72(t) withdrawal during FIRE

[DoNorth]

I have about 20 months left on an overseas employment contract.  I'm 40, married with two kids 9 and 7.

Our plan is to return to our home in the upper midwest after my job is done overseas.  I'm considering setting up a 72(t) withdrawal when we return and want some feedback on pros and cons.

I receive a military pension w/ VA disability.  By 2019, this will total $63,600/year (adjustable to inflation each year like SS) of which $20,500 is federally taxable income .  Our tax deferred accounts total around $500K.  Taxable investments around $100,000.  The 72(t) calculators tell me with a reasonable interest rate of 3.4%, I could withdraw about $22,000/year until 60 with an ending balance of $359,000.

If I do this, my monthly cash flow would look something like this:

$5300 military/VA pension = $63,600 annually
$1866 --IRA withdrawal = $22,392 annually
$350--dividends from taxable investments = $4200 annually
-----------
$7516 cash flow/month or $90,192/year annually

Taxes would look something like this (I hope)

$20,500 federally taxable pension
$22,392 IRA 72t
$4200 dividends
--------------
$47,092 taxable income
-$24,000 standard deduction
--------------
23,092= $2309 in tax
$2309 in child tax credits
-------------------------
$0 federal tax owed

We're pretty frugal so in all likelihood, we won't spend $7500/month during most months, but we travel a fair bit and want the flexibility to spend more if we want.  I was looking at a Roth conversion ladder, but I don't see a real advantage over doing a 72(t) with my tax situation.  I suppose doing the Roth conversion would let me accumulate a much bigger tax free stash into my 60's, but I don't see much fun in that.  I do have some hesitations since the 72t isn't reversible and I definitely wouldn't start it in a bear market, but market conditions can change quickly as we all know.  What should I do with the excess cash flow?  Put it into 529 or back into taxable investments?

[terran]

The advantage of Roth conversions over 72t is that they're much more flexible (once you get past the 5 year waiting period that is, of course). With 72t you MUST withdraw exactly the right amount over the next 20 years or you'll owe penalties for all of the past withdrawals as if they weren't qualified under 72t. Not to say it's not a viable option, or even that it's not the best option for you, but personally I'd rather stick with Roth conversions if you think you can make your taxable account last 5 years to get it going. Maybe you can add a bit more over the next year to make it work?

The other advantage of Roth conversions is that they'll still be tax advantaged even if you don't spend the whole amount, which it sounds like you think might happen. Any 72t distributions you don't spend will have to end up in the taxable account.

You could also do a combo with a smaller 72t and also Roth conversions to maintain some flexibility while still making your taxable account last longer.

[DoNorth]

Excellent points.  thanks

Does the five year waiting period begin once I've moved 401k assets into a traditional IRA?  What about contributions I've already made into a traditional IRA?

[terran]

Excellent points.  thanks

Does the five year waiting period begin once I've moved 401k assets into a traditional IRA?  What about contributions I've already made into a traditional IRA?

No, the 5 year period for a Roth conversion ladder starts when you convert from traditional to Roth. Double check my math and reasoning on this before relying on it, but it starts in the year of conversion (assuming it was done at the beginning of the year), so if you convert any time in 2019 then you can begin withdrawing anytime in 2020 even though the conversion might have happened as  little as 4 years and 1 day ago (probably slightly more given brokerage holiday closings).

Here's a good post to read: https://www.kitces.com/blog/understanding-the-two-5-year-rules-for-roth-ira-contributions-and-conversions/

[bacchi]

Excellent points.  thanks

Does the five year waiting period begin once I've moved 401k assets into a traditional IRA?  What about contributions I've already made into a traditional IRA?

No, the 5 year period for a Roth conversion ladder starts when you convert from traditional to Roth. Double check my math and reasoning on this before relying on it, but it starts in the year of conversion (assuming it was done at the beginning of the year), so if you convert any time in 2019 then you can begin withdrawing anytime in 2020 even though the conversion might have happened as  little as 4 years and 1 day ago (probably slightly more given brokerage holiday closings).

Here's a good post to read: https://www.kitces.com/blog/understanding-the-two-5-year-rules-for-roth-ira-contributions-and-conversions/

I think you meant 2015.

