Author Topic: Reader Case Study – Evaluate Our Five Year Plan to FIRE?  (Read 8028 times)

petunia4014

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Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« on: February 24, 2015, 03:21:53 PM »
We are trying to determine if we can FIRE in five years, and if we can, what are the best things to do now to get ready. There are a few scenarios we’re running to try to determine this, but a lot of it comes down to the cost of housing. We live in a very high COL area on the East Coast. We’re open to moving once we FIRE (in fact we most likely have to in order to retire), but we’re not sure where.

I am 40, husband is 36. We have two kids, ages 5 (in Kindergarten) and 3 (in daycare). We both work and together we earn about $180K (gross). 

We have no debt. We have two paid off cars, both older (2002 and 2009) and fuel-efficient. Gas is relatively inexpensive (~$120 month total for both cars). Car insurance is about $1K a year.

Housing is our big burden. We spend $2100 on our mortgage, plus $625 on insurance and taxes each month. Total is $2725. We live in small house (just over 1K sq ft) in a “not so good” area. This is just what houses cost here. Given the small size of the house we can’t rent a room, get a roommate, or do anything to reduce our housing cost. We have a low rate, so refinancing isn’t a useful option. The upside is that our house is in an extremely walkable and bikeable place, so we do lots of local things in our neighborhood without getting in a car, aside from the fact that we love living here.

We have also optimized our electric and gas bills, doing several studies on what appliances use the most power, and have been working to make our home more energy efficient. We have life insurance, which is relatively reasonable for both of us (~$500/year each for $1,000,000 policies).

Food is expensive, but we are working on bringing that down. We both have cell phones through lost cost providers, no cable/TV bills, we use Ooma for our home phone, we have cheap internet, and we spend maybe $40 a month on eating out once and some cheap entertainment with the kids. We have great healthcare through my job so those bills are low. No HSA available, unless my husband goes off my insurance and uses his, but his insurance is absolutely horrible. 

We both max out our Roth IRAs. We also both max out our 401K (husband, and he gets an employer match of 3%) and my 457 (no match). I also have a pension I pay into that kicks in after traditional retirement age, but I have not investigated too much on that.

Daycare is expensive, but we have it figured out to get the best care for the best price in the best location. Switching wouldn’t generate savings.

We put $400 a month per kid into their 529 plan, with the goal of front-loading while they are young. We may not always contribute this much, especially if we FIRE, so we are hoping compounding and a low HH income in the future when/if they go to college will help.

Our home is worth about $650K, we have $235K equity in it. The kids’ 529s have about $100K in them total.

Our IRAs (both Roth) have about $225K total, in Vanguard Index Funds. My husband’s 401Ks have about $475K in them, in mostly Vanguard and Fidelity funds (no choice on Fidelity). My 403B and 401K together have about $200K, and my 457 for my current job has about $225K in it. So, our total investments, all in retirement accounts total roughly $1,125,000. That isn’t counting our house equity, the pension I pay into, or the kids’ 529s.

Here’s the kicker though, we have no savings. We are living paycheck to paycheck. We have about $7K in cash on hand (trying to build up savings and our normal cash on hand for our bills each month). We had a ton of savings, but daycare, especially paying two daycares at once drained everything. I am working to save 1K a month each month for the next five years as part of our FIRE plan, but it’s tough. We generally spend exactly what we make a month as we always seem to have some expense come due (car needing extensive repairs, summer camps, etc.) just as we’re about to start saving. We’re hoping that getting an even tighter rein on the spending will help. My husband is FINALLY on board, so I think this year will be our best yet.

So here’s the main question. We’d like to retire, but where we live we spend a little over $70K a year, just under half on housing. Obviously, we’ll need to move to FIRE, because we would need over $2,000,000 to retire otherwise.   

So, how do we best position ourselves given that we have five years to get ready? We’re trying to use these next five years to put as much money away as possible, but one of our major questions is where is the best place for the money to go. What should we do/think about/prepare for? Should we change where we are investing? I can’t get out of the mindset that I need to max my tax-advantaged accounts; I’ve been doing this all my working life. I need a kick in the pants to figure out what to do.

We also need some help evaluating the smartest way to set up our post-FIRE income stream in the next five years so we can retire successfully. How do we best set up our cash flow from the investments we have and the savings we’re trying to accumulate in these next five years?

