Author Topic: What would you do? Tax advantaged or taxable?  (Read 1766 times)

rugorak

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What would you do? Tax advantaged or taxable?
« on: November 28, 2021, 07:34:01 AM »
Short version at the bottom, Long version here:

Long version:
My wife and I are expecting twins. We also have been working towards FIRE. We both are currently working but that may change once the kiddos arrive. We have been both maxing out our retirement plans. We both paused for the end of the year and beginning of next so as to build up our "Oh shit" fund just in case. All decisions are on hold until a little after kids arrive. Just in case something happens. But assuming all goes well and mom and kiddos are perfectly healthy and no other issues we are trying to figure out the best course of action. We also aren't sure if my wife will go back to work or not. I make more and with 2 at once child care would basically wipe out her paycheck anyway. Not even taking into consideration the non-financial benefits of having a parent taking care of them. Or if they are not 100% healthy, etc. We know we can make it on just my pay. Assuming no unexpected changes we still will have a little extra left over even then.

Ideally we were hoping to FIRE in about 10-15 years. It would be around 20 years before we could touch our retirement accounts without penalty. That may be to conservative or too aggressive depending what life throws us. Our current spending is around $60K a year on average which includes mortgage and some larger one time costs. Those one time costs are done for over a decade or more, but with kids I think that is still a fair estimate of annual spending. And I'd rather be high than low on the estimate. No other debt other than the mortgage. Neither of us has a match from work. My work just automatically puts money in whether I contribute or not. My wife gets nothing at all. So no leaving money on the table if we don't contribute to our work retirement accounts.

We have just short of $1 million in our retirement accounts combined. And about $20k in taxable.

Our current thought is put any extra into taxable until we have enough to cover about 5 years of expenses. Then re-assess at that point in time. But until then if we are building up our taxable it allows us more flexibility should something come up. And then we just finish building our tax advantaged until we are comfortable enough to pull the trigger. Obviously if inflation stays berserk for the long term, we have other costs, markets perform like crap, or whatever else changes we'll change. But lets not overly complicate things. Lets just assume things will more or less stay "normal" for the decade or longer time table we are looking at.

What would you do/suggest if the goal was to FIRE sooner rather than later given this?

Short version:
~$1 million in retirement accounts
~$20k in taxable investment
~$60k in spending a year
Tentatively planning to FIRE in about 10-15 years.
~20 years before we could touch retirement accounts.

Would you suggest putting extra funds into retirement funds or taxable funds?

Thanks for any suggestions. Always appreciate the perspectives!

seattlecyclone

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Re: What would you do? Tax advantaged or taxable?
« Reply #1 on: November 28, 2021, 11:22:36 AM »
1) Are you aware of the ways to get money out of your retirement accounts at any age with no penalty? You could include this in your planning. Taxable accounts of course offer the most flexibility, but that comes at a cost. Perhaps you'll find that making Roth contributions to build up a chunk of principal you can withdraw free at any time might be a better happy medium here?
2) Taking care of babies is hard. Even if your wife working outside the home is only a break-even thing from a financial perspective, she may very much appreciate the opportunity to do other (perhaps easier) work for much of the day. Also keep in mind that child care costs decrease as they get older, and being out of the workforce for a while can hurt your own earning potential. If your wife is thinking about getting back into it once the twins are in school maybe it makes more sense long-term to keep on going in her career for now.

Catbert

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Re: What would you do? Tax advantaged or taxable?
« Reply #2 on: November 28, 2021, 11:38:02 AM »
If you have any room in tax advantaged accounts for this year fill them up quick.  It appears that your taxes will be higher this year than for the next few bc of lower income if your wife stays home plus you'll have twin deductions.

For the coming years certainly put enough in 401k/TSP/etc to get whatever match is available.  Then I'd focus on taxable accounts at least until you have a years worth of money there.  Beyond that it really depends on your tax bracket current and future.

As Seattlecyclone pointed out there are ways to get to retirement saving before you're 59.5.  This assumes you're in the US.

MDM

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Re: What would you do? Tax advantaged or taxable?
« Reply #3 on: November 28, 2021, 09:28:31 PM »
Tentatively planning to FIRE in about 10-15 years.

Would you suggest putting extra funds into retirement funds or taxable funds?
If "retirement" includes both "traditional" and "Roth" then "retirement".  You then get to make the Traditional versus Roth choice.

See the Investment Order sticky for generic advice.  Won't apply to everyone, but will work well for most.

zolotiyeruki

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Re: What would you do? Tax advantaged or taxable?
« Reply #4 on: November 29, 2021, 10:19:38 AM »
The Investment Order thread is good advice, except that it's very easy to end up with all your money locked up in tax-deferred accounts that would incur a 10% penalty.

