Author Topic: How much to hold back from tax-advantaged retirement accounts?  (Read 6511 times)

TaronM

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How much to hold back from tax-advantaged retirement accounts?
« on: October 09, 2016, 11:33:58 AM »
I wasn't sure if this should be in the Taxes board, the Investments board, or here, so if a mod wants to move it to a better location, please do!

Let's say I get $60,000 in a year, and live off $30,000 of it, giving $30,000 to invest, so following advice I see around sites like this I do this:

$30,000
  -$6,750 - HSA
  -$5,500 - Wife's IRA
  -$5,500 - My IRA
  -$5,000 - Wife's 401k
  -$7,250 - My Solo 401k
  = $0

And that's not even getting close to the limit of how much I could contribute to my Solo 401k, but the $30k is fully invested now...

But, if I do this... um, how am I supposed to retire early again?  All my funds are locked away in tax-advantaged retirement accounts I can't access until 59.5.  The Roth Laddering method won't really help me, because you have to wait 5 years after a conversion to pull the funds out, so I need something to live off of in the meantime.  I realize that SEPP or 72t is an option but that seems very "last resort" to me.

So, seems I need to keep at least some of my investments in a plain Brokerage account so I have some funds to retire early from.  It also seems that with the 0% LTCG tax rate that having plain Brokerage funds around can be useful even post-retirement-age for optimizing taxes alongside the Roth Laddering method (since stocks sold and then pulled out of non-Roth retirement accounts are taxed as ordinary income regardless of whether or not they are held long term, and of course can't Tax Loss Harvest from one either).

Now here's another wrench - I am self-employed, so my income is very unstable.  Sometimes I'll make little enough that I won't have any to spare for investments (or may even need to use a small bit of them), other times I'll make several times the amount I need to live off of that year, it depends on when I release each product and how well it does.  Thus, I don't have a set "early retirement date" to shoot for, I figured I'd just reduce expenses as much as possible, invest the rest, and check calculators now and then to see if have enough saved yet.  It could be in a couple years, it could be 10, depends on how my business does.  Unfortunately this means I can't even pick a fixed number for how much to keep in the Brokerage based on some kind of plan for needing to last X years from it and planning to have that much saved in X amount of time.  I need something more ball-park and dynamic.

What I've been working on is a spreadsheet (I do so love making spreadsheets) to automatically calculate how much funds to shift over to tax-advantaged accounts each year, so it adapts to whatever my income/tax bracket happens to be that year, with the idea that my wife could use the spreadsheet in my absence to continue our plan without needing to know every detail about why this or that should be done.  But I'm at a loss on a formula for determining what the absolute maximum amount I should shift over to tax-advantaged accounts should be so that I have enough left over in the Brokerage account to be able to retire early with.  Should it be a percentage of how much total I have to spare that year, like always hold back at least 25% of invest-able funds in the Brokerage and shift up to 75% (or up to contribution max) to IRA/401k/etc?  Or try to do some kind of re-balancing where I look at my total portfolio compared to Brokerage and try to keep some % of that total in the Brokerage, regardless of how much I actually made that year?  Should the % held back be based on my age and go down over time, or stay fairly flat since Brokerage could still be useful after retirement age?

I mean, obviously in a super high-income year, I'd shift everything I could to tax-advantaged to lower my marginal tax bracket and would probably have left over to go into the Brokerage anyway, but I have no idea if and when more of those will come, and for years like the example I gave at the start where I could theoretically shift everything into tax-advantaged retirement accounts, how much should I hold back?

Any thoughts?
« Last Edit: October 09, 2016, 11:46:54 AM by TaronM »

NathanDrake

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #1 on: October 09, 2016, 06:30:55 PM »
Begin here:

http://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

The Roth IRA conversion ladder should work, presuming:

1. You have some form of direct Roth IRA contributions where principal is immediately accessible.

or

2. Some after-tax money.


TaronM

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #2 on: October 09, 2016, 10:31:38 PM »
Begin here:

http://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

The Roth IRA conversion ladder should work, presuming:

1. You have some form of direct Roth IRA contributions where principal is immediately accessible.

or

2. Some after-tax money.

I've read through that before, but like you said, the Roth Laddering strategy requires Roth contributions or after-tax money, so my question is how to make sure I have these things in the first place.  If 100% of my excess funds above expenses is going into Traditional IRA/401k/HSA than I won't have any after-tax money or Roth contributions to start the process.  Everyone says to put as much as possible into pre-tax accounts (with many early retirement blogs suggesting Roth is not as beneficial as traditional accounts besides using it for laddering), but if your income is such that your contribution limits are so high that you could put in literally every cent beyond what you spend to live, you'll never be able to early retire without using SEPP, and SEPP has many downsides I'd like to avoid.  So all I need to do is keep some portion of my money out of pre-tax retirement accounts, but how much?  and what do I base the amount to keep out on?  That's the problem I'm trying to solve here.

terran

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #3 on: October 09, 2016, 10:58:54 PM »
You would need 5 years of expected expenses (including taxes you'll need to pay on the roth conversions) in Roth basis (contributions, not earnings) and taxable accounts to have enough to get the roth conversion pipeline going since you need to leave those conversions for 5 years before they can start being withdrawn.

You should probably be contributing some to Roth anyway because with your level of income and those contribution levels you're probably already paying no federal income tax when the savers tax credit is taken into account: https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-savings-contributions-savers-credit

You should try entering your numbers into some tax software to check out what happens with different levels of roth vs traditional contributions.

TaronM

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #4 on: October 09, 2016, 11:48:54 PM »
You would need 5 years of expected expenses (including taxes you'll need to pay on the roth conversions) in Roth basis (contributions, not earnings) and taxable accounts to have enough to get the roth conversion pipeline going since you need to leave those conversions for 5 years before they can start being withdrawn.