One thing we’re hoping/planning to do is a year+ long round-the-world trip as soon as we FIRE while renting our house (we can definitely rent for more than our mortgage). That gives our investments another year to appreciate (hopefully) and we can use the savings we’re building in these five years to travel, which should be cheaper than a year in our current location. When we return, we can sell the house and move somewhere cheaper and be permanently FIREd. Or not?

It’s all a bit overwhelming to figure out. So, clever Mustachians with much more financial sense than I – what would you do to optimize a five year FIRE plan in our situation?

Thanks for your thoughts!!

MDM

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #1 on: February 24, 2015, 03:51:44 PM »
Your situation actually looks pretty good, although it's possible there's a rosy tint to my glasses.

See attached, and some background.  The OP was vague on a few points so there are guesses in those areas.  If interested you can fill in your own numbers and draw your own conclusions.  Further questions welcome.

Whatever else you do, redirecting the 529 contributions seems a good idea.

fartface

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #2 on: February 24, 2015, 03:54:37 PM »
First of all, great job on your retirement savings.

Second, STOP contributing to the 529. Holy Cow! 2 kids and you're already at $100k? If you put NOTHING more in those accounts and they grow at a rate of 7%/year, in 15 years you'll have $275,000. Exactly how much do you think your kids NEED for college savings. Sheesh.

You can now bank that $800/month into your FIRE Vanguard Brokerage account over the next five years. That, coupled with the 72t rule when you're ready, should mean you're just fine...especially if you move to a lower COL area.

Good luck!

mandy_2002

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #3 on: February 24, 2015, 03:55:03 PM »
I'm not a full mustachian, so I'll give you my personal views on a few things, and leave the heavy lifting to others. 
1.  Student savings - $100K for two kids more than 10 years from college sounds amazing.  I would start putting that monthly payment toward your own retirement (you can finance college, you can't finance retirement).  If you've been paying into one kid's for 5 years and the other for 3, you could continue the second child's for another couple years to even it out if unevenly funding give you heartburn.  (College funding will likely be changing before their time, but if you have low ER incomes, the FAFSA will work in your favor to get scholarships and subsidized loans that you can help pay off as possible.)
2.  Your retirement account balances look great. 
3.  The house.  There's a few things I could think of here, and this is one of them.  If you sold it, you would walk away with just above $200k.  That would buy you a nice (and probably larger) house in many lower cost areas. If one of you could continue a job making about the same money, you could move to one of these areas, get rid of the house payment altogether other than tax and insurance, and stop daycare payments for the child not in school and both if needed during non-school times (after-school and summer). 

waltworks

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #4 on: February 24, 2015, 04:00:00 PM »
Roths? At $180k income? Do traditional IRAs and max your 401k/403b stuff going forward.

-W

justajane

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #5 on: February 24, 2015, 04:13:48 PM »
+1 to the thought that you are oversaving for your childrens' educations. Start saving that in a taxable investment account for your own FIRE. That alone in five years would equal almost 50K.

MDM

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #6 on: February 24, 2015, 04:44:31 PM »
Roths? At $180k income? Do traditional IRAs and max your 401k/403b stuff going forward.
They'd probably love to do tIRAs but the IRS won't let them deduct the tIRA contribution with their MAGI>$118K.

ecmcn

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #7 on: February 24, 2015, 05:00:56 PM »
Congratulations on getting as far as you have! Our life circumstances are almost identical. We're a little older and further behind you to FIRE, but the young kids, expensive housing and wondering how to deal with mostly retirement savings strikes a chord.

Five years sounds reasonable to me. You'll have closer to $300k equity in your home, which if you're ok with moving will get you all or most of a house in many places. Your daycare expenses will decrease in two years, and once you FIRE I bet you could lower other monthly expenses, like the second car. If your non-housing expenses are around $35k now you should have no problem living on what will likely be over $1.5M.

How to tap it takes some strategerizing, something I'm working through as well. You'll be able to use your retirement savings without penalty at age 59.5, so the trick is the first ~14 years.  You're already maxing out your Roth IRAs so you'll have immediate access to those contributions. A Roth Conversion Ladder seems like a great option for part of your income. The five-year lag before you can use it requires planning, and I wouldn't start the conversions until your income drops when you FIRE or taxes will chew it up. Beyond that a taxable account is probably your best bet and/or one of you working part-time.

