Author Topic: I'm not convinced on 401k for early retiree  (Read 15076 times)

genesismachine

  • Stubble
  • **
  • Posts: 100
I'm not convinced on 401k for early retiree
« on: February 15, 2014, 05:29:57 PM »
My nominal tax rate is 39% now. Later, in retirement, that means my tax rate would have to be at least 29% to overcome the 10% penalty.

I have a rental house which will provide my 'base' income (~20k). Anything above that is hit with at least a 25% tax.

For the high fees and limited investment options, I'm thinking that closes any kind of tax benefit gap.

So why should I max out my 401k?

There must be something I'm not seeing here... Since everyone seems to be on this train... Please school me :)

AlexK

  • Bristles
  • ***
  • Posts: 327
  • Age: 45
  • Location: Sparks, NV
Re: I'm not convinced on 401k for early retiree
« Reply #1 on: February 15, 2014, 05:36:53 PM »
It is for spending after age 59.5 or if you need it sooner you can do Roth conversion ladder and pay no penalty.

shuffler

  • Bristles
  • ***
  • Posts: 316
Re: I'm not convinced on 401k for early retiree
« Reply #2 on: February 15, 2014, 06:05:29 PM »
I have a rental house which will provide my 'base' income (~20k). Anything above that is hit with at least a 25% tax.
Sorry, I don't follow you.  Why 25% tax?
Tax tables show $20k => $2,558 in tax (for filing single).  That's < 13%, and doesn't take into account any deductions, which would significantly reduce the bill.
(Pardon me if you're not in the USA ...)

For the high fees and limited investment options, I'm thinking that closes any kind of tax benefit gap.
Not everyone's plans have high fees and limited options.  Depends on your employer.

iamlindoro

  • Handlebar Stache
  • *****
  • Posts: 1520
    • The Earth Awaits
Re: I'm not convinced on 401k for early retiree
« Reply #3 on: February 15, 2014, 06:33:40 PM »
My nominal tax rate is 39% now. Later, in retirement, that means my tax rate would have to be at least 29% to overcome the 10% penalty.

I have a rental house which will provide my 'base' income (~20k). Anything above that is hit with at least a 25% tax.

Hennnnnghhhhh?

Single Filing Status

[Tax Rate Schedule X, Internal Revenue Code section 1(c)]
10% on taxable income from $0 to $8,925, plus
15% on taxable income over $8,925 to $36,250, plus
25% on taxable income over $36,250 to $87,850, plus
28% on taxable income over $87,850 to $183,250, plus
33% on taxable income over $183,250 to $398,350, plus
35% on taxable income over $398,350 to $400,000, plus
39.6% on taxable income over $400,000.

Married Filing Jointly or Qualifying Widow(er) Filing Status

[Tax Rate Schedule Y-1, Internal Revenue Code section 1(a)]
10% on taxable income from $0 to $17,850, plus
15% on taxable income over $17,850 to $72,500, plus
25% on taxable income over $72,500 to $146,400, plus
28% on taxable income over $146,400 to $223,050, plus
33% on taxable income over $223,050 to $398,350, plus
35% on taxable income over $398,350 to $450,000, plus
39.6% on taxable income over $450,000.

Married Filing Separately Filing Status

[Tax Rate Schedule Y-2, Internal Revenue Code section 1(d)]
10% on taxable income from $0 to $8,925, plus
15% on taxable income over $8,925 to $36,250, plus
25% on taxable income over $36,250 to $73,200, plus
28% on taxable income over $73,200 to $111,525, plus
33% on taxable income over $111,525 to $199,175, plus
35% on taxable income over $199,175 to $225,000, plus
39.6% on taxable income over $225,000.

Head of Household Filing Status

[Tax Rate Schedule Z, Internal Revenue Code section 1(b)]
10% on taxable income from $0 to $12,750, plus
15% on taxable income over $12,750 to $48,600, plus
25% on taxable income over $48,600 to $125,450, plus
28% on taxable income over $125,450 to $203,150, plus
33% on taxable income over $203,150 to $398,350, plus
35% on taxable income over $398,350 to $425,000, plus
39.6% on taxable income over $425,000.

There isn't any conceivable filing status that taxes 20k of income at 25%.  Moreover, our system of taxation is progressive-- only the amount within the range is taxed at that rate, not the whole of your earnings.  *Absolute* worst case scenario (Single filing status) you have to hit almost double that income ($36,250) before you get to the 25% bracket.

BTW, you say your tax rate is 39%... so your income is > 400K a year (in which case only the income over 400K is taxed at 39.6%)?  If you want your maximum rate of taxation to be under 29%, then all you need to do is get your annual expenses under $73K in the worst case scenario.

Finally, You needn't pay any penalty on 401k income in early retirement.  Various strategies outlined here (the most usable of which is the Roth IRA pipeline):

http://www.mrmoneymustache.com/2011/11/11/how-much-is-too-much-in-your-401k/
« Last Edit: February 15, 2014, 06:40:49 PM by iamlindoro »

beltim

  • Magnum Stache
  • ******
  • Posts: 2825
Re: I'm not convinced on 401k for early retiree
« Reply #4 on: February 15, 2014, 06:42:32 PM »
My nominal tax rate is 39% now. Later, in retirement, that means my tax rate would have to be at least 29% to overcome the 10% penalty.

I have a rental house which will provide my 'base' income (~20k). Anything above that is hit with at least a 25% tax.

Hennnnnghhhhh?

Single Filing Status

[Tax Rate Schedule X, Internal Revenue Code section 1(c)]
10% on taxable income from $0 to $8,925, plus
15% on taxable income over $8,925 to $36,250, plus
25% on taxable income over $36,250 to $87,850, plus
28% on taxable income over $87,850 to $183,250, plus
33% on taxable income over $183,250 to $398,350, plus
35% on taxable income over $398,350 to $400,000, plus
39.6% on taxable income over $400,000.

Married Filing Jointly or Qualifying Widow(er) Filing Status

[Tax Rate Schedule Y-1, Internal Revenue Code section 1(a)]
10% on taxable income from $0 to $17,850, plus
15% on taxable income over $17,850 to $72,500, plus
25% on taxable income over $72,500 to $146,400, plus
28% on taxable income over $146,400 to $223,050, plus
33% on taxable income over $223,050 to $398,350, plus
35% on taxable income over $398,350 to $450,000, plus
39.6% on taxable income over $450,000.

Married Filing Separately Filing Status

[Tax Rate Schedule Y-2, Internal Revenue Code section 1(d)]
10% on taxable income from $0 to $8,925, plus
15% on taxable income over $8,925 to $36,250, plus
25% on taxable income over $36,250 to $73,200, plus
28% on taxable income over $73,200 to $111,525, plus
33% on taxable income over $111,525 to $199,175, plus
35% on taxable income over $199,175 to $225,000, plus
39.6% on taxable income over $225,000.

