Stop contributing to IRAs exclusively?

[El_Viajero]

Hello! I'm crowdsourcing advice from the MMM community about my situation. I'm 30, my wife is 31, and we have an infant son... so a family of three. I've been socking away money in my Roth IRA and SEP IRA (I am self-employed) for a number of years now, but 100% of my investments are in these tax-advantaged accounts that I can't touch until I'm 59.5 years old without paying a penalty.

My question is whether I'm doing it right. I'd like to FIRE, of course, but I'm not sure what my trajectory should be. Obviously, I should keep saving and investing as much as possible, but what kind of accounts should I use for the stash? IRAs? Taxable brokerage?

At this point, I'm thinking I'll just need to get our IRA accounts up to around $300K before I turn 40, which is the point at which I could put them on autopilot for 20 years with no contributions and be totally set when I'm 60 years old (assuming 5% or higher growth over 20 years). In the meantime, however, I'd still have to work part time to cover expenses.

This scenario is realistic but I don't see how it gets me to FIRE since I'll still have to work until I'm 60 to pay the bills. I guess I could save up another ten years worth of expenses between the ages of 40 and 50 and retire at 50. That seems pretty far away, though!

So... should I start using a taxable brokerage account instead of the IRAs? I'm sort of confused about how FIRE can work for me if I stay committed to funding the IRAs given all of their restrictions. I know there are a lot of questions in here, but I guess I'm just looking for some "what would you do if you were I" responses from some experienced early retirement enthusiasts.

Here are my stats (do we call them "stats" around here?):

$45,000 net income/year... since I am self-employed this number is totally unpredictable; this year it's looking like I'll make more than 45K, but it's hard to say. I could probably make way more if I actually worked 40 hrs per week, but I can't be bothered. I value other things more than work and fewer hours keep my stress levels low. Maybe I'm already "semi-retired?"

$0 income/year for my wife... she's staying home with our son and probably won't go back to work for another 2-3 years; when she does go back, she will be working as a teacher making around $38,000 year

The stash:

$57,285.06 in index funds, all living in our Roth IRAs or my SEP IRA
$13,500 emergency fund... I know some mustachians think 911 funds are silly, but I am self-employed and having a lot of cash around is important for me.
$0 debt of any kind (we are renters and might always be; I hate mowing lawns, cleaning gutters, decorating, painting, owning and serving appliances, et al.)

$31,604.16 annual expenses the last time I calculated; this is a "give or take $2K" figure and includes all expenses for my business in addition to personal expenses and allowances for fun stuff (eating out once a month, guitar lessons, etc.)

Thoughts? With any luck, I'll be able to return the favor one day with some advice of my own.

[Kernel Fielding]

I am not an early retirement expert.

That said, if you're only investing the yearly IRA maximum of $11K for a couple for ten years to the two accounts (presuming one IRA is yours, and the other your wife's - $5.5K per person, max until you are 50 or older), you won't reach $300K unless you can average a bit better than 8% growth each year. You can access your Roth contributions before age 59.5 without penalties, but not any of the growth from it. Assuming your SEP is pre-tax dollars, your money is indeed tied up until age 59.5, unless you pay your penalties and taxes on withdrawal.

Consider setting up a taxable brokerage account and invest as much as possible in low-expense ratio total stock, total international, and total bond index funds, in the ratio which best suits your investing style and goals. Since there are no dollar limits to how much you can invest each year, once both you and your wife have combined income you'll be more likely to reach your FIRE goal, depending of course on how much you can invest and what kind of return your investments provide.

[mjb]

Assuming you have Traditional and not Roth IRAs: at that income, do you have a low enough AGI to convert some of your Traditional IRA balance tax-free to a Roth?

I'm self-employed as well, and part of plan to is get my AGI low enough to allow some headroom to do this.

[MDM]

How would an Individual 401k work for you, instead of the SEP IRA?

[MustacheNY]

With the SEP IRA, you are able to save up to about 25% of your Net Income minus half the self-employment tax.  Plus, you are able to fund $11,000 into Roth IRAs (5,500 each for you or your spouse).  The stated Net Income seems to be After Tax, which would make the actual business income closer to 60K, which would mean you could probably contribute up to $15K or so into your SEP.  That would mean a total of $26,000 available savings a year into tax advantaged savings.  You seem to only be currently saving $13K ($45K-32K).  Generally, it is better to max out all of your tax advantaged savings before you make additional contributions into non tax advantaged accounts.  You already carry a nice cash buffer for emergencies, and have access to some Roth principal tax free if it has been seasoned for 5 years, so you should be ok on the liquidity front.  The impact of taxation on your investment returns is significant, so try to get as much as possible stashed away tax advantaged.  If anything, I would recommend doing a deep dive into your expenses to see if you can find any opportunities to reduce this a little bit so you can take even greater advantage of your SEP contributions. 

[El_Viajero]

Consider setting up a taxable brokerage account...

But should I max out the IRAs every year before investing through the taxable account? I realize that the tax advantages of the IRAs are excellent, but my concern is that I won't have enough left over after maxing out the IRAs to also invest in the taxable accounts such that FIRE becomes a reality. Investing in the IRAs exclusively all but guarantees I won't be able to tap the money until we're 59.5.

Maybe FIRE just isn't realistic at our income level?

If anything, I would recommend doing a deep dive into your expenses to see if you can find any opportunities to reduce this a little bit so you can take even greater advantage of your SEP contributions. 