The 529 is a major unknown in my book, and actually I'm a little pissed off at it right now because it reminds me of an FSA, which I consider a tax on unanticipated health problems. If you put too much into it you're penalized, and considering your kids could run the gamut from nothing to Harvard it's kind of ridiculous making parents guess how much they're going to need in 15-20 years. I need to keep telling myself that the 529 is just an *optimization* of funds, and that I can also save for my kids' college in a taxable account. I may guess low on the 529 target and lose out on some tax savings, but that's probably better than guessing too high (note: I still haven't fully spreadsheet-tested various scenarios, this is just my perception from just starting to think hard about this). So anyway, I think my strategy will be to figure out the type of school I'd like to cover for my kids and save maybe 40-50% of that in a 529 and the rest in a taxable account that I can use for other things if needed. Of course, if you did that this money would be earmarked for college and not FIRE, but it gives you some flexibility. For example you could have the kids get partial student loans that you then pay back in a few years when you can access your retirement funds. Or you find that once you FIRE you're making money on part-time work. And so on. The point is you may be close to done with the 529 anyway.

The part about FIRE and college I've been debating the ethics of is student aid. From what I understand, I think someone with a low income but high net worth mostly in retirement accounts would qualify for aid. This is more of an ethical gray area to me than, say, not having to pay taxes because all of your income is from long-term gains and you're in a low tax bracket. But if you consider that's how the rules are set up and you're just playing by them... I dunno. Seems a little like sponging off of society, but I'd be interested in what people had to say about it.

I'd suggest making a long-term plan based on age milestones. Something like...

Age 45: FIRE
Age 53: Kid 1 starts college
Age 60: Tap retirement
Age ?: Start pension
Age ?: Start Social Security early for the lower earner
Age ?: Start SS late for the high earner

Eric

waltworks

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #8 on: February 24, 2015, 05:07:14 PM »
Derr, my brain isn't working. Thanks for setting me straight.

-W

Roths? At $180k income? Do traditional IRAs and max your 401k/403b stuff going forward.
They'd probably love to do tIRAs but the IRS won't let them deduct the tIRA contribution with their MAGI>$118K.

madamwitty

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #9 on: February 24, 2015, 05:25:00 PM »
If you've been paying into one kid's for 5 years and the other for 3, you could continue the second child's for another couple years to even it out if unevenly funding give you heartburn.
This is probably not necessary since you can redirect the first account to Kid #2 as a beneficiary when you are done spending on Kid #1.

GregO

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #10 on: February 24, 2015, 05:38:58 PM »
I'd say the most important thing is to lay out a budget for FIRE.  The only information you gave on your spending is that you spend $70k a year right now.  How much of those expenses will translate to retirement?  And what expenses will be added (healthcare?)?  Once you have put together a FIRE budget, you can begin to make a plan for housing, retirement age, and your FIRE income strategy.  You may be able to retire sooner than you are planning.

mozar

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #11 on: February 24, 2015, 06:25:26 PM »
If it were me I would rent out the house, and start travelling now. That saves you on childcare and house at once. Then when both kids are old enough for full day school you could come back and have a lower cost of living.
Could you live on the rent? Then in a year you could start your roth ladder. Or sell your house and start travelling. You can live off the proceeds until your ladder matures. 235k/5=47k. That seems like plenty of money a year to me.

It's great to travel with little kids, while they still want to be spending time with you and not their friends, and before they settle into school and activities.

Hotstreak

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #12 on: February 24, 2015, 06:28:15 PM »
There are lots of areas in the country where the equity you have in your current residence, would buy a home outright.  Probably a nicer home.


You should figure out what your expenses will be once you retire.  Figure out what your year of travel will cost first, then figure out what a normal year will look like.  Add healthcare, subtract child care, subtract work related expenses, maybe add more travel. 


You're in a good position with your retirement assets.  You can probably live off your ROTH distributions for 6+ years, during which time you can also be doing the ROTH Pipeline.  You won't be paying capital gains on any of this, so you can precisely calibrate your income to take advantage of maximum ACA credits.  Because you can withdraw from your ROTH tax-free, that serves as your emergency fund for the time being.


Your investments of $1.125M would support a 4% WD rate of $45,000 per year, or a 3% WD rate of $33,750 per year.  That will be plenty until your kids go to college in 18 years, at which time you can use the 529 to support them.  If things get a little hairy with the market/health or (heaven forbid!) you decide to pay for both of them to go to med school or something :), you will be social security age right around that time as well.


I think you can retire at the end of 2015.  You could probably do it now, financially, but it seems like you need to go through the planning stage a bit more first.  I suggest moving some tax advantaged contributions to cash, just because you will be on the "fixed income" of the ROTH pipeline and may need an emergency reserve to dip in to (without increasing your taxable income through IRA rollovers).