Head of Household Filing Status

[Tax Rate Schedule Z, Internal Revenue Code section 1(b)]
10% on taxable income from $0 to $12,750, plus
15% on taxable income over $12,750 to $48,600, plus
25% on taxable income over $48,600 to $125,450, plus
28% on taxable income over $125,450 to $203,150, plus
33% on taxable income over $203,150 to $398,350, plus
35% on taxable income over $398,350 to $425,000, plus
39.6% on taxable income over $425,000.

There isn't any conceivable filing status that taxes 20k of income at 25%.  Moreover, our system of taxation is progressive-- only the amount within the range is taxed at that rate, not the whole of your earnings.  *Absolute* worst case scenario (Single filing status) you have to hit almost double that income ($36,250) before you get to the 25% bracket.

BTW, you say your tax rate is 39%... so your income is > 400K a year (in which case only the income over 400K is taxed at 39.6%)?  If you want your maximum rate of taxation to be under 29%, then all you need to do is get your annual expenses under $72K in the worst case scenario.

I don't know why you're lecturing about progressive taxes - the OP used language consistent with understanding progressive taxes.

As for the particular rate, maybe the OP is including state taxes?  And as for actually answering his question, AlexK faves two of the three options:
1) use aftter age59.5
2) do a Roth conversion ladder (which, if your tax numbers are accurate, may not help you)
3) substantially equal periodic payments (SEPP or 72t payments) can be used to access your accounts before 59.5 as long as you continue equal withdrawals for the longer of 5 years or until age 59.5

iamlindoro

  • Handlebar Stache
  • *****
  • Posts: 1520
    • The Earth Awaits
Re: I'm not convinced on 401k for early retiree
« Reply #5 on: February 15, 2014, 06:53:29 PM »
I don't know why you're lecturing about progressive taxes - the OP used language consistent with understanding progressive taxes.

To be clear, I mentioned the progressive rates of taxation as an aside and "just in case," the primary issue was what I perceive to be hand-wavey (wrong) math regarding income over $20K being taxed at a minimum of 25%.

By all means, set me straight-- In what US state would $20K of income lead to a nominal 25% tax rate?

Edit:  I'll make it even easier.  Pick any state you like, and take a base income of $35K.  Show your work.
« Last Edit: February 15, 2014, 06:55:20 PM by iamlindoro »

beltim

  • Magnum Stache
  • ******
  • Posts: 2825
Re: I'm not convinced on 401k for early retiree
« Reply #6 on: February 15, 2014, 07:09:47 PM »
I don't know why you're lecturing about progressive taxes - the OP used language consistent with understanding progressive taxes.

To be clear, I mentioned the progressive rates of taxation as an aside and "just in case," the primary issue was what I perceive to be hand-wavey (wrong) math regarding income over $20K being taxed at a minimum of 25%.

By all means, set me straight-- In what US state would $20K of income lead to a nominal 25% tax rate?

Edit:  I'll make it even easier.  Pick any state you like, and take a base income of $35K.  Show your work.

The OP may very we'll be wrong on his marginal tax rate. But I think he understands marginal tax rates.  And, to answer your question (that's not important to my point), if you're single at 30k, your marginal federal tax rate is 15%. If you're in New York City, your state marginal tax rate is 6.45%. And your New York City tax marginal tax rate is 3.591%.  So there you go - at 30k (less than the 35 you asked about), your marginal tax rate is just over 25%.

Another possibility: the OP may be mistakenly including FICA taxes in his retirement planning.

Tax rate sources:
http://www.tax.ny.gov/pdf/current_forms/it/it201i_tax_rate_schedule.pdf
http://www.tax.ny.gov/pdf/current_forms/it/nyc_tax_rate_schedule.pdf

Cheddar Stacker

  • Magnum Stache
  • ******
  • Posts: 3714
  • Age: 41
  • Location: USA
Re: I'm not convinced on 401k for early retiree
« Reply #7 on: February 15, 2014, 07:44:08 PM »
My nominal tax rate is 39% now. Later, in retirement, that means my tax rate would have to be at least 29% to overcome the 10% penalty.

Federal only? Fed, state, city, and FICA?

If it's federal only, you literally can't get any higher and tax rates are higher now than they've been for 15 years. You are the perfect candidate for deferring as much taxable income as possible. Your rate can't go up.

As for the penalties, they are very easily avoidable, just read around the forum a bit and see Beltim's 3 suggestions below.

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 27774
  • Age: -999
  • Location: Traveling the World
Re: I'm not convinced on 401k for early retiree
« Reply #8 on: February 15, 2014, 07:58:05 PM »
You aren't convinced on a 401k for an early retiree?

Okay.

Read this post.

It will convince you.

http://www.madfientist.com/retire-even-earlier/
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

Cheddar Stacker

  • Magnum Stache
  • ******
  • Posts: 3714
  • Age: 41
  • Location: USA
Re: I'm not convinced on 401k for early retiree
« Reply #9 on: February 15, 2014, 08:24:39 PM »
Arebelspy I almost posted that link, but it would've been at least the 15th time I've done so on this forum.

If that doesn't convince OP, nothing will.

foobar

  • Pencil Stache
  • ****
  • Posts: 731
Re: I'm not convinced on 401k for early retiree
« Reply #10 on: February 15, 2014, 08:48:31 PM »
At 30k I think your in the 3.534 bracket so your just under but I am not an expert in NYC tax law and the deductions you get:). I just want to know who is the genius who has the rates varying from 2.907 to 3.876. 5 brackets for 1%. That seems a bit excessive to me:)

I figure the OP is a troll. Heck the ability to convert the 401(k) to a ROTH ira along is worth the price of admission even if you end up paying taxes at the same rate. Then throw in a lot of people are going to be able to put money in at 25% and take it out at 0-10% (when you have  a 20-30 year time frame you can really spread out your distributions), it is a no brainer. Now if I was living in Florida and planning on moving to CA, the math might be more interesting. 


The OP may very we'll be wrong on his marginal tax rate. But I think he understands marginal tax rates.  And, to answer your question (that's not important to my point), if you're single at 30k, your marginal federal tax rate is 15%. If you're in New York City, your state marginal tax rate is 6.45%. And your New York City tax marginal tax rate is 3.591%.  So there you go - at 30k (less than the 35 you asked about), your marginal tax rate is just over 25%.

Another possibility: the OP may be mistakenly including FICA taxes in his retirement planning.