Right, but I don't think its a good idea to save up the 5 years of taxable account all at once before beginning to contribute to pre-tax accounts and getting tax benefits, nor do I want to put everything in pre-tax before building up taxable and Roth contributions or I might end up with enough total assets in my portfolio but no (penalty-free) way to access them by neglecting to hold some back.  I believe I should be contributing to both pre-tax and post-tax/taxable accounts at the same time, but at what ratio?  Too much in taxable and I'm missing out on tax savings and gimping my returns, but too much in post-tax/taxable and I could also gimp my returns by having to pay tax penalties to get it back out!  Either way delays ER.

You should probably be contributing some to Roth anyway because with your level of income and those contribution levels you're probably already paying no federal income tax when the savers tax credit is taken into account: https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-savings-contributions-savers-credit

Yeah I figured before the ratio I just mentioned would be a factor, my first priority would be that in a super high-income year (when my business releases a new product for example) I should dump enough into pre-tax accounts to lower my marginal rate down as much as possible to the 15% bracket, and in a super low-income year I should not bother with pre-tax accounts and go for Roth conversions and tax gain harvesting.  But its possible I'd end up with nothing but the middle ground income of my initial example every year, and that's where I'm stuck figuring out a good "rule of thumb" ratio.

Good point about the Saver's Credit...  Hmmm... I wonder if its better to go for the credit, or go for Tax Gain Harvesting by selling gain-realized stocks in a brokerage account to take advantage of 0% Long Term Capital Gains tax rate when in the 15% tax bracket?... hmmm...  Might have to re-think my original plan of using Tax Gain Harvesting any time my AGI was otherwise below the top of the 15% bracket...
« Last Edit: October 10, 2016, 12:03:18 AM by TaronM »

MDM

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #5 on: October 10, 2016, 12:19:25 AM »
You would need 5 years of expected expenses (including taxes you'll need to pay on the roth conversions) in Roth basis (contributions, not earnings) and taxable accounts to have enough to get the roth conversion pipeline going since you need to leave those conversions for 5 years before they can start being withdrawn.

You should probably be contributing some to Roth anyway because with your level of income and those contribution levels you're probably already paying no federal income tax when the savers tax credit is taken into account: https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-savings-contributions-savers-credit

You should try entering your numbers into some tax software to check out what happens with different levels of roth vs traditional contributions.
+1 to all points.

E.g., using the OP numbers (with some guesswork), the tIRA and 401k contributions above ~$13,350 are saving 0% so those amounts ought to go to Roth.  For the purposes of this chart, all pre-tax IRA and 401k contributions are lumped together.  Note that the marginal savings rate for that $13,350 is ~26% due to the saver's credit, despite the couple being in the 15% or 10% tax bracket:


The table below shows how the total federal income tax (other than FICA) would be $0 with that amount of tIRA/401k contributions:
CategoryMonthly
Comments
Annual
Salary/Wages for earner #1$3,000$36,000
Pretax Health Ins.$100$1,200
Employer-sponsored HSA$563At maximum$6,750
FICA base salary/wages$2,338$28,050
401(k) / 403(b) / TSP / etc.$1,113Room to increase?$13,355
Income subject to IRS tax$1,225$14,695
Schedule C net profit$2,000$24,000
Federal Total Income$3,225$38,695
Federal tax$02016 rates, MFJ, stand. ded., 2 exempt.$0
State/City tax$127Guess, using 5.00% * (AGI - Exempt'n)$1,530
Soc. Sec.$145Assumes 1 earner paying$1,739
Medicare$34$407
Self-employment Tax$283$3,391
Total income taxes$589$7,067
Income before other expenses  $2,636$31,628


Filing Status21=S, 2=MFJ, 3=HOH
# Exemptions2
Adult #1Adult #2
Age2828
# of earners1
Total Income$38,695
Std. Deduct.$12,600
Act. Deduct.$12,600
Exemption$8,100
Deductible SE tax$1,696
AGI$36,999
MAGI$38,695
Taxable$16,299
1040 Tax$1,630
AMT adder$0
Saver's credit$2,000
Tax after n-r credit$0
NIIT$0
EIC$0
Child Tax Cred.$0
Net Tax$0
Monthly$0
State tax$1,5305.00%
Item. Deduct.$1,530
VersionV8.09

See the case study spreadsheet to check specific numbers.

TaronM

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #6 on: October 10, 2016, 12:52:57 AM »
E.g., using the OP numbers (with some guesswork), the tIRA and 401k contributions above ~$13,350 are saving 0% so those amounts ought to go to Roth.

Whoops!  Hmm, I just used those numbers as a quick example, but would you then say that in most cases this problem would work itself out like that if you just avoid contributing to pre-tax accounts when there would be no tax benefits, and put the rest into Roth/Taxable?  For example, my actual max contribution in 2016 to pre-tax accounts would be $53,750 so what if I said I made like $90k in a year and contributed up to my max, would the same thing happen?

Is there even a scenario where one could contribute that much, actually gain tax benefit from the full amount contributed, and and NOT have any income above expenses to spare to put into Roth or Taxable accounts?  Or would you always either have too low of an income for the full contribution to give tax benefit or too high of an income to be without leftovers?

What if I change the expenses part of it, say $40 or $50k expenses instead of $30k, leaving me less excess funds to save, would that lead to a scenario where I could end up contributing ALL of the excess to pre-tax accounts, gaining full tax benefits from them, but potentially no basis in Roth and no taxable brokerage funds?

