridge not the full 15 years worth of payments.  my guess is this will come out far ahead.  at 50k you can convert alot of money over to roth and pay just 15% or less tax on it. with no penalty.

This. 

Also, how old are you?  If you are close to 59.5, then you could consider SEPP distributions(this means you start drawing a monthly income from your 401K penalty free.  If you are really far from 59.5, then the Roth conversion is probably better, for two reasons.  First, you have 6 years to prepare, so the roth conversion ladders 5 year wait period is no problem.  Second, you can turn the spigot off on the conversion ladder.  Once you start SEPP distributions, you can't stop, which is why I think they are meh for people who are really young. 

So yeah, probably just do the conversion ladder like Boarder said, good luck!

millennialonfire

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Re: 10% Penalty vs Taxable
« Reply #4 on: February 20, 2017, 05:38:34 PM »
I am planning on quitting before my 31st birthday so the roth conversion ladder seems like the best plan. I think I will max out a roth IRA for the next 6 years in order to cover the first 5 years worth of mortgage payments by only withdrawing the contributions. I will also be adding anything left over to a traditional IRA and begin converting a years worth of mortgage payments plus taxes each year after quitting my job. I ran my numbers to the best of my abilities and I think thats the best solution.

boarder42

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Re: 10% Penalty vs Taxable
« Reply #5 on: February 20, 2017, 08:03:13 PM »
You can't max a Roth and do trad IRA.

millennialonfire

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Re: 10% Penalty vs Taxable
« Reply #6 on: February 21, 2017, 05:47:22 AM »
I just realized that the IRA max contribution of $5500 per individual was the total of roth and traditional. However, I reran the numbers and now I believe the tax savings of traditional contributions during our double income years outweighs the 10% penalty during our reduced tax burdened single income years. So I will max out all available traditional savings and just accept the 10% penalty to pay the mortgage during the first 5 years before the roth pipeline conversions are available.

boarder42

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Re: 10% Penalty vs Taxable
« Reply #7 on: February 21, 2017, 06:01:36 AM »
I just realized that the IRA max contribution of $5500 per individual was the total of roth and traditional. However, I reran the numbers and now I believe the tax savings of traditional contributions during our double income years outweighs the 10% penalty during our reduced tax burdened single income years. So I will max out all available traditional savings and just accept the 10% penalty to pay the mortgage during the first 5 years before the roth pipeline conversions are available.

you believe it does or you know it does.  i'd be 100% sure on the math.  but it typically is better than roth or taxable. 

teen persuasion

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Re: 10% Penalty vs Taxable
« Reply #8 on: February 21, 2017, 07:07:52 AM »
Have you looked at how your taxes will change with that drop in income + addition of a child?  Half the income, additional personal exemption, child tax credit, possibly EITC (if AGI is lowered by 401k contributions), possibly in range for Retirement Saver's credit...