Tax rate sources:
http://www.tax.ny.gov/pdf/current_forms/it/it201i_tax_rate_schedule.pdf
http://www.tax.ny.gov/pdf/current_forms/it/nyc_tax_rate_schedule.pdf

beltim

  • Magnum Stache
  • ******
  • Posts: 2825
Re: I'm not convinced on 401k for early retiree
« Reply #11 on: February 15, 2014, 09:18:18 PM »
At 30k I think your in the 3.534 bracket so your just under but I am not an expert in NYC tax law and the deductions you get:). I just want to know who is the genius who has the rates varying from 2.907 to 3.876. 5 brackets for 1%. That seems a bit excessive to me:)

I figure the OP is a troll. Heck the ability to convert the 401(k) to a ROTH ira along is worth the price of admission even if you end up paying taxes at the same rate. Then throw in a lot of people are going to be able to put money in at 25% and take it out at 0-10% (when you have  a 20-30 year time frame you can really spread out your distributions), it is a no brainer. Now if I was living in Florida and planning on moving to CA, the math might be more interesting. 


The OP may very we'll be wrong on his marginal tax rate. But I think he understands marginal tax rates.  And, to answer your question (that's not important to my point), if you're single at 30k, your marginal federal tax rate is 15%. If you're in New York City, your state marginal tax rate is 6.45%. And your New York City tax marginal tax rate is 3.591%.  So there you go - at 30k (less than the 35 you asked about), your marginal tax rate is just over 25%.

Another possibility: the OP may be mistakenly including FICA taxes in his retirement planning.

Tax rate sources:
http://www.tax.ny.gov/pdf/current_forms/it/it201i_tax_rate_schedule.pdf
http://www.tax.ny.gov/pdf/current_forms/it/nyc_tax_rate_schedule.pdf

Given the number of mistakes made by very intelligent people, I'm quite reluctant to label anyone a troll.  And in cases where there aren't mistakes, there's usually very different starting assumptions.  For example, arebelspy and cheddar stacker posted a link to a madfientist article on why a 401k is great for early retirement.  And it is - if you're starting from the same assumptions. But there are two key assumptions in that article that may not apply to the OP:
1) there is a 401k match
2) you will be in a lower tax bracket when you retire
For the average poster on its board, those are good assumptions. But many people do not receive a 401k match which accounts for I think a third of the benefits, according to the madfientist article).  And if you do not plan to retire to mustachian levels of spending, you may not be able to convert a traditional IRA to a Roth at an advantageous tax rate.  In a particular set of circumstances, the madfientist advice is inapplicable.


EscapeVelocity2020

  • Handlebar Stache
  • *****
  • Posts: 2179
  • Age: 45
  • Location: Houston
    • EscapeVelocity2020
Re: I'm not convinced on 401k for early retiree
« Reply #12 on: February 15, 2014, 09:35:39 PM »
I second this.  I am struggling to find a way to apply 72t or Roth Conversion, since these are so limited (10k income/yr at best).  I think that there is a subset of Mustachian ER which assumes you will have a substantial portion of your ER covered by royalty (or blog) income, landlording, or a side hustle.  401k max-out can be an easy mistake for a high earner - you lower your currently high taxes, then get hit with higher than you should have taxes in retirement.  I don't want people to have to play tax games, but I can start to see how it happens.

Nords

  • Magnum Stache
  • ******
  • Posts: 3181
  • Age: 58
  • Location: Oahu
    • Military Retirement & Financial Independence blog
Re: I'm not convinced on 401k for early retiree
« Reply #13 on: February 15, 2014, 09:38:25 PM »
For the high fees and limited investment options, I'm thinking that closes any kind of tax benefit gap.
So why should I max out my 401k?
I'm not going to jump into the tax mosh pit, but I'll point out that conventional wisdom for crappy 401(k)s is to max out the match and then use an IRA for the rest of your tax-deferred investing.  The benefit of the match will overcome most of the high fees and limited options, although the high fees & limited options may adversely impact any long-term tax-deferral benefit.

If you don't get a 401(k) match then yeah, you might be better off in low-cost taxable accounts.

iamlindoro

  • Handlebar Stache
  • *****
  • Posts: 1520
    • The Earth Awaits
Re: I'm not convinced on 401k for early retiree
« Reply #14 on: February 15, 2014, 09:40:15 PM »
I second this.  I am struggling to find a way to apply 72t or Roth Conversion, since these are so limited (10k income/yr at best).

Why would a Roth conversion have a limit of $10K/year?  You can roll as much each year in as you are willing to pay the income taxes on.

Cheddar Stacker

  • Magnum Stache
  • ******
  • Posts: 3714
  • Age: 41
  • Location: USA
Re: I'm not convinced on 401k for early retiree
« Reply #15 on: February 15, 2014, 09:44:50 PM »
Beltim,

I initially had the same thought as foobar about the troll thing as it was an anti/prove me wrong attitude and he/she just threw out some random facts that didn't seem to really add up, but you may be correct, OP may just need some insight. If this site has taught me anything, it's to keep an open mind.

I agree the Madfientist/gocurrycracker strategies are not perfect for everyone, but they are worth everyone understanding and considering. At the very least, this info could "school" OP as he/she put it in the question.

Lastly, I find it hard to swallow your second point about the assumptions, that the OP will not be in a lower tax bracket in retirement. At the very least, he/she can't get much worse than his/her current rate, so at worst it seems the strategy would be break even.

Cheddar Stacker

  • Magnum Stache
  • ******
  • Posts: 3714
  • Age: 41
  • Location: USA
Re: I'm not convinced on 401k for early retiree
« Reply #16 on: February 15, 2014, 09:50:41 PM »
I second this.  I am struggling to find a way to apply 72t or Roth Conversion, since these are so limited (10k income/yr at best).

Why would a Roth conversion have a limit of $10K/year?  You can roll as much each year in as you are willing to pay the income taxes on.

There is no annual limit. Convert at least up to $10K/year tax free if you don't have other taxable income. Then another $9K (single) at 10%, then another $27K at 15%. These rates should be crazy low compared to what a typical person pays during their working career.

With a wife and 2 young kids I can convert about $45K/year before I pay any tax once I stop working.

genesismachine

  • Stubble
  • **
  • Posts: 100
Re: I'm not convinced on 401k for early retiree
« Reply #17 on: February 15, 2014, 09:51:49 PM »
Ok, so first off, I'm not a troll, just someone who doesn't understand taxes very much. I'm an engineer, so I'm very good with numbers.

Previously, I've been trying to focus mental energy on learning about other retirement related subjects, and just never gave taxes much thought. That all changed this year. I went from paying ~10% overall to 17%. And next year, we will have ~50% more income, so it is actually going to become my biggest individual expense by far. It's like 3 times more than the next largest expense I have (mortgage+taxes on my rental property)

To summarize, I think my nominal tax rates could be off. I live in Oregon. Here's what I'm envisioning for retirement income:
~$2k/month rental income
~$3k/month other income (probably some form of either IRA/401k withdrawal, and dividends from after tax investments, but that is what this whole thread is about)

In terms of counting on tax laws, I'm much more comfortable shooting straight and counting on a lower tax rate (if that is the case) than I am counting on the Roth conversion thing I read about (maybe I'm wrong, but I think that is the type of thing that could perhaps go away, and that I should therefore not count on).

