When my DW and I reach financial independence, we plan on purchasing some property in our desired retirement location, and then building a nice downsized home to meet our needs.
I was recently looking through our investment and drawdown strategy to see how I can fit a property purchase and home build into the FIRE plan, but with planning to heavily rely on tax-deferred investment vehicles, I feel like it would be really difficult to execute everything without paying some penalties or higher tax rates.
Here is where we are currently at:
- Age 31
- Gross Income: ~$130k
- 25% marginal tax bracket
- His 401(k) contributions Maxed out at the current annual contribution limit of $18,000/year. Receive 4% company match
- Her 401(k) contributions 3% of pay, with 3% company match
Current Investment Plan:
- His 401(k) Continue to contribute annual maximum allowed for given year
- Her 401(k) Within the next 4 weeks, contribute annual maximum allowed, divided equally into bi-weekly paychecks: $18,000/26
- Traditional IRA 1 Fall of 2016; contribute maximum allowed, divided into equal monthly payments: $5,500/12
- Traditional IRA 2 Some time 2017/2018; contribute maximum allowed, divided into equal monthly payments: $5,500/12
- Taxable Account After 401(k)s and IRAs are maxed out, skim excess monthly savings into Taxable Account
Current Drawdown Plan:
- Assume $40k annual spending
- Reach financial independence work the following year and max out 401(k) and Traditional IRA contributions as quickly as possible
- Retire at age 43ish receive no additional income from job/career
- Roll 401(k) into Traditional IRA
- Establish a Roth IRA account and use laddering method to access funds 5 years later
- Use money out of Taxable account to pay for annual expenses until Roth Pipeline is established
When my wife and I reach financial independence, our accounts might look something like this (assuming 5% average return):
- His 401(k): $508,000
- Her 401(k): $341,000
- Traditional IRA 1: $86,000
- Traditional IRA 2: $72,000
- Taxable Account: $121,000
Our current home has a current estimated value of $240,000
Estimated Property Cost: $75,000
Estimated Home Build Cost: $250,000
Problems:The first big problem is that at early retirement, our taxable account will not have enough in it to sustain us for 5 years at $40k annual spending until the Roth Pipeline is established.
The second problem is, is that I have no idea how to sequence all of the events together to make the transition, and how to drawdown the accounts to purchase the property and build the home.
This is what I was thinking of possibly doing:
Retire -- Establish Roth IRA and begin laddering method -- Use money from Taxable Account to secure a Construction-to-Permanent Loan (~$85,000 down payment) -- Once house is built, sell existing home and use the proceeds from the sale to pay off the Construction-to-Permanent Loan -- Continue to use Taxable Account to pay for annual expenses (at this point, only have about 1 year of money remaining) -- Once Roth Pipeline is established, used money from Roth to pay for annual expenses -- Live happily ever after
So we can use the money from the Taxable Account to put a down payment on a Construction-to-Permanent loan, but as earlier mentioned, with the existing investment plan, there wont be enough money in the taxable account to sustain us for 5 years of annual expenses until the Roth Pipeline is established. With the above plan, we are missing 4 years of cash flow.
So how do we make up this difference?
At age 43, it looks like our options would be limited and we may end up having to pay penalties to withdraw some money from the Traditional IRA/401(k).
Instead of investing in Traditional IRAs, do we invest in Roth IRAs? If we went that route, we would have about $120,000 as the Roth basis, but minus 5 years of contributions, we would have about $65,000 for immediate use, with $11,000 every year thereafter. This route would give us an additional 2 years, extending our annual spending from 1 year to 3 years, but we are still missing 2 years until the Roth Pipeline is established.
Going this route, we would be growing our IRA investments with after-tax money, instead of tax-deferred money, meaning that we would be missing out on some free money up front, and limiting our future IRA balance. This won't help us much with our annual taxes from now until FIRE, and it would also extend our projected FIRE date by a little bit.
Do we scale back our contributions towards 401(k)s and IRAs and put more into the Taxable Account? Might be good at the end to make things easier, but it wont help us much with our annual taxes from now until FIRE, and it would also extend our projected FIRE date by a little bit.
I could extend my working career by 2 years, to age 45, but for reasons that I wish not to disclose, I wouldnt want to go past that. That being said; the earlier the better.
If I begin a Roth conversion while I am still employed, I will have to pay taxes on the conversion at the higher 25% marginal tax rate, as opposed to starting the conversion when being retired and being in a lower 15% marginal tax rate.
What about using a HELOC or some other sort of LOC? If this is a possible route, how should this be fit into the timeline of things?
Any thoughts on how to make this all work out while minimizing taxes and penalties?