Sorry if I'm not making any sense.  I guess I need to run some more example scenarios to see if this is even really a problem.  I didn't realize in my thought experiment example scenario that some of the pre-tax contributions would give 0% benefit anyway - it was just an example to illustrate the point of the possibility of ending up with enough money for early retirement but having 100% of it in pre-tax accounts and no Roth basis or taxable accounts to begin a laddering process, but perhaps that's an unlikely scenario anyway if just optimize taxes due year by year to whatever the lowest I can get away with is...

MDM

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #7 on: October 10, 2016, 01:16:36 AM »
I guess I need to run some more example scenarios to see if this is even really a problem.
Good plan!

You may be able to answer the previous questions for yourself.

Quote
...just optimize taxes due [and the traditional/Roth choice] year by year...
See https://www.bogleheads.org/wiki/Traditional_versus_Roth for more.

teen persuasion

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #8 on: October 11, 2016, 08:05:18 AM »
Sounds to me that your income in any given year can fall into one of several bands:

1. Lowest income, none left over for saving, may need supplementing.  You should have something liquid set aside for these times, not in retirement accounts.

2. Enough to cover expenses with some left over for saving, but not enough to max all tax advantaged accounts.  Put enough in pre-tax accounts to get taxes to a minimum, then shift remaining savings to Roth IRAs.

3. High enough to require going all pre-tax to reduce taxes, but none left for Roth or taxable.

4. High enough to completely fill tax advantaged accounts with more left over.  Put left over $ in taxable.

Our income doesn't go up and down much, it's pretty stable if creeping up.  We are in stage 2, haven't ever gotten to stage 3 or higher.  We've also got 5 kids, which sets up a whole 'nother dynamic in taxes - CTC and EITC, both refundable credits.  Just getting to zero fed tax was easy on our income with 5 extra exemptions and credits.  However, I realized we could do much better than zero.  DH contributes as much as possible to his 401k, to about the zero taxable income point, which increases the EITC (we're in the 21% phaseout range).  Our state matches the EITC at 30%, and matches the CTC at 33%, too.  Instead of zero taxes, we've seen refunds large enough to fund both of our Roth IRAs.  Since we were at the point of owing no tax, and traditional IRA contributions do not increase EITC, Roth IRAs were a no-brainer.

Unfortunately, the kids are aging out of that sweet spot, only one left to claim for CTC, and 2 for EITC. It's no longer enough to fully fund Roth IRAs for both of us, but I keep maxing them to get enough contributions in there to cover 5 years expenses.  There hasn't been extra to go to taxable, yet.  There is the HSA, though.  I've been paying health care expenses OOP, and saving the receipts for future reimbursement.  I could also draw those whenever I want.

TaronM

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #9 on: October 11, 2016, 12:30:51 PM »
Sounds to me that your income in any given year can fall into one of several bands:

1. Lowest income, none left over for saving, may need supplementing.  You should have something liquid set aside for these times, not in retirement accounts.

2. Enough to cover expenses with some left over for saving, but not enough to max all tax advantaged accounts.  Put enough in pre-tax accounts to get taxes to a minimum, then shift remaining savings to Roth IRAs.

3. High enough to require going all pre-tax to reduce taxes, but none left for Roth or taxable.

4. High enough to completely fill tax advantaged accounts with more left over.  Put left over $ in taxable.

Our income doesn't go up and down much, it's pretty stable if creeping up.  We are in stage 2, haven't ever gotten to stage 3 or higher.  We've also got 5 kids, which sets up a whole 'nother dynamic in taxes - CTC and EITC, both refundable credits.  Just getting to zero fed tax was easy on our income with 5 extra exemptions and credits.  However, I realized we could do much better than zero.  DH contributes as much as possible to his 401k, to about the zero taxable income point, which increases the EITC (we're in the 21% phaseout range).  Our state matches the EITC at 30%, and matches the CTC at 33%, too.  Instead of zero taxes, we've seen refunds large enough to fund both of our Roth IRAs.  Since we were at the point of owing no tax, and traditional IRA contributions do not increase EITC, Roth IRAs were a no-brainer.

Unfortunately, the kids are aging out of that sweet spot, only one left to claim for CTC, and 2 for EITC. It's no longer enough to fully fund Roth IRAs for both of us, but I keep maxing them to get enough contributions in there to cover 5 years expenses.  There hasn't been extra to go to taxable, yet.  There is the HSA, though.  I've been paying health care expenses OOP, and saving the receipts for future reimbursement.  I could also draw those whenever I want.

Yes exactly, my dilemma is in regards to the parts I bold'ed above - I want to make sure I have something liquid available for times when in #1, but if I coincidentally end up in #3 for a while, I would not have any liquid assets available.  Unfortunately I used a bad example, since it turned out to be in Band #2 when I meant it to be an example of Band #3.

Anyway, to solve this I wanted to set some kind of "cap" while in #3 to make sure I always set aside some money in Roth and Taxable even if that means missing out on some tax savings that year, because I never know when I might drop back down into #1 again.  I just haven't settled on a good formula for what that cap should be, and if it should be based on whatever my income that year happens to be, or maybe base it on my overall portfolio at the time (like, say, have a rule that says "x% of all portfolio must be in a liquid form [taxable/roth contributions/roth conversions/HSA-redeemable receipts] so don't contribute more to tIRA/401k if it would cause liquid assets to drop below x%!").  I didn't want to set a fixed amount either, like "3 years worth of expenses", because I didn't want to waste tax savings for several years building up some minimum liquid assets amount.

To be honest, I tried to simplify my original question and that was probably a mistake causing more confusion than clarity.  My real plan is actually not to early retire like many people here (by earning a lot of money and saving it up and then quitting jobs entirely), but rather to be perpetually semi-retired from now until too old to want to work any more.  My wife and I want to be free to work part-time jobs and/or take on jobs that are more appealing to us even if they don't pay all that well (by relieving the pressure to have high incomes) while we are still young enough to enjoy our work and live a simple, frugal lifestyle.  After all, most early retirees still do work anyway because its satisfying and they'd get bored otherwise, they just don't NEED to work, so I figure if I'm likely to work during ER anyway, why not just start right now working as if I'm already retired, even if I don't actually have enough funds to fully retire yet, as long as we save up enough to be okay once we get too old?