I posted this right before a family event, so I'm only just starting to read this thread, and there is so much info! Thanks
« Last Edit: February 15, 2014, 09:53:28 PM by genesismachine »

Cheddar Stacker

  • Magnum Stache
  • ******
  • Posts: 3714
  • Age: 41
  • Location: USA
Re: I'm not convinced on 401k for early retiree
« Reply #18 on: February 15, 2014, 10:13:54 PM »
Glad to hear this is a geniune question.

You said "I" most of the time, but then you threw in a "we" when you said 50% more income. So married filing jointly I guess?

Based on the 17% rate you are likely just into the 25% bracket, so maybe $80K taxable right now and you have up to $146K taxable income before you reach the 28% bracket. You said your income might go up 50% so you might reach the 28% bracket this year. I don't know Oregon taxes so you'll have to add that in to your calculations.

The $2K rental income pretty much wipes out the exemptions and standard deduction for 2 people (about $20K). If that's a net taxable $2K/month you will not have any "free" conversions/withdrawals unless you itemize your taxes or have some kids. However, the next 72K or so would be taxed at either 10% or 15% which is lower than your current 25% federal rate.

So, if you can live on maybe $92K during retirement, and you can utilize the Roth conversion ladder or rule 72t, you will likely pay about a 13-14% federal tax rate on the IRA conversion/draw. If this beats the rate you are paying while you work, it makes sense to me to defer as much as possible.

You are correct the Roth conversion thing could go away. If you don't want to count on it you can simply count on slowly taking IRA withdrawals via rule 72t.

EscapeVelocity2020

  • Handlebar Stache
  • *****
  • Posts: 2179
  • Age: 45
  • Location: Houston
    • EscapeVelocity2020
Re: I'm not convinced on 401k for early retiree
« Reply #19 on: February 15, 2014, 11:25:13 PM »
I second this.  I am struggling to find a way to apply 72t or Roth Conversion, since these are so limited (10k income/yr at best).

Why would a Roth conversion have a limit of $10K/year?  You can roll as much each year in as you are willing to pay the income taxes on.

There is no annual limit. Convert at least up to $10K/year tax free if you don't have other taxable income. Then another $9K (single) at 10%, then another $27K at 15%. These rates should be crazy low compared to what a typical person pays during their working career.

With a wife and 2 young kids I can convert about $45K/year before I pay any tax once I stop working.
Sorry, I'll clarify.  I'll have about 40k in passive income when I ER, so I feel limited on how much taxable I should withdraw just to put toward Roth conversion. I thought this was part of the original issue, it is regularly part of the actual problem.

genesismachine

  • Stubble
  • **
  • Posts: 100
Re: I'm not convinced on 401k for early retiree
« Reply #20 on: February 15, 2014, 11:29:59 PM »
I forgot to mention my current income is 80k/year. My wife, who is currently not working, will be starting to work, and her average income will probably be in the ~40k-ish range. Each year, she will be getting a 10k raise until she hits ~70k a year. We have ~14k/year from a rental house as well.

Our current spending is in the ~24k/year range without a mortgage, plus I'd want a $5k/year buffer just in case. I'm shooting for a number somewhere around 700k + paid off house, or some combo of some money and a paid of rental house or something like that.

I think the next question is whether or not buying another rental house to get the tax deductions (depreciation/etc...) is worth it. We're also exploring the idea of buying land and building our own house on it and renting out our current condo.

This is all very new to me, and I'm still learning the ropes. I am surprised that someone managed to figure out the 72t and Roth conversion loopholes though... I'm even more surprised that those loopholes exist. lol. I guess this is what rich people do...

Left

  • Handlebar Stache
  • *****
  • Posts: 1159
Re: I'm not convinced on 401k for early retiree
« Reply #21 on: February 15, 2014, 11:34:46 PM »
While it isn't something I can do right now, but when I get closer to retirement (have enough saved up for it), I'm planning to roll my 401k traditional IRA and from there, roll that into a self-directed 401k and buy a rental house. Then I just let it collect rent as I would but the rental income would be tax free until I take it out. Then I'd just do the roth conversion to get the money out. So if I get $800/month from rentals, but I only need $500/month, I can keep the $300 as tax free.

I'd have to pay a fee for the self-directed ira but I don't think it's more than the tax advantage. I might be wrong though, I haven't looked into it a lot since I'd need to save up enough into an IRA to buy a house outright and well, I don't have that much in an IRA right now.

edit: I don't think the loopholes there by accident.. They are written in by intent for the rich who fund the people writing the laws :S Like how congress can keep pulling a paycheck when they shutdown the rest of government?
« Last Edit: February 15, 2014, 11:38:13 PM by eyem »

beltim

  • Magnum Stache
  • ******
  • Posts: 2825
Re: I'm not convinced on 401k for early retiree
« Reply #22 on: February 15, 2014, 11:46:24 PM »
Beltim,

I initially had the same thought as foobar about the troll thing as it was an anti/prove me wrong attitude and he/she just threw out some random facts that didn't seem to really add up, but you may be correct, OP may just need some insight. If this site has taught me anything, it's to keep an open mind.

I agree the Madfientist/gocurrycracker strategies are not perfect for everyone, but they are worth everyone understanding and considering. At the very least, this info could "school" OP as he/she put it in the question.

Lastly, I find it hard to swallow your second point about the assumptions, that the OP will not be in a lower tax bracket in retirement. At the very least, he/she can't get much worse than his/her current rate, so at worst it seems the strategy would be break even.

My point about the assumption of lower tax rates in retirement was more in relation to the Roth conversion pipeline described in the mad fientist article than it was specifically about the OP.  It's less common for extreme early retirement than for "regular" retirement, but some cases off the top of my head where it can easily happen:
1) start at a low salary, then start to receive a much higher salary a few years after working.  The initial salary can be lower than the retirement expenses, especially if one of the following happen
2) you have dependents during your working years but not in retirement
3) you move from a low income tax to a high income tax state
4) you have high deductions (house?) during your working years
5) when you receive social security or other pension
I think usually you need more than one of these to happen in order to see a higher marginal tax rate in retirement, but it's certainly possible.

chasesfish

  • Magnum Stache
  • ******
  • Posts: 3035
  • Age: 37
  • Location: Texas
    • Years in the making, I created a journal!
Re: I'm not convinced on 401k for early retiree
« Reply #23 on: February 16, 2014, 06:36:06 AM »
"My nominal tax rate is 39% now"

Doesn't that answer your question already.  Unless you plan on making 200k in taxable income after retirement, the 401k is a good way to go.  The tax savings (and growth tax free) offset however bad the crummy fees are.