CanuckExpat

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #13 on: February 24, 2015, 06:38:38 PM »
Hi Petunia,

I think you are well on your way, and you might be closer to FIRE than you think. In fact I think if you wanted to, you could retire today, in certain scenarios.

Your post resonated with me, because we are in a similar situation (albeit a different coast), where we could be essentially FIRE today in some other location, or about five years from now if we don't move and things continue to go well. I'm a big advocate of loving where you live, so I wouldn't recommend moving only for financial reasons, if you love the place you live. That being said, I also think it's good to consider all the options and decide what is best for you, there might be somewhere else that you love even more.

If I understood correctly, you have about $1,125,000 investable assets and $235k home equity (with about $400,000 owing on mortgage?). Your annual expenses are $70,000 a year, about $25,000 of which is mortgage principle and interest. Does that all sound correct?

What is missing from your post is what level of safe withdrawal rate you are comfortable with and your current savings rate. Assuming that four percent is ok as a savings rate, a couple of optimistic scenarios pop out at me:

1) You move somewhere cheaper and retire today: If you find somewhere you like that where can buy a house $235k in cash, your spending will be about $40,000 a year if you have no mortgage to pay, and assuming you no longer need daycare (which is probably also a large expense) and some commuting costs go down.

2) You stay where you are while you accumulate enough to pay off your house (as an example, not that you have to pay it off). Again your spending will be about $40,000 a year, assuming no daycare and some other reduced costs. You didn't say how much your take home pay or savings rate was, but with your salaries and already accumulated stash, I don't think it would be outrageous for you to save $400,000 or $500,000 in five years. In that case you could retire in your current location in five years.

Am I being too optimistic with those scenarios?
« Last Edit: February 24, 2015, 06:45:32 PM by CanuckExpat »

petunia4014

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #14 on: February 25, 2015, 08:51:54 AM »
Thanks to everyone for your thoughts so far! I am so impressed with the knowledge you all have!

A few clarifications:

We do have a budget currently and track everything in Mint. Bare bones, not including savings, it is as follows:

Car fuel $120
Water/Sewer/Trash $55
Internet $50
Cell phones $55
Electric ranges from $60-$100 depending on the month
Gas ranges $20-$150 depending on the month
Mortgage $2725
Groceries $900-$1000 (yes, I know this is high, but I am working to get it down as much as possible. We live in HCOL area, and we eat organic especially for meats, and I’m not willing to compromise. It’s our one vice and I’ll put off FIRE to keep doing this).
Restaurants/entertainment: $40
Charity: ranges from $70-$100
Medical: $50
Household: $1000 (this is a catch all category for whatever it takes for our household to run – clothes for the kids, school and activity fees, pet food and vet bills, gifts for family and friends, cleaning supplies, car insurance, life insurance, car repairs, summer camps, house repairs, etc. I did it this way because it was tricky to amortize events that occur randomly throughout the year (car repairs, a month full of birthdays, sick pet) or on a 1-2/x year schedule (insurance) monthly. It seems to work out. Some months we spend tons on car repairs and nothing on the kids and the opposite it’s flipped. But sadly it seems to be about $1k a month despite my best efforts).
Daycare (until September 2016): $700
 
So that total comes to about $5445, give or take, giving us a yearly spend rate of $65,340 barebones, but honestly it’s been more like $70K as we’ve been paring down the last few years. Housing is $32,700 of that, so without housing, assuming we move for FIRE, it comes to spending of $27-38K.  I have no idea if it would go up or down with FIRE, as that somewhat depends on where we’d be living, and what the kids might cost as they get older. And, this is also without the $1700 a month that we put toward IRAs and 529s.  That makes our total outflow about $7145 and we bring home about $7500 a month (after paying for healthcare and dental, 401k/457, pension, dependent care account, flexible spending account, and of course, taxes). Pay check to pay check.

Regarding the 529s: we live in a state that allows us to deduct contributions on our state income tax up to $4k per account per year with unlimited carry forward to future tax years. We have been contributing about $5500 per account per year, so we would still have some tax deductions we could make on our state income taxes for a few years in the future. Does the advice to contribute less still hold given the tax deduction allowed for us?