Unfortunately there's not very much info out there about good strategies for this, as most finances talk is focused on full retirement (early or otherwise), with strategies regarding "accumulation phase" vs "distribution phase".  I've been trying to adapt the various principles and strategies out there into a single "phase" plan that dynamically adjusts to whatever our income happens to be each year, much like your "income bands", with a set of calculations and suggestions for what to do in each income band so we can just refer to my spreadsheet each year instead of keeping all this in my head all the time.
« Last Edit: October 11, 2016, 12:43:56 PM by TaronM »

teen persuasion

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #10 on: October 11, 2016, 02:03:46 PM »
I'm not sure that percentages is the best way to go.  I tend to see income steps where things change.  What would be the incomes at which YOU reach each of the bands?  It will depend on your situation - MFJ, kids or not, accounts available to each of you, tax brackets, tax cliffs (like cutoffs for the Saver's credit).

Once you have a list of income steps, figure out your own version of MDM's savings accounts priorities.  Maybe your need for liquid savings pushes taxable (or Roth) up higher on the list than for the general population.

What is the likely range for annual income?  Are low/supplement years rare, or frequent?  Are boom years rare or frequent?  Having some idea of how often you may tap or refill the liquid bucket can influence your rules.  I'd term it an emergency fund; I liked to keep at least a year's expenses in ours, since I was SAHM for nearly 20 years, and we thus had only one earner.  Even when DH's employer went out of business and DH opted to go to grad school for a career change (a year w/o earnings, but with unemployment), we didn't dip into the EF.  I'm much more comfortable with a smaller EF now, so I've been more aggressive about pushing up our retirement percentages as much as possible, even if I draw down the EF a bit.  I'd never draw it down completely, though - if a true shortfall occurred and I tapped it, I'd build it back up before more aggressive retirement saving.

TaronM

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #11 on: October 11, 2016, 02:40:47 PM »
Yeah I think a "bucket" strategy may be called for here, I just didn't want to miss out on tax savings and thus partially gimp my investment returns while waiting for the first "bucket" (liquid assets) to fill up, as I figured I could use our HELOC for a true emergency in the meantime, but you are right that a %-based formula is probably not the way to go for defining the pre-tax investment cap when in income band #3.

Truth be told I'm probably just over-thinking it, I'm a bit of a perfectionist and wanted it to all work with maximum optimized efficiency once I get everything all set up, but the odds are probably low for being in band #3 for an extended period of time then dropping to #1, and even if it did happen, there's always alternatives to having liquid assets such as HELOC, increasing income temporarily, decreasing expenses further, or just biting the bullet and accepting the early withdrawal penalty or using SEPP or whatever.

boarder42

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #12 on: October 11, 2016, 02:47:12 PM »
Yeah I think a "bucket" strategy may be called for here, I just didn't want to miss out on tax savings and thus partially gimp my investment returns while waiting for the first "bucket" (liquid assets) to fill up, as I figured I could use our HELOC for a true emergency in the meantime, but you are right that a %-based formula is probably not the way to go for defining the pre-tax investment cap when in income band #3.

Truth be told I'm probably just over-thinking it, I'm a bit of a perfectionist and wanted it to all work with maximum optimized efficiency once I get everything all set up, but the odds are probably low for being in band #3 for an extended period of time then dropping to #1, and even if it did happen, there's always alternatives to having liquid assets such as HELOC, increasing income temporarily, decreasing expenses further, or just biting the bullet and accepting the early withdrawal penalty or using SEPP or whatever.

optimal efficiency would be to take as many tax breaks now as you can then fund some taxable prior to retirement b/c who knows what taxes will do.

MDM

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #13 on: October 11, 2016, 03:02:44 PM »
Yeah I think a "bucket" strategy may be called for here, I just didn't want to miss out on tax savings and thus partially gimp my investment returns while waiting for the first "bucket" (liquid assets) to fill up, as I figured I could use our HELOC for a true emergency in the meantime, but you are right that a %-based formula is probably not the way to go for defining the pre-tax investment cap when in income band #3.

Truth be told I'm probably just over-thinking it, I'm a bit of a perfectionist and wanted it to all work with maximum optimized efficiency once I get everything all set up, but the odds are probably low for being in band #3 for an extended period of time then dropping to #1, and even if it did happen, there's always alternatives to having liquid assets such as HELOC, increasing income temporarily, decreasing expenses further, or just biting the bullet and accepting the early withdrawal penalty or using SEPP or whatever.

Heck, this is at least as easy as determining when to start taking Social Security (SS).  There, all you need to know is the real return you will get in the future, and when you will die. ;)

Ok, the SS issue is not so simple and neither is the problem here.  Both boil down to It’s Difficult to Make Predictions, Especially About the Future.

Consider what happens if you make an "incorrect" choice regarding traditional vs. Roth, after having made a reasonable guess at marginal withdrawal vs. savings rates:
1) If you put "too much" into traditional, that will be because your marginal withdrawal rate became higher than your current marginal savings rate...so congratulations!  You probably became wildly successful, and developed a "first world problem."
2) If you put "too much" into Roth, that will be because your marginal withdrawal rate became lower than your current marginal savings rate...ouch.  You probably hit a rough patch, don't have much income, and are left wishing to have back the taxes you paid before contributing.

For those without defined benefit pensions, and expecting small SS benefits, traditional is almost always the way to go for the reasons you mention.

incognito

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #14 on: October 11, 2016, 03:29:32 PM »
I wasn't sure if this should be in the Taxes board, the Investments board, or here, so if a mod wants to move it to a better location, please do!