I don't think I can get them down any lower. We're already super mustachian in our approach: Costco, bikes, one car (no loan), no commute, modest accommodations well below our means, CFL and LED bulbs, dry our clothes in the sun, cook at home 95% of the time, index funds, no TV, library cards, cloth diapers for the kid... my "fun" budget consists of one meal out each month, 2 guitar lessons/month, a couple of yoga classes for my wife. I gave up drinking long ago, so there's no boozing and schmoozing. I buy clothes at the thrift shop or when someone gives me a Target gift card for Christmas. That's it! Even if I cut out the small indulgences of guitar/yoga it wouldn't change the status quo for us. We're not dropping big money on that stuff.

Assuming you have Traditional and not Roth IRAs: at that income, do you have a low enough AGI to convert some of your Traditional IRA balance tax-free to a Roth?

There are 2 Roths (mine and my wife's) and a SEP (mine). The Roth has better tax advantages in the long run, so I'm currently maxing that one out first. Yes, the SEP would allow me to lower my AGI each year before filing taxes as it functions like a traditional IRA. Not sure why I would convert it to a Roth, though, given that it functions as an "extra" tax advantaged account to use after I've already maxed out the Roth. In the last couple of years, I've used an HSA to lower my AGI, although I don't have an HSA-eligible plan at this point.

How would an Individual 401k work for you, instead of the SEP IRA?

I could be mistaken, but I think it would be similar albeit with slightly less flexibility and possibly a lower contribution threshold.

The bigger question is whether it makes the most sense for me to keep maxing out the IRAs first, contribute to the IRAs and a taxable account more less in tandem, or eschew the IRAs for contributions to a taxable account to increase my likelihood of FIREing.

Or just find another profession that pays more?

Or work longer hours? (Ugh)

[MDM]

How would an Individual 401k work for you, instead of the SEP IRA?

I could be mistaken, but I think it would be similar albeit with slightly less flexibility and possibly a lower contribution threshold.

No firsthand experience, but from http://investorjunkie.com/13066/sep-ira-solo-401k/ it appears the opposite (regarding contribution amounts) is true.

The bigger question is whether it makes the most sense for me to keep maxing out the IRAs first, contribute to the IRAs and a taxable account more less in tandem, or eschew the IRAs for contributions to a taxable account to increase my likelihood of FIREing.

Usually avoiding taxes leads to a better outcome than paying taxes.  Much depends on the individual circumstances.  Without knowing gross income and all the line items that lead to that $45K net it's tough to say more.  You could use http://forum.mrmoneymustache.com/ask-a-mustachian/how-to-write-a-%27case-study%27-topic/ as a guide if interested.

[El_Viajero]

Thanks for the link about solo 401K vs SEP. I'll have to think about it. As to the other point...

Usually avoiding taxes leads to a better outcome than paying taxes.  Much depends on the individual circumstances.

I completely understand. However, the tax benefits of the IRAs also come with the tradeoff of not being able to withdraw the money until I'm 59.5, making it impossible to retire early unless I've got some investments stashed somewhere else, too (i.e. an account I can access BEFORE I turn 59.5).

I don't think it's necessary to list out all my line item income stats to get some insights into that particular conundrum.

Here's the scenario I'll potentially face: Having enough money to retire early at some point EXCEPT that the money is all in my IRAs. So instead of retiring early, I'd have to say, "Well, crap. Looks like I'll have to keep working until I'm 60 to pay the bills EVEN THOUGH I've got enough money in the IRAs to last me a long, long time."

Maybe what I need are some allocation suggestions...

[RWD]

Have you read about the Roth conversion ladder?
http://www.madfientist.com/retire-even-earlier/

[MustacheNY]

With your expenses around the $30K level, you will be able to roll your IRA into a Roth IRA with no or minimal tax effect when you retire even if it is tomorrow, and have access to all of the principal.  If you roll over your annual expenses every year, and create a five year ladder of expenses seasoned in the Roth IRA, you will be able to access these tax free.  The IRA rollover to a Roth will be treated as taxable income, however, due to your low income level, it would most likely not reach the threshold that would trigger any tax impact.  Therefore, you can still focus on putting everything you can into the SEP IRA, and still have the flexibility to access this money for early retirement well before you are 59 and 1/2.

[El_Viajero]

Have you read about the Roth conversion ladder?
http://www.madfientist.com/retire-even-earlier/

No I had not, but I'm so glad you posted this link!

With your expenses around the $30K level, you will be able to roll your IRA into a Roth IRA with no or minimal tax effect when you retire even if it is tomorrow, and have access to all of the principal.  If you roll over your annual expenses every year, and create a five year ladder of expenses seasoned in the Roth IRA, you will be able to access these tax free.  The IRA rollover to a Roth will be treated as taxable income, however, due to your low income level, it would most likely not reach the threshold that would trigger any tax impact.  Therefore, you can still focus on putting everything you can into the SEP IRA, and still have the flexibility to access this money for early retirement well before you are 59 and 1/2.

This is very encouraging. I had never heard of this strategy, but it makes sense when you consider the fact that you can withdraw any contributions to a Roth without penalty.

Outstanding advice, folks!

[MDM]

I don't think it's necessary to list out all my line item income stats to get some insights into that particular conundrum.

Others have already commented well on the Roth pipeline, etc. 

Also, if really needed, you can withdraw directly from a traditional IRA at any time, including before age 59.5 - you just pay 10% extra tax for the privilege.  Not something you might want to do, but far from a catastrophe if needed.

The point of the quoted item: without knowing gross income and how much is being subtracted for taxes vs. tax-advantaged (IRA, HSA, etc.) the word "net" in "net income" is unclear.  There are various "cliffs" in the tax code, e.g., the Saver's Credit, that one can either use or miss depending on how the tax-advantaged plans are used.  You certainly don't have to provide all the details here, but investigating them for yourself could be worthwhile.

[ender]

This might be helpful - http://www.mrmoneymustache.com/2011/11/11/how-much-is-too-much-in-your-401k/