@rugorak Is any of your retirement savings in Roth accounts?  The issue I foresee is the one above, where you're 50 years old, have twice as much money as you need to retire, but will incur a 10% early withdrawal penalty.

You didn't mention If your wife decides to leave paid employment to take care of the babies (I hesitate to say "quit working," since taking care of kids is a whole lot of work), then here are my suggestions for after the babies are born:
  • max out any company match (it doesn't sound like it applies, but is worth mentioning)
  • contribute just enough pre-tax money to stay within the 12% bracket - with a $24k standard deduction, your AGI can be $107,550 and you can stay in the 12% bracket
  • max out Roth IRA contributions - contributions (but not gains) can be withdrawn penalty-free at any time, and since you're hoping to retire sooner than later, the locked-away gains aren't as much of an issue.
  • plow everything else into taxable accounts - so you can have enough "accessible" money for your first 5 years of early retirement, while you build your Roth Pipeline

You didn't mention any specific numbers regarding income or how much extra cashflow you have to invest, so it's hard to give more specific advice than the above.

(edited to fix formatting)
« Last Edit: December 04, 2021, 08:05:58 AM by zolotiyeruki »

rugorak

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Re: What would you do? Tax advantaged or taxable?
« Reply #5 on: December 03, 2021, 07:37:25 PM »
Thanks! This is what I was looking for.

I do know most of the tricks of getting money out early. Roth ladders, rule of 55, SEPP, etc. But some of the tax laws may change by that time so I don't want to put all my eggs in that basket.

We are considering everything on her decision. But her job is really stressful. Her words to me are that taking care of twins would be a lot less stressful than dealing with her job. And I cannot disagree based on what I see. They are freaking out that she will be out for 12+ weeks. She usually can't take a day off without someone bugging her. The only way they don't bug her is when they are off to. 12+ weeks and they might burn the place down. She isn't making the decision until the kids are here. I'll support her in whatever her decision is. She also won't be parenting by herself by any means. I will be working from home 4 days a week once I go back and am hoping I can get all 5. Only reason I don't have that guarantee is some internal politics. My boss and his boss are all for me being 100% remote as I have been doing it for the past 2 years and haven't set foot in the office once. But worst case one day a week. And yes I'll be working but I can give her a break on lunch or during a quick break. I'm on call 24/7365 so my boss gives me and my team a fair bit of flexibility. And with no commute can jump right into helping as soon as I am done. Honestly I'd quit if she made more and had a less stressful job. And I think we both would if we could FIRE now. We just aren't there yet.

I didn't include hard numbers on my income because I just don't know. They announced a COLA raise at work this week. 4% but they said some people may not see the full raise if they are higher in their pay grade. I think I am higher but I am not sure. They redid things a few times and took down what the salary ranges are in the pay grades. But I'll find out for sure in the next month. Also with the big unknowns on what taxes will look like next year it is hard to know either. A lot of the child tax credits are set to expire this year so if they aren't renewed it could be very different.

We do have Roth and traditional. About 25% is in Roth, the rest in traditional.

We almost did max out our retirement accounts this year. And we've been maxing them out for the past 8 years. So I'm not too concerned on the tiny bit of extra taxes for a little over a month of not contributing.

I think that for us the best bet will be following the plan laid out by zolotiyeruki. I don't have a match, but 7% additional of my salary automatically in is a lot better than most places match. Staying in the 12% bracket shouldn't require us to put anything in to pre-tax. And there is no way in hell we'll be able to get down into 10% territory. We'll see what reality brings. There are too many unknowns. We are hoping my wife and the kids will all be healthy, but we are the types of people to plan for the worst and hope for the best. But maxing out our Roth's every year shouldn't be a problem unless something really bad happens. And hopefully everything works out.

Thanks for all the comments! We appreciate it!

zolotiyeruki

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Re: What would you do? Tax advantaged or taxable?
« Reply #6 on: December 04, 2021, 08:10:36 AM »
It sounds like you've got a plan.  I wouldn't worry about trying to squeeze yourself down from the 12% bracket into the 10% bracket.  The savings are pretty tiny.

Regarding your wife's workplace, they have plenty of advance warning about her leaving, so it is 100% their responsibility to make sure her duties are covered.  IMO if it all comes crashing down after your wife leaves, you should feel zero guilt about it.

NorCal

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Re: What would you do? Tax advantaged or taxable?
« Reply #7 on: December 04, 2021, 08:29:18 AM »
I think in general, your situation is pretty good, and maxing tax advantaged accounts is a good thing.