Let's say I get $60,000 in a year, and live off $30,000 of it, giving $30,000 to invest, so following advice I see around sites like this I do this:

$30,000
  -$6,750 - HSA
  -$5,500 - Wife's IRA
  -$5,500 - My IRA
  -$5,000 - Wife's 401k
  -$7,250 - My Solo 401k
  = $0

And that's not even getting close to the limit of how much I could contribute to my Solo 401k, but the $30k is fully invested now...

But, if I do this... um, how am I supposed to retire early again?  All my funds are locked away in tax-advantaged retirement accounts I can't access until 59.5.  The Roth Laddering method won't really help me, because you have to wait 5 years after a conversion to pull the funds out, so I need something to live off of in the meantime.  I realize that SEPP or 72t is an option but that seems very "last resort" to me.


Like you said in your original post, if all of your savings is locked away in tax advantaged accounts "um....how am I supposed to retire early again?". I've been thinking the same thing lately.

I'm self employed and don't qualify for Roth. I'm considering pausing my tax advantaged contributions so I can maximize contributions to my taxable investment accounts and also buy real estate. I know, I know, I'll pay more in taxes both now, and over the long term. But is the point of all this to avoid taxes at all costs, or to be financially independent at an early age? If I have to choose between paying some taxes in order to reach FI early in life (or go part-time) vs. paying less taxes but having to wait until I'm 60, the choice is pretty clear for me.

Like you, I don't like the Roth ladder or 72t options either, both because of the 5 year timelines involved and also the fact that those rules are not static. I don't like my whole FI plan to be hinged on some obscure rules that could change or go away completely if uncle Sam decided to do so.

You were wondering about a percentage that you should be holding back from your tax advantaged investments. Maybe consider 50%, 75%, or even 100%. That's what I'm considering right now. I suppose a lot of it might depend on how much you already have accumulated in your tax advantaged accounts. Maybe use the FIREcalc to see how long your current retirement savings with growth will last you after age 60, and also how long it will last you if you only contributed xx dollars/year from now on instead of the max.

If you contribute less to your tax advantaged accounts, then you'll miss out on some tax savings now. Ouch. But if you don't contribute to taxable accounts, you'll miss out on early retirement. Bigger ouch. It's one of those have your cake and eat it too situations. You can't have both (unless you have the income to do both).

You may find this article interesting.
http://www.dividendmantra.com/2013/08/why-i-hold-100-of-my-equity-investments/

Feel free to let me know if you think I'm completely crazy. I can take it. :)

TaronM

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #15 on: October 11, 2016, 05:19:43 PM »
optimal efficiency would be to take as many tax breaks now as you can then fund some taxable prior to retirement b/c who knows what taxes will do.

Sure for the typical situation, but with variable income from SE I'm going to need taxable long before full-on retirement.  I'm coming to accept that "optimal efficiency" is just not in the cards for my semi-retired variable-income self-employed plan.  Then again, I wasn't really optimizing for wealth, but more for happiness, so part of my goals were to make my plan as stress-free as possible to implement (hence making a spreadsheet to remind me what to do once I've got it all figured out so I don't have to remember every little trick for the rest of my life).

Feel free to let me know if you think I'm completely crazy. I can take it. :)

Well, *I* don't think you are crazy, sounds like we have similar concerns, and I have also thought about possibly forgoing pre-tax retirement accounts entirely (probably would still do HSA and Roth IRA though since they are far easier to get money back out of).  I mean, yes, taxes do add up, and the savings over time can be pretty large, but I don't think in the long run the impact of them is as significant as some people make it out to be.  After all, you do still have to pay income tax later on anyway, and RMD's sound like a pain, especially if, as you said, the law changes and Roth conversions are no longer a valid workaround (some lawmaker brings it up at least once a year).  There's also already some great tax-saving tricks you can only get outside of retirement accounts like Tax Gain Harvesting, Tax Loss Harvesting, and the (current) 0% LTCG tax rate.

Also, on a note completely unrelated to being FI, I think paying taxes is important and always feel a little guilty when doing things to avoid them - that's why I don't ever bother trying to itemize deductions even though I probably could get something out of it since I work out of my home and all that.  After all, my wife is a public school teacher, so in essence a lot of my income comes from taxes, seems only fair to give some of it back right?

One idea I've been seriously considering that leans in the direction you are talking about is to ONLY use pre-tax accounts to lower tax bracket when I have a high-income year (release a new product) and would otherwise be higher than the 15% tax bracket.  I feel morally justified in doing this partially because variable income like mine isn't handled all that fairly by the current tax system (if it were based on, say, an average income over the last X years, that would be better, but instead I get shafted by paying a huge amount of tax when I release a new product, even though I then have to make those funds last for several years with minimal income while working on the next release, whereas if I received the same amount of money spread evenly over 3-5 years I would pay less overall in taxes due to the way tax brackets work).

Since I'll likely always be somewhere in the 15% bracket (or whatever its equivalent is in the future) in terms of how much income I actually need for expenses, putting money in to save 15% and then pulling it back out in retirement and paying the 15% at that point makes me question how worth it it really is compared to having the flexibility of a taxable account in the interim.