Also, I do think college will cost a LOT for the kids. I doubt we can get one kid through college for $275K, let alone two (assuming we pay the full way, which we have no way of knowing). While we are lucky to live in a state with amazing public options, if we FIRE elsewhere, we may not. I am going to encourage each kid to work, and take a gap year, and to only consider public education (and maybe not to go to college unless it helps them achieve their goals), but I do really think it is important to give them as much of a debt-free start to life as possible. This is why we’ve been emphasizing the 529s, and it is honestly is one of my biggest worries if we do FIRE. Also, in our state we have an option to prepay college tuition which is calculated by the age of the child when you start the monthly payments into the 529 account. That option is MORE per month than we’re putting away now, so I think that is why I have the perception that I wasn’t putting away enough. But you’ve all given me much to think about. It would be fantastic to put that money toward FIRE. And yes, I guess I was just thinking that college funds were in 529s or nothing. Once we get our taxable accounts built up and the kids get closer to college we can reevaluate how and what to pay for, and with what accounts.

Regarding the house/location: we can’t leave here and make anywhere close to what we currently make. My job is so (stupidly) specialized that even in a major metro area there are only literally 3-4 people that do what I do. Once I leave this job I would either need to retire for good, or switch careers to have another job. My husband’s job is more portable but he wouldn’t command but half of what he does here. He makes 2/3rd of our income, so that would be a huge hit and I’m not sure that moving before we FIRE would help us reach our goals any faster.

We can rent the house for more than we pay in mortgage, but not much more (probably about $3k a month). So it’d be covered, and it would be easy to rent and get good tenants but not enough to live on.

I do like the idea of traveling now :), but for a few reasons we need to stay here for at least the next three if not five years. This is definitely the place we can maximize our income. And we really do love where we live. We moved here about three years ago, and the place we lived for the last ten before that was so miserable I don’t even want to think about it. We saved a lot, but it came at great mental health costs. That’s one of the reasons I’m so worried about moving just to save money and FIRE.

And on the Roths vs Traditional IRAs, I got all excited for a second there thinking there was a income loophole I hadn’t heard about. Oh well. :)

Regarding the income stream: I have a 457 with my current job. I’ve heard that once I am no longer employed, I could tap that immediately without penalty with no age restrictions. That is my back up plan for the five years of income before the Roth Conversion Ladder could kick in. I’d rather not spend that to give it time to grow, so I’m trying to figure a better way.

Thank you again for all your thoughts!

tyd450

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #15 on: February 25, 2015, 10:31:52 AM »
How would things look for you guys if you retired and stayed at home with the kids for a few years? 

Your husband making 2/3rds of the income could keep working for a few years, you can stay home and raise the kids and lose the daycare expense.  You being at home without a career to worry about will probably result in you discovering some ways to cut back on groceries and other household expenses.  There could be a lot of convenience type purchases that you can cut back on now that you have a little more time to breathe. 

Also, depending on how walkable your location is and if your husband needs the car for work everyday, you could also maybe sell one of the cars.

I think all of that in addition to losing the 529 contributions, considering how well funded they are already, could put you guys in a good spot.

Just food for thought- obviously some people have no interest in staying at home so it may not even be of consideration for you. 

SunshineGirl

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #16 on: February 25, 2015, 10:54:31 AM »
So, give us details of your pension and how vesting works, because if you can be fully vested when you leave the job, you can still tap into the income source once you hit age 50, or later depending on various scenarios. Most likely, it would be at least enough to pay for your property taxes wherever you go, for the rest of your life.

mandy_2002

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #17 on: February 25, 2015, 12:22:36 PM »
Specifically for the college aspects, thank you for supporting non-college choices.  That is so important now especially with the college debt crisis.  Also, setting a limit per year based on an accredited 4 year school is very smart.  If it's a blank check, too many go to $60K/year liberal arts schools for jobs they know will pay little.  That's an expensive teaching degree.  (Two siblings I know where forced by their parents to go to a community college because the two older siblings did this and drained all of the college funds for the others). 

From my personal experience, when a student has zero skin in the game (mommy and daddy pay for everything, including the math tutor because they're failing and the beer they drink as a 19 year old), there tends to be very little commitment to school.  I say this as a 2 year Resident Assistant with about 100 test subjects, and a math tutor who fired students who didn't want to be there.  I could tell in a week with 95% accuracy whether the cost of school was given to them or borrowed by them (some were grateful for it, but many just expected it).

I went to college with zero parental support, and I am bitter to this day about that, but I have a very good attitude toward money and wasteful spending (mostly because my parents bought a plane shortly after telling me they couldn't pay anything towards school).  I don't suggest this course, but having to partially support yourself (whether it's a work study in the registrar's office for non-school costs or a subsidized loan) ensures that you are evaluating your choice to be in school. 