Having only $20K in taxable is light by my personal preferences, but I acknowledge that it's a personal preference and not some true piece of wisdom.

The missing piece of the puzzle is whether you have any life plans that will require a big chunk of capital in the near future.  For example, are you planning on buying a house, moving, or buying a car with all cash in the next few years?  If so, get those funds easily accessible in a taxable account first.  These big things commonly happen around the time kids come along.

With a kid coming, I'd also bulk that taxable amount up to $50K-$100K just to add some life flexibility in case life happens.  You can go back to maxing tax advantaged accounts after that.


rugorak

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Re: What would you do? Tax advantaged or taxable?
« Reply #8 on: January 06, 2022, 09:36:02 AM »
Regarding your wife's workplace, they have plenty of advance warning about her leaving, so it is 100% their responsibility to make sure her duties are covered.  IMO if it all comes crashing down after your wife leaves, you should feel zero guilt about it.

I'm not the one that needs convincing. But hopefully once the kiddos get her that will help sway her mind.

Having only $20K in taxable is light by my personal preferences, but I acknowledge that it's a personal preference and not some true piece of wisdom.

The missing piece of the puzzle is whether you have any life plans that will require a big chunk of capital in the near future.  For example, are you planning on buying a house, moving, or buying a car with all cash in the next few years?  If so, get those funds easily accessible in a taxable account first.  These big things commonly happen around the time kids come along.

With a kid coming, I'd also bulk that taxable amount up to $50K-$100K just to add some life flexibility in case life happens.  You can go back to maxing tax advantaged accounts after that.

Oh we'd like to up that but we've been DINK's for a while so it made more sense to max out tax deferred and then put what was left in taxable. And we beefed up our cash on hand in case we need it for medical. We have no other life plans at the moment. We love our home. We've got a bit of land, a not too big house but big enough that each kid could get their own room if they want in the future. We would just lose our office. Vehicles are good. We might even go down to one if my wife stays home and I can swing 100% remote. Otherwise plan on making them both last as long as possible.

The only other thing we'll probably do is start 529's. We do have a state tax benefit and we figure if we start early even if we are tighter in the future it will continue to grow and they should be in good shape.

Again thanks to everyone for the advice. Even just the comments about the plan seeming good help us feel better that we have a decent plan.

DaTrill

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Re: What would you do? Tax advantaged or taxable?
« Reply #9 on: January 06, 2022, 01:55:25 PM »
two cents: Increase taxable contribution.  Way too much in traditional IRA.  LTCG are quite low compared to income tax rates if Traditional balance grows until RMDs. 

lutorm

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Re: What would you do? Tax advantaged or taxable?
« Reply #10 on: January 06, 2022, 02:34:49 PM »
Quote
it made more sense to max out tax deferred and then put what was left in taxable.

Except only 2% was left, it seems?

I'm confused about how one ends up with 1mil in retirement accounts and only 2% of that in taxable. Not to be rude, but it seems more like you maxed out tax deferred and then spent the rest, unless your income was magically just at the level where a reasonable savings rate equaled maxing the tax-deferred savings?

I'm asking because before I learned about FIRE I would also have equated the idea with "enough retirement savings" with "maxing out the accounts earmarked for retirement" and had felt a moral license to spend the rest since "I'm maxing out my retirement savings". Making that mental shift was one of the biggest adjustments for me.

joe189man

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Re: What would you do? Tax advantaged or taxable?
« Reply #11 on: January 06, 2022, 03:31:08 PM »
PTF

rugorak

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Re: What would you do? Tax advantaged or taxable?
« Reply #12 on: January 07, 2022, 10:48:46 AM »
You are oversimplifying the math. Yes our taxable is 2% of our retirement value today. However that doesn't mean we are spending like mad. You may have noticed I never mentioned how much we make nor how much we have in cash. Here are a few things you don't know:

1. We bought a house and took the 20% down payment out of taxable. Well worth it as we both love where we live. And it is well worth delaying FIRE a little bit. The pandemic even made it more so. And as many FIRE people have said getting to FIRE as fast as possible while being miserable is not necessarily worth it. We have a bit of wooded land that has been great for our mental health. Especially since we tend to not like being around a lot of people.
2. Our old place, which my wife bought on her own in 2007 long before we even met, did not sell or rent for over a year after we moved. We knew this was likely going in and planned for it financially. We still maxed out retirement but paying 2 mortgages meant taxable investing didn't happen. Again we planned for this and it wasn't a problem. We now have great tenants so no longer an issue. At some point we'd like to sell, but we have a great retired couple on a fixed income who take great care of the place. So we are content to let them live there and pay us rent. They have no interest in buying. And we've been able to cover the mortgage, taxes, insurance, and occasional things that break (like the water heater). It really doesn't make us a lot of money but we aren't losing money and rarely need to do anything.
3. We save a lot more of our gross pay than we spend. It has just been lopsided over the years with most going into tax advantaged.
4. Since taxable was reduced for our down payment and we had a period we didn't contribute to it, we've had a lot more growth in our retirement than our taxable just because of time in the market.
5. We do put extra down on our mortgage every month as well. We know the math doesn't always work. However when interest rates dropped we just figured out how much extra we needed to put down to make our effective rate lower than the going rates. It was our way of diversifying our risk. It is a balance of the math and the security of knowing we will have the house paid off sooner.
6. We had some medical costs both planned and unplanned over the years that have taken small bites out of what we could invest. We have decent insurance for the US but it still sucks compared to the rest of the world.
7. 4 years ago we were rear ended by a tractor trailer. And since my car was 12 years old at the time the payout was way too small to get anything equivalent as we had that thing in great shape and it easily would have ran another 10 years. We were able to pay cash for the new to us used vehicle that was in good shape and good on gas. But it still was a few thousand dollars we would have been able to invest otherwise.

I don't know why the sudden negativity that we are spend thrifts and how can we possibly have so little saved in taxable. We would rather live a decent life now and not be miserable trying to get to FIRE and have it be a little later in coming. We spend on things we feel are worth it in the grand scheme of things. Having a good home we love where we spend most of our time. Even more so since the pandemic. Working towards having a family. We may be slower FIRE than some but we are not typical save 0-15% types either. And life happens. We've had some hiccups like most people do. But unlike most people we were able to take it in stride and still have a ton more in retirement than people actually at traditional retirement age.

Honestly I thought about not responding to this at all. But I wanted to let people who might otherwise be discouraged know that life happens. You'll most likely have some bumps in the road. And it is ok. There are many paths to FIRE. My view on FIRE has been that it is a goal I am going to try and get to, but it isn't my only single minded focus. I am going to live now as well. And if I don't actually retire early that is ok. Trying to still puts us in an immensely better position that most people.


LightStache

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Re: What would you do? Tax advantaged or taxable?
« Reply #13 on: January 07, 2022, 11:24:30 AM »
I read @lutorm's post as more probing than accusatory. Given the info provided, seems like a reasonable line of inquiry.

The picture you painted is just a little atypical and the deferred-taxable ratio definitely stands out. That ratio, your age, and long planned working life means that the regular investment order doesn't apply to you.

If you work for 15 more years, your tax deferred balance could be $3.1M without any additional contributions. If you then start to make withdrawals, even at a modest 6% pa, that will mean paying income tax on $186K/yr. And that will probably go higher when you hit RMDs.

So I agree with @DaTrill that you should shift to taxable (except getting the match of course), assuming that'll put you down in the 12% or 22% brackets. If you're up in the 24% bracket, then more tax deferred may be warranted. My goal would be to save enough for the first five years of a Roth conversion in case you change your mind and want to RE before 15 years are up.

rugorak

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Re: What would you do? Tax advantaged or taxable?
« Reply #14 on: January 07, 2022, 12:00:39 PM »
I read @lutorm's post as more probing than accusatory. Given the info provided, seems like a reasonable line of inquiry.

The picture you painted is just a little atypical and the deferred-taxable ratio definitely stands out. That ratio, your age, and long planned working life means that the regular investment order doesn't apply to you.

If you work for 15 more years, your tax deferred balance could be $3.1M without any additional contributions. If you then start to make withdrawals, even at a modest 6% pa, that will mean paying income tax on $186K/yr. And that will probably go higher when you hit RMDs.

So I agree with @DaTrill that you should shift to taxable (except getting the match of course), assuming that'll put you down in the 12% or 22% brackets. If you're up in the 24% bracket, then more tax deferred may be warranted. My goal would be to save enough for the first five years of a Roth conversion in case you change your mind and want to RE before 15 years are up.

Not all of that 1 million is in tax deferred. About 25% of that is in Roth. But you've pretty much laid out the plan. Who knows maybe we'll find we are way ahead of the game and don't have to work as long as we are thinking. But with health insurance costs I'd rather have too much than not enough. Even when we eventually hit 65 and have Medicare, there are still a lot of additional costs. I see it with my parents. Not to mention there is no dental, etc. Until then we'll pay for initial kiddo costs and start putting spare money into 529's and taxable.

Apologies if I took it more as accusatory and it wasn't meant that way. It just read to me as we are spending way too much.