Even if I went for that idea though, of course if any job I or the wife gets that has 401k matching, would take advantage of that regardless, and HSA seems like a no-brainer.  Roth IRA contributions probably aren't a terrible idea either since can always get the basis back out anyway.
« Last Edit: October 11, 2016, 06:24:46 PM by TaronM »

incognito

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #16 on: October 11, 2016, 08:23:16 PM »

Well, *I* don't think you are crazy, sounds like we have similar concerns, and I have also thought about possibly forgoing pre-tax retirement accounts entirely (probably would still do HSA and Roth IRA though since they are far easier to get money back out of).  I mean, yes, taxes do add up, and the savings over time can be pretty large, but I don't think in the long run the impact of them is as significant as some people make it out to be.  After all, you do still have to pay income tax later on anyway, and RMD's sound like a pain, especially if, as you said, the law changes and Roth conversions are no longer a valid workaround (some lawmaker brings it up at least once a year).  There's also already some great tax-saving tricks you can only get outside of retirement accounts like Tax Gain Harvesting, Tax Loss Harvesting, and the (current) 0% LTCG tax rate.

Yeah, for sure. I've read good things about Betterment's automatic tax loss harvesting, and I plan on checking that out soon.


Quote
Also, on a note completely unrelated to being FI, I think paying taxes is important and always feel a little guilty when doing things to avoid them - that's why I don't ever bother trying to itemize deductions even though I probably could get something out of it since I work out of my home and all that.  After all, my wife is a public school teacher, so in essence a lot of my income comes from taxes, seems only fair to give some of it back right?

Trying to skip out on taxes completely is one thing, but there's nothing morally wrong with minimizing your taxes. That's what the tax code is there for, it's a guidebook that tells you what economic activities the government wants you to do (tax breaks), and what economic activities they don't want you to do (heavy taxes).

Quote
One idea I've been seriously considering that leans in the direction you are talking about is to ONLY use pre-tax accounts to lower tax bracket when I have a high-income year (release a new product) and would otherwise be higher than the 15% tax bracket.  I feel morally justified in doing this partially because variable income like mine isn't handled all that fairly by the current tax system (if it were based on, say, an average income over the last X years, that would be better, but instead I get shafted by paying a huge amount of tax when I release a new product, even though I then have to make those funds last for several years with minimal income while working on the next release, whereas if I received the same amount of money spread evenly over 3-5 years I would pay less overall in taxes due to the way tax brackets work).

Makes sense.

Quote
Since I'll likely always be somewhere in the 15% bracket (or whatever its equivalent is in the future) in terms of how much income I actually need for expenses, putting money in to save 15% and then pulling it back out in retirement and paying the 15% at that point makes me question how worth it it really is compared to having the flexibility of a taxable account in the interim.

Yeah, so it's basically a wash if your tax rate in retirement will likely be the same tax rate as now. Kind of defeats the purpose.

Quote
Even if I went for that idea though, of course if any job I or the wife gets that has 401k matching, would take advantage of that regardless, and HSA seems like a no-brainer.  Roth IRA contributions probably aren't a terrible idea either since can always get the basis back out anyway.

Yeah, the Roth is still good since you can access those contributions any time without penalty, and a 401K match is free money.

One other thing I REALLY like about having funds in a taxable account is that you can pull some out whenever you want to if you find a good business opportunity, or find a really great income producing piece of real estate. If I'm averaging 7% on my index funds, but I see a business opportunity where I can get a 25% ROI, I could actually access my money to make it happen. Can't do that if all my money is held in tax advantaged accounts.






Dexterous

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #17 on: October 13, 2016, 04:22:22 AM »
We max 2x Traditional 401k accounts (mine is technically the TSP), 2x Roth IRAs, and then use a taxable account.  We could invest in 2x Traditional IRAs to lower our taxes more, but will likely need access to Roth contributions during the first 5 years of retirement.  I also fear that tax laws may change regarding "Traditional IRA to Roth IRA transfers being considered contributions after 5 years".  For those reasons, we choose to pay more in taxes now in order to ensure access to extra money during the first few years of retirement.
« Last Edit: October 13, 2016, 04:24:08 AM by Dexterous »

incognito

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #18 on: October 13, 2016, 10:42:48 AM »
Great post. I've been pondering the same thing lately only I have a military pension coming upon retiring at 44/45 so I have the "Gap" between retirement and 59 1/2 covered (low expense rate covered by pension plus the wife works and she likes her job, I'm gonna do odd jobs, part time jobs, work I want to do....).

Quote
I'm playing with calculators to see if I've got more than enough in the retirement accounts, it's not a common problem to be solved, I'm not finding a lot of resources on the subject either.

The best calculator I've found to analyze that issue is this
http://firecalc.com/

Quote
Finished a book on the great depression, the author mentioned time and time again how someone with some free capital could really take advantage of the opportunities presented, something I plan to do in the "bound to happen in the future" recession...

Cool, what was the book?


incognito

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #19 on: October 13, 2016, 10:57:44 AM »
incognito, this is the book:

https://www.amazon.com/Great-Depression-Diary-Benjamin-Roth/dp/1586489011

Figured I'd link to it to save time. I got it from the local library....

Awesome, my library has it! Thanks!
« Last Edit: October 13, 2016, 10:59:23 AM by incognito »

TaronM

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #20 on: October 13, 2016, 04:37:11 PM »
All right, after a lot of thought, running test scenarios, and crunching numbers, I have a tentative plan in regard to tax optimization with my situation (self-employed, highly variable income, focused on being perpetually semi-retired rather than necessarily early retirement).

-----

The Plan:

1) Fully fund HSA every year, if eligible

2) Always contribute up to employer match for 401k, if available, but no more than that (unless know for sure that income from that job is going to consistently put me in the 25% tax bracket or higher - see #3)

3) Other than above, contribute to pre-tax accounts (tIRAs & Solo 401k) and/or purposefully realize capital losses ONLY IF income for the year would put me in the 25% tax bracket or higher, and even then, only enough to lower reported income to the top of the 15% tax bracket

4) Contribute full allowed amounts to Roth IRA's (allowed amount reduced by tIRA contributions if #3 applied, of course)

5) IF the year's income was low enough that did not need to use #3 above, use Tax Gain Harvesting for as many gains as can claim at the 0% LTCG tax rate

6) IF the year's income was low enough that did not need to use #3 above, and still below the top of the 15% bracket after #5 above, convert some Traditional IRA funds (which should also contain funds from 401k's from previous jobs) over to Roth IRA to bring reported income up to the top of the 15% bracket.