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 27774
  • Age: -999
  • Location: Traveling the World
Re: I'm not convinced on 401k for early retiree
« Reply #24 on: February 16, 2014, 08:32:25 AM »
I'd have to pay a fee for the self-directed ira but I don't think it's more than the tax advantage. I might be wrong though, I haven't looked into it a lot since I'd need to save up enough into an IRA to buy a house outright and well, I don't have that much in an IRA right now.

They're super cheap.  Few hundred a year, at most. (It obviously varies depending on which company you use. I have a couple I like.)
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

Cheddar Stacker

  • Magnum Stache
  • ******
  • Posts: 3714
  • Age: 41
  • Location: USA
Re: I'm not convinced on 401k for early retiree
« Reply #25 on: February 16, 2014, 09:16:44 AM »
Beltim,

I initially had the same thought as foobar about the troll thing as it was an anti/prove me wrong attitude and he/she just threw out some random facts that didn't seem to really add up, but you may be correct, OP may just need some insight. If this site has taught me anything, it's to keep an open mind.

I agree the Madfientist/gocurrycracker strategies are not perfect for everyone, but they are worth everyone understanding and considering. At the very least, this info could "school" OP as he/she put it in the question.

Lastly, I find it hard to swallow your second point about the assumptions, that the OP will not be in a lower tax bracket in retirement. At the very least, he/she can't get much worse than his/her current rate, so at worst it seems the strategy would be break even.

My point about the assumption of lower tax rates in retirement was more in relation to the Roth conversion pipeline described in the mad fientist article than it was specifically about the OP.  It's less common for extreme early retirement than for "regular" retirement, but some cases off the top of my head where it can easily happen:
1) start at a low salary, then start to receive a much higher salary a few years after working.  The initial salary can be lower than the retirement expenses, especially if one of the following happen
2) you have dependents during your working years but not in retirement
3) you move from a low income tax to a high income tax state
4) you have high deductions (house?) during your working years
5) when you receive social security or other pension
I think usually you need more than one of these to happen in order to see a higher marginal tax rate in retirement, but it's certainly possible.

It's certainly possible and those are all good things to consider. The original facts implied the highest federal rate possible which was why I thought there was no way to have a higher rate in retirement. Facts have changed.

Cheddar Stacker

  • Magnum Stache
  • ******
  • Posts: 3714
  • Age: 41
  • Location: USA
Re: I'm not convinced on 401k for early retiree
« Reply #26 on: February 16, 2014, 09:21:21 AM »
I second this.  I am struggling to find a way to apply 72t or Roth Conversion, since these are so limited (10k income/yr at best).

Why would a Roth conversion have a limit of $10K/year?  You can roll as much each year in as you are willing to pay the income taxes on.

There is no annual limit. Convert at least up to $10K/year tax free if you don't have other taxable income. Then another $9K (single) at 10%, then another $27K at 15%. These rates should be crazy low compared to what a typical person pays during their working career.

With a wife and 2 young kids I can convert about $45K/year before I pay any tax once I stop working.
Sorry, I'll clarify.  I'll have about 40k in passive income when I ER, so I feel limited on how much taxable I should withdraw just to put toward Roth conversion. I thought this was part of the original issue, it is regularly part of the actual problem.

So then it depends on the type of passive income you have. If the $40K is all rental real estate or K-1 income you likely won't have much room to convert tax free, but you could still use the 10% & 15% brackets for your conversions and pay some federal tax. If the $40K is mostly Long-Term Capital Gains or Qualified Dividends, you would not have to pay federal taxes on those at all if you stayed within the 15% tax bracket. This rule might change, but for now it's a permanent part of the tax law.

Either way, good luck figuring out the best strategy for your situation.

Rural

  • Magnum Stache
  • ******
  • Posts: 4834
Re: I'm not convinced on 401k for early retiree
« Reply #27 on: February 16, 2014, 09:27:38 AM »
I second this.  I am struggling to find a way to apply 72t or Roth Conversion, since these are so limited (10k income/yr at best).

Why would a Roth conversion have a limit of $10K/year?  You can roll as much each year in as you are willing to pay the income taxes on.

There is no annual limit. Convert at least up to $10K/year tax free if you don't have other taxable income. Then another $9K (single) at 10%, then another $27K at 15%. These rates should be crazy low compared to what a typical person pays during their working career.

With a wife and 2 young kids I can convert about $45K/year before I pay any tax once I stop working.
Sorry, I'll clarify.  I'll have about 40k in passive income when I ER, so I feel limited on how much taxable I should withdraw just to put toward Roth conversion. I thought this was part of the original issue, it is regularly part of the actual problem.

With that level of passive income, why would you need to access the 401k early, anyway?

genesismachine

  • Stubble
  • **
  • Posts: 100
Re: I'm not convinced on 401k for early retiree
« Reply #28 on: February 16, 2014, 05:44:38 PM »
"My nominal tax rate is 39% now"

Doesn't that answer your question already.  Unless you plan on making 200k in taxable income after retirement, the 401k is a good way to go.  The tax savings (and growth tax free) offset however bad the crummy fees are.

To clarify, my federal nominal tax rate is not 39%. My state rate is 9% and my federal is 25%. Social security and Medicare taxes add another 5-6%.

It's looking very possible that I'll be able to max out 401k (35k/year), hsa (6.5k/year) and traditional ira (11k/year) this coming year. I have the ability to borrow a bit to kick into 2013's tax-advantaged accounts, but probably shouldn't be kicking in more than 10k or so since that's roughly the amount that I think I would have 'extra' in 2014 (the tax break I get would easily pay for the ~1-2 months of interest before I pay it off). Would it make more sense to do the HSA, traditional IRA or 401k?

Cheddar Stacker

  • Magnum Stache
  • ******
  • Posts: 3714
  • Age: 41
  • Location: USA
Re: I'm not convinced on 401k for early retiree
« Reply #29 on: February 16, 2014, 07:50:41 PM »
If you're talking about making a 2013 contribution in 2014, you only have one option out of those 3, and that's the IRA. 401K and HSA are both limited to contributions during the tax year, so that window is closed.

If you put $10K into a traditional IRA and deduct it on your 2013 return, don't forget you will be getting 25% of it back via your federal refund. I'm not sure about your state, check local listings, but you might get another 9% back there.

As far as the 39% tax rate I see where you were coming from now, but one point you should be aware of if you aren't already. The SS & Medicare tax will be paid now no matter what you do. All these tax deferred accounts do not affect the amount subject to SS/Med, so you will pay that 7.65% now. When you draw down any tax deferred accounts, you pay federal and state income taxes on them at ordinary rates, but you will pay no SS/Med tax at that time.

And congrats on being able to save so much. Very nice.