[Catbert]

I would als20 o urge caution in using 72t for someone so young.  20 years is a long time to be locked into a specific withdrawal strategy.  I believe if you fail to follow through exactly that you not only owe penalty for the year you messed up but for previous years also.  No 100% of that however.

I'd look for a way to support your family during the 5 years you are making a Roth pipeline of conversions.  Do you already have any Roth money?  You can withdraw contributions (not profits or conversions) at any time without tax or penalty. Maybe you could work a bit?  Or if you have money in a brokerage/mutual fund you could withdraw and pay capital gains.  If might even make sense to make some withdrawals from an IRA and pay the 10% early withdrawal penalty along with whatever tax would be due.   

[DoNorth]

Thanks, I am hesitant to try the 72t for the reason you mention and definitely don't like that I would be forced to sell shares during down markets. 

We used our Roth to buy a (one of a kind sort of)  property last year and just finished paying the tax burden on that.  Financing wasn't an option and I was working under a constrained timeline to ensure we could keep it in the family so the Roth is completely depleted.

Prior to accepting this overseas job, I worked PT at a non-profit and made a modest salary, but I was replaced when I left and frankly, I don't think I want to work right away when we get back to the US.  This will be my second shot at FIRE and there are things I definitely want to do differently this time, so my wife and I decided we're taking our first year back without making commitments so we can settle into our new routines.

With my remaining 20 months overseas, I can max my 401k in 2019 and 2020, max both our IRAs both years and after that, I can still put away about $5000/mo in taxable investments so I could potentially use the pool of taxable investments to cover any shortfalls during the five year period.  I have the option to extend my overseas tour here 12 months, but my kids will be getting older and I'd like to get them back into US schools before my son starts 6th grade so that is an option, but I'm not sure I (or they) want to stay longer although that would be the logical financial choice.

[terran]

Excellent points.  thanks

Does the five year waiting period begin once I've moved 401k assets into a traditional IRA?  What about contributions I've already made into a traditional IRA?

No, the 5 year period for a Roth conversion ladder starts when you convert from traditional to Roth. Double check my math and reasoning on this before relying on it, but it starts in the year of conversion (assuming it was done at the beginning of the year), so if you convert any time in 2019 then you can begin withdrawing anytime in 2020 even though the conversion might have happened as  little as 4 years and 1 day ago (probably slightly more given brokerage holiday closings).

Here's a good post to read: https://www.kitces.com/blog/understanding-the-two-5-year-rules-for-roth-ira-contributions-and-conversions/

I think you meant 2015.

Yeah, I don't know what I meant, but as late as Dec 31 2015 to as early as Jan 1, 2020, or as late as Dec 31, 2019 to as early as Jan 1, 2024 (ignoring issues with those dates related to brokerages being closed) would match my understanding of how it works.

[terran]

Thanks, I am hesitant to try the 72t for the reason you mention and definitely don't like that I would be forced to sell shares during down markets. 

We used our Roth to buy a (one of a kind sort of)  property last year and just finished paying the tax burden on that.  Financing wasn't an option and I was working under a constrained timeline to ensure we could keep it in the family so the Roth is completely depleted.

Prior to accepting this overseas job, I worked PT at a non-profit and made a modest salary, but I was replaced when I left and frankly, I don't think I want to work right away when we get back to the US.  This will be my second shot at FIRE and there are things I definitely want to do differently this time, so my wife and I decided we're taking our first year back without making commitments so we can settle into our new routines.

With my remaining 20 months overseas, I can max my 401k in 2019 and 2020, max both our IRAs both years and after that, I can still put away about $5000/mo in taxable investments so I could potentially use the pool of taxable investments to cover any shortfalls during the five year period.  I have the option to extend my overseas tour here 12 months, but my kids will be getting older and I'd like to get them back into US schools before my son starts 6th grade so that is an option, but I'm not sure I (or they) want to stay longer although that would be the logical financial choice.

I bet you can make it work. It might be a little close/tight, but it also seems pretty close/doable.

What tax bracket are you in now? If you're in the same tax bracket now as you will be in retirement then you could switch some/all of you IRA and 401(k) contributions to Roth now and those would be available for immediate withdrawal whenever you want.