Case Study - Savings on track?

[evanc]

Okay, fellow mustachians, I need your expert advice on where I should be allocating my savings. The goal is to have accessible monthly income, later, in "early retirement" while still maximizing available tax incentives, now. I recognize that I will be “retired” many years prior to being able to receive funds from 401k, pension, SSA, etc., so the way I’m looking at it, what’s already in our respective 401k accounts (combined ~$225k) will be left untouched until 59.5 or later. It would be nice if Social Security provides some additional income at age 65, but I’m not counting on that whatsoever.

I'm 37, married, and plan/project to be FI w/in 9 years from today.  I'm debt-free except for the mortgage on my house (~$138k, 3% interest), which is where I'm focusing a significant amount of my attention for the next 3 years, at which point it will be completely paid off (the subsequent 6 years will be all savings).

Post-tax (net) monthly income is as follows -

Salary (self and spouse combined): 8100
Other non-taxable income: 1900

Savings (currently) as follows -

401(k) self: 5% (just enough to maximize employer matching)
401(k) spouse: N/A (her employer contributes a percentage of her salary, regardless of whether she contributes)
Vanguard Index VTSMX: $3000 (plan to switch to VTSAX).  Once house is paid off in 3 years, this amount will increase to $7000 (the current $3k plus the $4k we pay monthly in principal + interest + prepayment right now). 

Assuming a return rate of 5% on the Vanguard funds, estimate having the following in 9 years:

$700k + in Index Funds
$200k + in Home Equity

Using the “4% method,” the income generated on investments would be $28k/yr, so adding that to the $22.8k/yr of nontaxable income I already receive (and will continue to receive in perpetuity), our annual anticipated combined income of $50.8k should cover our anticipated (i.e. minus current mortgage) expenses of $48k/yr.

I should also state that we are assuming the following as a “cushion” for later life:

Above mentioned 401k accounts (not to be used until age 59.5 or later).

Also at age 58, I will start receiving a monthly pension from my current employer, which I estimate to be valued at (in today’s dollars) ~$1500

Given the above, is it wise to throw all my eggs in the index fund basket at this point in lieu of higher contributions to the 401k (or IRA or rIRA)? My reasoning is that I won’t be able to draw any income from the latter between ages 46 (anticipated retirement) and 59.5. At the same time, I recognize that I will pay taxes on the stock investments now, while I am at a disadvantageous tax rate, due to my salary. I want to ensure that I will have sufficient, AVAILABLE income during those years from 46-59.5, so I'm willing to pay some additional taxes if that's what's necessary to get there from here.

I have tried to include all relevant info, but let me know if I have overlooked anything.

Thank you in advance for your feedback!

[terran]

It is possible to get money out of tax advantaged accounts before age 59.5. Take a look at this: http://forum.mrmoneymustache.com/taxes/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-ag-39647/

Even if that weren't the case, paying the 10% penalty isn't the worst thing in the world if you assume it goes in while you're in the 25% tax bracket and comes out at 15% or less. You could also consider how your state taxes are likely to compare if you plan to move to another state in retirement.

Anyway, given your income I'd certainly at least make sure you get down into the 15% bracket by adding to your 401k, and frankly I'd max out all tax advantaged accounts even if it gets you well into the 15% bracket (whether that means switching to Roth for some of your contributions or not is up for debate).

[evanc]

It is possible to get money out of tax advantaged accounts before age 59.5. Take a look at this: http://forum.mrmoneymustache.com/taxes/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-ag-39647/

Even if that weren't the case, paying the 10% penalty isn't the worst thing in the world if you assume it goes in while you're in the 25% tax bracket and comes out at 15% or less. You could also consider how your state taxes are likely to compare if you plan to move to another state in retirement.

Anyway, given your income I'd certainly at least make sure you get down into the 15% bracket by adding to your 401k, and frankly I'd max out all tax advantaged accounts even if it gets you well into the 15% bracket (whether that means switching to Roth for some of your contributions or not is up for debate).

Thanks for the link and your suggestions. I was aware of the "pipeline" and "SEPP" methods, but as the author of that article acknowledged:

•An early retiree will likely find that SEPP payments for a younger person are a low percentage of their account. Someone in their 30s will withdraw 1.9%-2.7% of their account if they use the required minimum distribution method. Therefore someone depending on a 4% withdrawal rate will need to get some money from other sources (taxable accounts, rental real estate, etc.) to bridge the gap.

Not to mention:

•This method [i.e. pipeline] may result in high taxes during the last few years of work, when starting the conversion pipeline and earning money from a job at the same time. To avoid this, consider having some money in taxable accounts and/or direct Roth contributions to pay for part or all of the first five years of early retirement.


Nonetheless, food for thought.

[MDM]

Given the above, is it wise to throw all my eggs in the index fund basket at this point in lieu of higher contributions to the 401k (or IRA or rIRA)?

I'm guessing "no", because I think you'll have enough in taxable accounts that you can start the Roth pipeline after retirement, and the tax savings by using 401k/IRA could be significant.

You might do some "what if?"s in the case study spreadsheet, and then more detailed calculations in one or more of these: Best and/or Recommended Retirement Calculator - Bogleheads.org.