KBecks

  • Handlebar Stache
  • *****
  • Posts: 1692
Re: I'm not convinced on 401k for early retiree
« Reply #30 on: February 17, 2014, 06:25:20 AM »
I really appreciate this conversation because we aren't maxing out DH's 401k but we probably could.  We are in the 25 to 28% tax bracket.  I had not really understood the tax savings of putting more money into the 401k and these rules about rolling out and seasoning into a Roth, but now I've read a little and it seems to make sense.

So our priority would be to max the 401k before paying down the house (3.5% mortgage?)  Yes?  Yes?

I will go back and read through and try to get my head all the way around it so I can explain to DH!

And the tax savings then compensates for the poor investment options and 1%+ fees in the 401k's investment plan choices?  Yes?  Yes?

engineerjourney

  • Bristles
  • ***
  • Posts: 272
  • Age: 31
Re: I'm not convinced on 401k for early retiree
« Reply #31 on: February 17, 2014, 07:18:04 AM »
If you're talking about making a 2013 contribution in 2014, you only have one option out of those 3, and that's the IRA. 401K and HSA are both limited to contributions during the tax year, so that window is closed.

You can add to an HSA before filing your taxes, similar to an IRA if you didn't reach the limit the previous year.  You miss out on the FICA benefit but you are allowed to do a direct contribution (not from payroll) and claim it on your taxes.  I only contributed $2K last year to my family HSA and was able to contribute over $4K to reach the 2013 limit last month to claim on my taxes.  My HSA provider recommended it and made it really easy to specify that the contribution was for 2013.  I would think it would be the same no matter the provider.  HSAs are awesome, so max it out if you can!

jhartt3

  • Guest
Re: I'm not convinced on 401k for early retiree
« Reply #32 on: February 17, 2014, 09:12:07 AM »
i could be wrong here but i bet you will have to go Roth IRA after your wife starts working.  your income level will be too high to contribute to a traditional IRA and get the tax break.  That was my issue this year so i went with roth instead.

genesismachine

  • Stubble
  • **
  • Posts: 100
Re: I'm not convinced on 401k for early retiree
« Reply #33 on: February 17, 2014, 01:36:09 PM »
I really appreciate this conversation because we aren't maxing out DH's 401k but we probably could.  We are in the 25 to 28% tax bracket.  I had not really understood the tax savings of putting more money into the 401k and these rules about rolling out and seasoning into a Roth, but now I've read a little and it seems to make sense.

So our priority would be to max the 401k before paying down the house (3.5% mortgage?)  Yes?  Yes?

I will go back and read through and try to get my head all the way around it so I can explain to DH!

And the tax savings then compensates for the poor investment options and 1%+ fees in the 401k's investment plan choices?  Yes?  Yes?

The way I'm understanding this, yes. If you're being taxed 25% on each dollar and you're deferring the tax to let's say a 15% tax later when you're retired, you just made 10% (plus the capital gains/dividends are taxable at the lower rate as well). So right off the bat, you need about 3 years of mortgage interest to match what you make in an instant. Plus, every year, if it returns the historical 8% return every year, the gap never narrows, and just grows over time.

Is there an income limit for traditional IRAs? The way I see it, I don't see why anyone would choose to fund a Roth vs. a Traditional IRA... For us early retirees, almost everyone would be making more in their 'career' than retirement, no? So what would be the point of directly funding a Roth (not considering the Roth rollover ladder or whatever)?


iamlindoro

  • Handlebar Stache
  • *****
  • Posts: 1520
    • The Earth Awaits
Re: I'm not convinced on 401k for early retiree
« Reply #34 on: February 17, 2014, 02:01:06 PM »
So what would be the point of directly funding a Roth (not considering the Roth rollover ladder or whatever)?

The Roth grows tax free.  Everything you make on it is untaxed.  Given that, with a long enough time horizon, it's potentially huge untaxed gains.

iamlindoro

  • Handlebar Stache
  • *****
  • Posts: 1520
    • The Earth Awaits
Re: I'm not convinced on 401k for early retiree
« Reply #35 on: February 17, 2014, 04:34:29 PM »
So what would be the point of directly funding a Roth (not considering the Roth rollover ladder or whatever)?

The Roth grows tax free.  Everything you make on it is untaxed.  Given that, with a long enough time horizon, it's potentially huge untaxed gains.

Ok, so basically the Roth IRA only makes sense over the traditional IRA if the timeline is VERY long (like regular retirement 'long' haha).

Wow, that's definitely not what I meant at all.  Let's say your timeline is 10 years... $5500 into the Roth IRA every year, let's say 7% return, gives you $55K in contributions and ~$26,300 in tax free gains.  Not to mention by the end of 10 years, it's basically throwing off $5300 in gains every year you leave it alone.

I'm not talking in terms of geological time frames, I'm just talking in terms of "more than a couple years."

... And the above are if you only fund your own and ignore your spouse!

genesismachine

  • Stubble
  • **
  • Posts: 100
Re: I'm not convinced on 401k for early retiree
« Reply #36 on: February 17, 2014, 05:03:59 PM »
Can you use the 401k, IRA, or Roth IRA to buy real estate?

One of my life goals was to get into building houses and doing fixers too.

So here's my scenarios:
1 - Buy plot of land. Build house on it. Rent it out at some point, or sell it.
2 - Buy fixer, rent it out. Sell at some point.

If I can buy using the 401k or IRA, how would the rent and/or selling for profit tie into it? Would my profit be rolled back into my 401k/IRA? Is this even a possibility?

I'm crunching the numbers and the house plan seems to give roughly the same return on investment (after factoring in taxes) as just dumping it into tax advantaged accounts... So if it's one or the other, I might as well pick the one that's the least work (dumping into accounts). But it would be awesome if I could get the best of both worlds...

By the way, thank you everyone for the advice. I've been reading for a week or two, and learned more from this thread than during those weeks. I already opened up a Roth IRA account for me and one for my wife and we're in the process of funding them. Thanks so much!

Left

  • Handlebar Stache
  • *****
  • Posts: 1159
Re: I'm not convinced on 401k for early retiree
« Reply #37 on: February 17, 2014, 05:05:52 PM »
Genesis, yes, but you have to convert it to a self-directed ira/roth.
The profit/rent goes to ira and is tax sheltered until you withdraw it

I posted on my plan for it up above but like I said then, I need more in ira before I can do this

Undecided

  • Handlebar Stache
  • *****
  • Posts: 1080
Re: I'm not convinced on 401k for early retiree
« Reply #38 on: February 17, 2014, 05:06:22 PM »
Can you use the 401k, IRA, or Roth IRA to buy real estate?

One of my life goals was to get into building houses and doing fixers too.

So here's my scenarios:
1 - Buy plot of land. Build house on it. Rent it out at some point, or sell it.
2 - Buy fixer, rent it out. Sell at some point.