Anything left over after expenses and all of the above will go into my taxable brokerage account (well besides keeping about ~$10k in checking to prevent overdrafts) and/or paying off the HELOC if I had to use it as an emergency fund.

-----

Reasoning:

1) HSA's are one of the best deals the government is giving right now, its both pre-tax and post-tax benefits, you are statistically likely to be better off financially with one of the HDHPs that are required to get an HSA anyway, and if there's anything that's going to be an unexpected expense where you suddenly need to dip into savings, its likely to be a medical expense, so there's a high probability of having access to the funds if needed (especially since you can just hold on to your receipts for years and redeem them only when you really need the funds - I've been tracking them on a spreadsheet and storing digital copies of the receipts on Google Drive).  The only problem I've had with an HSA so far is that when self-employed its very difficult to find a good custodian - most have high fees, poor fund choices, and require you to keep some portion of it in cash.  I plan to convert mine to Saturna soon, which means only paying $14.95 once a year to dump my entire contribution into FSTVX (it costs $10 extra to dump it into VTSAX for some reason and FSTVX actually currently has an even lower expense ratio).

2) Employer match is free money, hard to justify passing this up

3) This is the controversial one that lead to me making this topic in the first place, because initially I felt like I should always max out tIRA and my Solo 401k, even if it meant pulling money out of my Brokerage to afford it.  I realized though that if my goal is to always be in the 15% tax bracket for my reported normal income, yet I have a variable income from self-employment and thus need to have liquid assets available, there's no benefit to pre-tax retirement accounts once I'm already within that 15% bracket.  That's because the pre-tax accounts are taxed as normal income on the gains, whereas taxable accounts are (currently, and if invested properly) not taxed on gains within this bracket.  I used a compound interest calculator and found I'd end up the same either way, and sometimes even in favor of the taxable account (e.g. $10k for 25 years @ 7% returns but then taxed 15% on the whole amount ends up at $46,122.18, but $8.5k [$10k after initial 15% tax] for 25 years @ 7% returns and no tax on the gains ends up at $46,133.18).  Not to mention that RMD's can make it hard to keep tax bracket low later on!  That's why I decided it only made sense to use these accounts to get reported income per year down to the top of the 15% bracket and no lower.

4) Might as well get guaranteed tax-free gains even if the LTCG tax rate goes up later, as well as being a good place to put any Bonds or other investments where can't benefit from the 0% LTCG rate.  There's a loss of versatility here compared to a taxable account but its much more liquid than pre-tax accounts since I can take the contributions back out at any time.  I am only restricted from accessing the gains without penalty, and this restriction seems worth the above benefits.

5) I don't know how long that 0% LTCG tax rate is going to be around, so might as well take advantage of completely tax-free capital gains from any wiggle room I have in a low-income year.  If nothing else, using Tax Gain Harvesting makes Tax Loss Harvesting later on (in a high-income year) more effective.  This option is one of the strengths of a taxable account that is not available in IRAs and 401k's, ESPECIALLY for a variable-income situation like mine where harvesting lots of gains in a low-income year then harvesting losses in a high-income year can be significant.

6) This of course is the Roth Laddering technique to move money out of those pre-tax accounts.  Since the funds in here should only be funds that would normally have been taxed at 25% (from #3), I'm saving 10% in tax from using the tIRA/401k in the first place (or more, if my bracket drops to the 10% or 0% [from standard deduction + exemptions] range) and after the conversion can now save tax on the gains as well, and of course reduce RMD's in late retirement and have access to more funds without early withdrawal tax before then.

-----

Conclusion:

With this setup, I should always have a decent chunk of my excess income going into fairly liquid accounts like taxable brokerage, Roth, and HSA.  My expenses are in the low-end of the 15% bracket, so any income between there and the top of the 15% bracket would go to these accessible locations.  Only income above that point, the 25% bracket or higher, would become tied up in pre-tax retirement accounts, and then only until I can convert it to my standard 15%-tax-rate funds via Roth Conversion.  This should hopefully give me plenty of funds (assuming my income averages out to being a fair amount above expenses) for both before and after retirement age without depending on SEPP or having my plan be completely derailed by Roth conversions being outlawed, yet still save me taxes from keeping myself outside of the 25% income bracket  (as much as I can get away with) and within the 0% LTCG bracket, as well as the tax benefits gained from Roth, HSA, and Tax Gain/Loss Harvesting.  Of course, all this is assuming tax brackets and laws stay the same as they are now, which is unlikely, but I don't think this plan is too overly-dependent on tax laws staying static.

Does this sound crazy?  Did I miss something critical?
« Last Edit: October 13, 2016, 07:24:45 PM by TaronM »

incognito

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Re: How much to hold back from tax-advantaged retirement accounts?
« Reply #21 on: October 15, 2016, 07:20:24 AM »
All right, after a lot of thought, running test scenarios, and crunching numbers, I have a tentative plan in regard to tax optimization with my situation (self-employed, highly variable income, focused on being perpetually semi-retired rather than necessarily early retirement).