CanuckExpat

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #18 on: February 25, 2015, 01:08:53 PM »
Regarding the 529s: we live in a state that allows us to deduct contributions on our state income tax up to $4k per account per year with unlimited carry forward to future tax years. We have been contributing about $5500 per account per year, so we would still have some tax deductions we could make on our state income taxes for a few years in the future. Does the advice to contribute less still hold given the tax deduction allowed for us?

Also, I do think college will cost a LOT for the kids. I doubt we can get one kid through college for $275K, let alone two (assuming we pay the full way, which we have no way of knowing). While we are lucky to live in a state with amazing public options, if we FIRE elsewhere, we may not. I am going to encourage each kid to work, and take a gap year, and to only consider public education (and maybe not to go to college unless it helps them achieve their goals), but I do really think it is important to give them as much of a debt-free start to life as possible. This is why we’ve been emphasizing the 529s, and it is honestly is one of my biggest worries if we do FIRE. Also, in our state we have an option to prepay college tuition which is calculated by the age of the child when you start the monthly payments into the 529 account. That option is MORE per month than we’re putting away now, so I think that is why I have the perception that I wasn’t putting away enough. But you’ve all given me much to think about. It would be fantastic to put that money toward FIRE. And yes, I guess I was just thinking that college funds were in 529s or nothing. Once we get our taxable accounts built up and the kids get closer to college we can reevaluate how and what to pay for, and with what accounts.

Given that you get a state tax deduction, and that you are relatively high income, I would say yes, keep contributing to maximize the tax deduction.

Now I'll give a thought I've been working on lately, but haven't fully researched, so someone correct me if I'm wrong:
If you put money in the 529, there is nothing to stop you (except perhaps your personal feelings on the matter) from raiding the principle later as part of your FIRE stash. 529s are different from Uniform Gifts to Minors custodial accounts, in that the funds still legally belong to you, and you can do with them as you wish.

There would be a tax penalty if you used the investment gains for non educational purposes, but as far as I understand, since the principle went in after taxes, you can withdraw that yourself without penalty at the federal level (there may or may not be impact regarding paying back state deductions).

Even if you ended up deciding/needing to take out the investment gains, I think the tax downside (paying taxes on gains + 10% penalty) isn't that bad considering you've now had 20 or 30 years of tax free compounding, plus if you are FIRE'd by that point, you might be in a very low or zero federal tax bracket. Add on top of that, if your child gets a scholarship and that is why you don't need the funds, then you can withdraw both the principal and gains, totally tax free and with no penalty.

So I'm thinking "over funding" your 529 isn't as bad as people make it out to be. In fact I think under current tax laws this could be an additional vehicle to tax shelter investment growth, use the gains for your child's educational purposes tax free, then withdraw the contribution back for your own purposes if you want. In that way, you can consider using a 529 as giving your future student an interest free loan that is invested for college.. they get the gains, you get the contribution back.
As I said, I'm still working on developing that idea, so if I misunderstood the tax implications, someone please let me know.

To your second point, I don't think college costs can continue growing faster than inflation, and outpacing general market returns indefinitely. It's not sustainable, but I can't tell you when that growth will stop :) As someone said, the market can stay irrational longer than you can stay solvent.

My perspective might be different, as I paid for college in Canada, not the US, but I didn't think it was that expensive, and I do think there is something to be said for adults (an 18 year old is an adult) paying their own way.

My parents made minimal contribution to my college costs, and I'm not bitter about it at all. I took out loans, then paid them off after I got a job. You do that, or work summers/during school and pay your way as you. I always thought that is just what adults do, unless you happen to be a rich kid. But again, my perspective could be different because I didn't go to school in the US.

madamwitty

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #19 on: February 25, 2015, 02:18:30 PM »
Now I'll give a thought I've been working on lately, but haven't fully researched, so someone correct me if I'm wrong:
If you put money in the 529, there is nothing to stop you (except perhaps your personal feelings on the matter) from raiding the principle later as part of your FIRE stash. 529s are different from Uniform Gifts to Minors custodial accounts, in that the funds still legally belong to you, and you can do with them as you wish.

There would be a tax penalty if you used the investment gains for non educational purposes, but as far as I understand, since the principle went in after taxes, you can withdraw that yourself without penalty at the federal level (there may or may not be impact regarding paying back state deductions).