If I can buy using the 401k or IRA, how would the rent and/or selling for profit tie into it? Would my profit be rolled back into my 401k/IRA? Is this even a possibility?

I'm crunching the numbers and the house plan seems to give roughly the same return on investment (after factoring in taxes) as just dumping it into tax advantaged accounts... So if it's one or the other, I might as well pick the one that's the least work (dumping into accounts). But it would be awesome if I could get the best of both worlds...

By the way, thank you everyone for the advice. I've been reading for a week or two, and learned more from this thread than during those weeks. I already opened up a Roth IRA account for me and one for my wife and we're in the process of funding them. Thanks so much!

You could not do the work (yourself) on a house owned by your (or your spouse's, or certain other person's) IRA.

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 27774
  • Age: -999
  • Location: Traveling the World
Re: I'm not convinced on 401k for early retiree
« Reply #39 on: February 17, 2014, 05:11:56 PM »
Can you use the 401k, IRA, or Roth IRA to buy real estate?

One of my life goals was to get into building houses and doing fixers too.

So here's my scenarios:
1 - Buy plot of land. Build house on it. Rent it out at some point, or sell it.
2 - Buy fixer, rent it out. Sell at some point.

If I can buy using the 401k or IRA, how would the rent and/or selling for profit tie into it? Would my profit be rolled back into my 401k/IRA? Is this even a possibility?

I'm crunching the numbers and the house plan seems to give roughly the same return on investment (after factoring in taxes) as just dumping it into tax advantaged accounts... So if it's one or the other, I might as well pick the one that's the least work (dumping into accounts). But it would be awesome if I could get the best of both worlds...

By the way, thank you everyone for the advice. I've been reading for a week or two, and learned more from this thread than during those weeks. I already opened up a Roth IRA account for me and one for my wife and we're in the process of funding them. Thanks so much!

Sort of.  You have to do a self directed IRA, but they come with lots of rules (you can't, for example, fix up a place yourself.  You can hire someone to do it.).

Google real estate and self directed IRAs and you'll find lots of reading.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

read books

  • 5 O'Clock Shadow
  • *
  • Posts: 12
Re: I'm not convinced on 401k for early retiree
« Reply #40 on: February 17, 2014, 05:25:00 PM »
Would expecting to inherit money change things? I'm not a troll either. I just don't know this stuff, and this thread has made me curious.

genesismachine

  • Stubble
  • **
  • Posts: 100
Re: I'm not convinced on 401k for early retiree
« Reply #41 on: February 17, 2014, 05:48:49 PM »
Can you use the 401k, IRA, or Roth IRA to buy real estate?

One of my life goals was to get into building houses and doing fixers too.

So here's my scenarios:
1 - Buy plot of land. Build house on it. Rent it out at some point, or sell it.
2 - Buy fixer, rent it out. Sell at some point.

If I can buy using the 401k or IRA, how would the rent and/or selling for profit tie into it? Would my profit be rolled back into my 401k/IRA? Is this even a possibility?

I'm crunching the numbers and the house plan seems to give roughly the same return on investment (after factoring in taxes) as just dumping it into tax advantaged accounts... So if it's one or the other, I might as well pick the one that's the least work (dumping into accounts). But it would be awesome if I could get the best of both worlds...

By the way, thank you everyone for the advice. I've been reading for a week or two, and learned more from this thread than during those weeks. I already opened up a Roth IRA account for me and one for my wife and we're in the process of funding them. Thanks so much!

Sort of.  You have to do a self directed IRA, but they come with lots of rules (you can't, for example, fix up a place yourself.  You can hire someone to do it.).

Google real estate and self directed IRAs and you'll find lots of reading.

Ok. If she becomes a journeyman carpenter in 4 years, does that change anything? Or does it not matter what our qualifications are? (Basically, do they see it as a conflict of interest, or just a lack of proper licensing?)

I find it crazy that IRA and other tax/financial basics are not taught in engineering school. I mean, it would seem like those types of courses would be FAR more useful for future high-earners than some BS course about gen ed.

Edit: I'm definitely going to max out my IRA for 2014, and do what I can for 2013 before April, but I am confused by this IRS site:
http://www.irs.gov/Retirement-Plans/Are-You-Covered-by-an-Employer's-Retirement-Plan%3F

I read this (potentially) as 'if your employer offers a 401k, then you are covered by an employer's retirement plan and therefore not eligible for a separate traditional IRA account' from the first bullet.

Assuming this is not the case, it leads me to this page:
http://www.irs.gov/Retirement-Plans/2013-IRA-Deduction-Limits-Effect-of-Modified-AGI-on-Deduction-if-You-Are-NOT-Covered-by-a-Retirement-Plan-at-Work

My wife will be working for the union with a traditional pension plan. If that is the case, then would only I be allowed to contribute my 5500 into the traditional IRA, and she would not be allowed any sort of contribution? We would be married filing jointly.

I'm assuming the following for 2014:
We can contribute the full 11k into traditional IRA
We can contribute the full 6550 into the HSA
We can contribute 17.5k into my 401k and 17.5k into her 401k

Do I have these numbers right?

Basically almost her entire income will be sent into these retirement accounts since she'll start out pretty low in pay.

Sorry for the basic questions, but literally a few weeks ago, I knew next to nothing about all this tax stuff.
« Last Edit: February 17, 2014, 06:07:49 PM by genesismachine »

CDP45

  • Pencil Stache
  • ****
  • Posts: 509
Re: I'm not convinced on 401k for early retiree
« Reply #42 on: February 17, 2014, 07:12:04 PM »
Yes I thought if you are eligible for an employer based 401k that made you ineligible to contribute to a traditional IRA. True?

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 27774
  • Age: -999
  • Location: Traveling the World
Re: I'm not convinced on 401k for early retiree
« Reply #43 on: February 17, 2014, 07:22:35 PM »
Ok. If she becomes a journeyman carpenter in 4 years, does that change anything? Or does it not matter what our qualifications are? (Basically, do they see it as a conflict of interest, or just a lack of proper licensing?)

Conflict of interest.  You can't go over and change out a dead lightbulb.

Basically the idea is you're allowed to contribute a maximum amount to these accounts.  By doing your own work, you are adding value above and beyond that, which isn't allowed.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

EscapeVelocity2020

  • Handlebar Stache
  • *****
  • Posts: 2179
  • Age: 45
  • Location: Houston
    • EscapeVelocity2020
Re: I'm not convinced on 401k for early retiree
« Reply #44 on: February 17, 2014, 07:50:52 PM »
I really appreciate this conversation because we aren't maxing out DH's 401k but we probably could.  We are in the 25 to 28% tax bracket.  I had not really understood the tax savings of putting more money into the 401k and these rules about rolling out and seasoning into a Roth, but now I've read a little and it seems to make sense.

So our priority would be to max the 401k before paying down the house (3.5% mortgage?)  Yes?  Yes?