-----

The Plan:

1) Fully fund HSA every year, if eligible

2) Always contribute up to employer match for 401k, if available, but no more than that (unless know for sure that income from that job is going to consistently put me in the 25% tax bracket or higher - see #3)

3) Other than above, contribute to pre-tax accounts (tIRAs & Solo 401k) and/or purposefully realize capital losses ONLY IF income for the year would put me in the 25% tax bracket or higher, and even then, only enough to lower reported income to the top of the 15% tax bracket

4) Contribute full allowed amounts to Roth IRA's (allowed amount reduced by tIRA contributions if #3 applied, of course)

5) IF the year's income was low enough that did not need to use #3 above, use Tax Gain Harvesting for as many gains as can claim at the 0% LTCG tax rate

6) IF the year's income was low enough that did not need to use #3 above, and still below the top of the 15% bracket after #5 above, convert some Traditional IRA funds (which should also contain funds from 401k's from previous jobs) over to Roth IRA to bring reported income up to the top of the 15% bracket.

Anything left over after expenses and all of the above will go into my taxable brokerage account (well besides keeping about ~$10k in checking to prevent overdrafts) and/or paying off the HELOC if I had to use it as an emergency fund.

-----

Reasoning:

1) HSA's are one of the best deals the government is giving right now, its both pre-tax and post-tax benefits, you are statistically likely to be better off financially with one of the HDHPs that are required to get an HSA anyway, and if there's anything that's going to be an unexpected expense where you suddenly need to dip into savings, its likely to be a medical expense, so there's a high probability of having access to the funds if needed (especially since you can just hold on to your receipts for years and redeem them only when you really need the funds - I've been tracking them on a spreadsheet and storing digital copies of the receipts on Google Drive).  The only problem I've had with an HSA so far is that when self-employed its very difficult to find a good custodian - most have high fees, poor fund choices, and require you to keep some portion of it in cash.  I plan to convert mine to Saturna soon, which means only paying $14.95 once a year to dump my entire contribution into FSTVX (it costs $10 extra to dump it into VTSAX for some reason and FSTVX actually currently has an even lower expense ratio).

2) Employer match is free money, hard to justify passing this up

3) This is the controversial one that lead to me making this topic in the first place, because initially I felt like I should always max out tIRA and my Solo 401k, even if it meant pulling money out of my Brokerage to afford it.  I realized though that if my goal is to always be in the 15% tax bracket for my reported normal income, yet I have a variable income from self-employment and thus need to have liquid assets available, there's no benefit to pre-tax retirement accounts once I'm already within that 15% bracket.  That's because the pre-tax accounts are taxed as normal income on the gains, whereas taxable accounts are (currently, and if invested properly) not taxed on gains within this bracket.  I used a compound interest calculator and found I'd end up the same either way, and sometimes even in favor of the taxable account (e.g. $10k for 25 years @ 7% returns but then taxed 15% on the whole amount ends up at $46,122.18, but $8.5k [$10k after initial 15% tax] for 25 years @ 7% returns and no tax on the gains ends up at $46,133.18).  Not to mention that RMD's can make it hard to keep tax bracket low later on!  That's why I decided it only made sense to use these accounts to get reported income per year down to the top of the 15% bracket and no lower.

4) Might as well get guaranteed tax-free gains even if the LTCG tax rate goes up later, as well as being a good place to put any Bonds or other investments where can't benefit from the 0% LTCG rate.  There's a loss of versatility here compared to a taxable account but its much more liquid than pre-tax accounts since I can take the contributions back out at any time.  I am only restricted from accessing the gains without penalty, and this restriction seems worth the above benefits.

5) I don't know how long that 0% LTCG tax rate is going to be around, so might as well take advantage of completely tax-free capital gains from any wiggle room I have in a low-income year.  If nothing else, using Tax Gain Harvesting makes Tax Loss Harvesting later on (in a high-income year) more effective.  This option is one of the strengths of a taxable account that is not available in IRAs and 401k's, ESPECIALLY for a variable-income situation like mine where harvesting lots of gains in a low-income year then harvesting losses in a high-income year can be significant.

6) This of course is the Roth Laddering technique to move money out of those pre-tax accounts.  Since the funds in here should only be funds that would normally have been taxed at 25% (from #3), I'm saving 10% in tax from using the tIRA/401k in the first place (or more, if my bracket drops to the 10% or 0% [from standard deduction + exemptions] range) and after the conversion can now save tax on the gains as well, and of course reduce RMD's in late retirement and have access to more funds without early withdrawal tax before then.

-----

Conclusion:

With this setup, I should always have a decent chunk of my excess income going into fairly liquid accounts like taxable brokerage, Roth, and HSA.  My expenses are in the low-end of the 15% bracket, so any income between there and the top of the 15% bracket would go to these accessible locations.  Only income above that point, the 25% bracket or higher, would become tied up in pre-tax retirement accounts, and then only until I can convert it to my standard 15%-tax-rate funds via Roth Conversion.  This should hopefully give me plenty of funds (assuming my income averages out to being a fair amount above expenses) for both before and after retirement age without depending on SEPP or having my plan be completely derailed by Roth conversions being outlawed, yet still save me taxes from keeping myself outside of the 25% income bracket  (as much as I can get away with) and within the 0% LTCG bracket, as well as the tax benefits gained from Roth, HSA, and Tax Gain/Loss Harvesting.  Of course, all this is assuming tax brackets and laws stay the same as they are now, which is unlikely, but I don't think this plan is too overly-dependent on tax laws staying static.

Does this sound crazy?  Did I miss something critical?

It's a solid plan, with sound reasoning.

On thing to consider. I see a lot of people in the FI information space tend to be laser focused on minimizing taxes and expenses, which is good, but many people seem to neglect the goal of increasing income. To me, reaching FI needs to be a two pronged plan with significant efforts being put into BOTH decreasing taxes and expenses, AND increasing income.

The tax avoidance attitude is so strong in this space, it seems like some people are hesitant to earn more money because then they would have to pay taxes on it!

So, now you've got your detailed tax efficiency plan. Next thing I would do is come up with an equally detailed plan on how you're going to increase your income and get you to your goal even faster. Good luck!