Even if you ended up deciding/needing to take out the investment gains, I think the tax downside (paying taxes on gains + 10% penalty) isn't that bad considering you've now had 20 or 30 years of tax free compounding, plus if you are FIRE'd by that point, you might be in a very low or zero federal tax bracket. Add on top of that, if your child gets a scholarship and that is why you don't need the funds, then you can withdraw both the principal and gains, totally tax free and with no penalty.

So I'm thinking "over funding" your 529 isn't as bad as people make it out to be. In fact I think under current tax laws this could be an additional vehicle to tax shelter investment growth, use the gains for your child's educational purposes tax free, then withdraw the contribution back for your own purposes if you want. In that way, you can consider using a 529 as giving your future student an interest free loan that is invested for college.. they get the gains, you get the contribution back.
As I said, I'm still working on developing that idea, so if I misunderstood the tax implications, someone please let me know.

Withdrawals from 529 plan accounts are prorated between principal and earnings. E.g. If you have doubled you principal, each withdrawal is 50% principal and 50% earnings. You don't get to withdraw principal first as you do with Roth IRAs.

For non qualified withdrawals, principal is still not taxed but earnings are taxed as income, not capital gains. That means you get hit at your marginal income tax rate rather than the long term capital gains rate. For many Mustachians, that means 10% or 15% rather than 0%. Not to mention the 10% penalty. It's probably not the end of the world of you over-save in a 529 account, but not something you want to do intentionally.

ZiziPB

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #20 on: February 25, 2015, 02:51:03 PM »
Quote
Housing is $32,700 of that, so without housing, assuming we move for FIRE, it comes to spending of $27-38K.

Small point, but you will still have taxes and insurance so your housing costs will not go down to zero.

madamwitty

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #21 on: February 25, 2015, 03:06:19 PM »
It's probably not the end of the world of you over-save in a 529 account, but not something you want to do intentionally.

For reference, I just ran some quick scenarios on a spreadsheet and was able to make the 529 account come out ahead of a taxable investment only if the investor is in a high current tax bracket (>30-33%) AND investment returns are heavily weighted toward dividends (as opposed to value growth) AND the non-qualified withdrawals are made entirely under the taxable income threshold. I suppose theoretically someone could be in that scenario although it seems to me the more effective route would be to choose low dividend investments.

I would love for someone to find other useful scenarios, though! It would be cool if I didn't have to worry about over-saving in my 529.

LadyStache

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #22 on: February 25, 2015, 03:17:16 PM »
Regarding the 529s: we live in a state that allows us to deduct contributions on our state income tax up to $4k per account per year with unlimited carry forward to future tax years. We have been contributing about $5500 per account per year, so we would still have some tax deductions we could make on our state income taxes for a few years in the future. Does the advice to contribute less still hold given the tax deduction allowed for us?

Also, I do think college will cost a LOT for the kids. I doubt we can get one kid through college for $275K, let alone two (assuming we pay the full way, which we have no way of knowing). While we are lucky to live in a state with amazing public options, if we FIRE elsewhere, we may not. I am going to encourage each kid to work, and take a gap year, and to only consider public education (and maybe not to go to college unless it helps them achieve their goals), but I do really think it is important to give them as much of a debt-free start to life as possible. This is why we’ve been emphasizing the 529s, and it is honestly is one of my biggest worries if we do FIRE.

You stated in the beginning that you expect to spend $70,000/year in retirement, less if you move to a lower cost area.  You could still qualify for financial aid at that income level. In addition, your kids are 2 years apart, which means that they would likely attend college at the same time for 2 years, which would reduce your expected contribution. But, by increasing the assets that you have (529s) that are not sheltered from the financial aid formulas (like your home, 401k, IRA, etc.), you are significantly reducing the likelihood of your children qualifying for any financial aid whatsoever. And I believe the withdrawal penalty if the funds in the 529 are not used for qualified education purposes would likely outweigh any state tax deduction you are currently receiving.

CanuckExpat

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #23 on: February 25, 2015, 05:24:51 PM »
Withdrawals from 529 plan accounts are prorated between principal and earnings. E.g. If you have doubled you principal, each withdrawal is 50% principal and 50% earnings. You don't get to withdraw principal first as you do with Roth IRAs.

For non qualified withdrawals, principal is still not taxed but earnings are taxed as income, not capital gains. That means you get hit at your marginal income tax rate rather than the long term capital gains rate. For many Mustachians, that means 10% or 15% rather than 0%. Not to mention the 10% penalty. It's probably not the end of the world of you over-save in a 529 account, but not something you want to do intentionally.