I will go back and read through and try to get my head all the way around it so I can explain to DH!

And the tax savings then compensates for the poor investment options and 1%+ fees in the 401k's investment plan choices?  Yes?  Yes?

The way I'm understanding this, yes. If you're being taxed 25% on each dollar and you're deferring the tax to let's say a 15% tax later when you're retired, you just made 10% (plus the capital gains/dividends are taxable at the lower rate as well). So right off the bat, you need about 3 years of mortgage interest to match what you make in an instant. Plus, every year, if it returns the historical 8% return every year, the gap never narrows, and just grows over time.

Is there an income limit for traditional IRAs? The way I see it, I don't see why anyone would choose to fund a Roth vs. a Traditional IRA... For us early retirees, almost everyone would be making more in their 'career' than retirement, no? So what would be the point of directly funding a Roth (not considering the Roth rollover ladder or whatever)?

Wow, this thread has turned into a 'one size fits all'.  First off, I would caution someone from 'overfunding a 401k', which I think will become an issue with two-income families in their late 30's, early 40's.  It's almost as if the government is encouraging us to retire early, given the incentives to do so in ACA.

I will give my specific situation, because you cannot apply a single 'rule of thumb'. My wife and I both maxed out our 401k for 7 years.  My wife stopped working 10 years ago, but her 401k is ~120k.  I have continued to max out my 401k because I have an employer match and high-ish tax bracket, so I have almost 500k sitting there, depending on how well the market is doing on a given day, but you will probably see something similar (law of large numbers ;).  Anyway, my 'problem' is that we are expected to use the 401k as our 'pension plan'.  If that's all I had and retired traditionally, I'd be 59.5 and have a nice taxable sum.  Even if I live carefully, by 70.5, required minimum distributions ensures that I draw my balance down unless I keel over.

So just watch out for these taxes, sometimes is good to think beforehand about saving outside the 401k.  Optimally, you want to max out the 401k, also save some good after tax amount, and retire early so that you can season a Roth or just live off of taxable passive income and a 72t.  If you are firm on what 4% income makes you comfortable, then you can estimate a retirement date (which is where I'm at, that I should retire now, or succumb to un-Mustachian lifestyle inflation).

As to purchasing property with your self-directed IRA, I looked into this once.  It is very hard to keep everything 'at an arm's length'.  And you probably won't get better-than-Market returns, but if you do, I can imagine the IRS will be very interested...

There have been some great comments in this thread, but it is tough to keep up with.  Maybe split it?

Cheddar Stacker

  • Magnum Stache
  • ******
  • Posts: 3714
  • Age: 41
  • Location: USA
Re: I'm not convinced on 401k for early retiree
« Reply #45 on: February 17, 2014, 09:06:58 PM »
Sorry for the long winded reply, but I was away from the interwebs today and there are so many good questions here that should be addressed (some have already addressed them, I'm just throwing in my thoughts).

Engineer journey, thanks for correcting me on the HSA contributions; you are right about making an "after payroll" HSA contribution that you can deduct on page 1 of your return. I was thinking about the payroll deduction version.

So our priority would be to max the 401k before paying down the house (3.5% mortgage?)  Yes?  Yes?

And the tax savings then compensates for the poor investment options and 1%+ fees in the 401k's investment plan choices?  Yes?  Yes?

Yes, and yes. Definitely invest vs. mortgage paydown in most circumstances. If you choose to do so in a 401K great, there are huge tax savings.

Tax savings definitely outweighs high fee investments, but get in as low fees as you can, and look into in-service withdrawals to get the money into an IRA as soon as you can.

i could be wrong here but i bet you will have to go Roth IRA after your wife starts working.  your income level will be too high to contribute to a traditional IRA and get the tax break.  That was my issue this year so i went with roth instead.

There are different limits for Roth IRA and TIRA. OP was not in the range for this being disallowed in 2013, but if income goes up 50% as he mentioned he will could be outside the range of TIRA Contributions. In that case, a Roth is definitely a good idea, but it might have to be a backdoor Roth.

Is there an income limit for traditional IRAs? The way I see it, I don't see why anyone would choose to fund a Roth vs. a Traditional IRA... For us early retirees, almost everyone would be making more in their 'career' than retirement, no? So what would be the point of directly funding a Roth (not considering the Roth rollover ladder or whatever)?

There are income limits for both TIRA and Roth IRA's. There are many, many circumstances when a Roth makes more sense. This is not one size fits all, so keep an open mind. I encourage TIRA, others encourage Roth, sometimes you can do either one, sometimes you are limited. I can not make any TIRA contributions. Joint income is too high, and we both have 401K's, so at best we can do a backdoor Roth. I'm trying to convince my wife to quit and be a full time SAHM, but that's not what she wants. At least I'm getting her to max her 401K this year.

Would expecting to inherit money change things? I'm not a troll either. I just don't know this stuff, and this thread has made me curious.

Inheriting money in itself is not taxable so it wouldn't affect any of this. However, the form of the inheritance matters, and what you do with it after that matters. It could be in a trust, it could be life insurance proceeds, it could be in a Roth IRA or TIRA, it could be cash or after tax investments. All of these would be treated differently, and what you do with them once they're yours affects their taxability, so it would affect any of these strategies.

Yes I thought if you are eligible for an employer based 401k that made you ineligible to contribute to a traditional IRA. True?

Being eligible for an employer 401K plan means you are "covered". Being covered changes the level at which you are allowed to deduct a TIRA contrbution. You can always contribute to a TIRA, it just won't be deductible after a certain level if both spouses are covered. The phaseout level is around $95K-115K AGI off the top of my head if you are both covered.


Other thought for Genesismachine - you mentioned your wife would not make much but would max out her 401K. There are sometimes limits to how much an employee is allowed to defer within their 401K. Sometimes it 50% of wages, sometimes it's much less or much more. If she makes $40K, and her employer only allows a 25% contribution, she might be limited to a $10K contribution. Have her check with HR as soon as she can to understand the limits of the plan.

There can also be "failures" in certain calculations within the plan that disallow people's contributions. This mostly happens when high earners contribute the max and all the $10/hour people contribute nothing, but be aware there can be limits to a 401K that are waaaay outside your control.

Gin1984

  • Magnum Stache
  • ******
  • Posts: 4718
Re: I'm not convinced on 401k for early retiree
« Reply #46 on: February 19, 2014, 08:21:17 AM »
Yes I thought if you are eligible for an employer based 401k that made you ineligible to contribute to a traditional IRA. True?
It depends on your income.  See here:
http://www.irs.gov/Retirement-Plans/2013-IRA-Deduction-Limits-Effect-of-Modified-AGI-on-Deduction-if-You-Are-Covered-by-a-Retirement-Plan-at-Work
But personally, I'd rather a Roth and 401k, to balance my tax burden.