For reference, I just ran some quick scenarios on a spreadsheet and was able to make the 529 account come out ahead of a taxable investment only if the investor is in a high current tax bracket (>30-33%) AND investment returns are heavily weighted toward dividends (as opposed to value growth) AND the non-qualified withdrawals are made entirely under the taxable income threshold. I suppose theoretically someone could be in that scenario although it seems to me the more effective route would be to choose low dividend investments.

I would love for someone to find other useful scenarios, though! It would be cool if I didn't have to worry about over-saving in my 529.

Madmwitty, thanks for clearing that up. You've obviously done more research than I have.
We shouldn't derail the original thread too much, but I am curious about your spreadsheet and calculations (and the source of your information regarding withdrawals). Maybe we could take this up in another thread?

mateoSF

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #24 on: February 25, 2015, 05:39:13 PM »
Hi Petunia - I was just eyeballing your 401k numbers (jealous just a bit), and was surprised how high your husband's is considering he's only been investing ~15 years.  Am I missing something, or was there some generous matching component?    Great savings numbers BTW!


mozar

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #25 on: February 25, 2015, 06:39:30 PM »
Your daycare isn't expensive. Your grocery and household misc are ridiculous. I live in a HCOL area as well and groceries aren't that expensive. And your household expenses...how many clothes to a 5 year old and a 3 year old need? Activities for a toddler? Gifts? What are buying these kids for their birthdays, drones? Maybe your "best efforts" will fly elsewhere but you deserve a facepunch.

On college costs I don't think that the cost will keep growing faster than inflation because at a certain point you could just give the kids the cash and they could retire.

And I don't understand how your childcare is only 700 a month. In my area it's 2000 a month.

madamwitty

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #26 on: February 25, 2015, 10:02:49 PM »
Withdrawals from 529 plan accounts are prorated between principal and earnings. E.g. If you have doubled you principal, each withdrawal is 50% principal and 50% earnings. You don't get to withdraw principal first as you do with Roth IRAs.

For non qualified withdrawals, principal is still not taxed but earnings are taxed as income, not capital gains. That means you get hit at your marginal income tax rate rather than the long term capital gains rate. For many Mustachians, that means 10% or 15% rather than 0%. Not to mention the 10% penalty. It's probably not the end of the world of you over-save in a 529 account, but not something you want to do intentionally.

For reference, I just ran some quick scenarios on a spreadsheet and was able to make the 529 account come out ahead of a taxable investment only if the investor is in a high current tax bracket (>30-33%) AND investment returns are heavily weighted toward dividends (as opposed to value growth) AND the non-qualified withdrawals are made entirely under the taxable income threshold. I suppose theoretically someone could be in that scenario although it seems to me the more effective route would be to choose low dividend investments.

I would love for someone to find other useful scenarios, though! It would be cool if I didn't have to worry about over-saving in my 529.

Madmwitty, thanks for clearing that up. You've obviously done more research than I have.
We shouldn't derail the original thread too much, but I am curious about your spreadsheet and calculations (and the source of your information regarding withdrawals). Maybe we could take this up in another thread?

At your suggestion I started a new thread here: http://forum.mrmoneymustache.com/investor-alley/529-plan-account-as-a-tax-shelter/

I may have been a bit hasty to rush to judgement on the 529 Plan. I threw a spreadsheet together in 10 minutes this afternoon and played around with the variables a bit, but it was not an exhaustive search. This evening I cleaned up my spreadsheet enough to feel comfortable sharing it, and in doing so found that there may be reasonable cases for which the 529 plan is a viable alternative [ETA: I mean, a viable alternative for a taxable account for non-qualified withdrawals. I am totally on board with 529's being excellent for college expenses!]. Check it out and let me know what you think...
« Last Edit: February 25, 2015, 10:04:48 PM by madamwitty »

fartface

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #27 on: March 01, 2015, 10:16:33 AM »
I think You pay a 10% penalty if 529 funds are not used for qualified education expenses plus tax on the gains.


aschmidt2930

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Re: Reader Case Study – Evaluate Our Five Year Plan to FIRE?
« Reply #28 on: March 01, 2015, 10:27:12 AM »
I think you're in the clear to retire in five years, even in your HCOL area.  To be honest, if you're open to moving to the Midwest or South you can probably retire today.  Assuming your home value is greater than your mortgage, you can get a pretty nice house (Double the size, at least) for the equity you have in your current house.