Author Topic: Case Study - sanity check before I pull the trigger  (Read 2483 times)

onelesscar

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Case Study - sanity check before I pull the trigger
« on: March 10, 2021, 09:27:20 PM »
I remember about 10 years ago when I found MMM's blog and devoured all the posts, excited in realizing that I wasn't alone in some of my feelings and tendencies.

Thank you to everyone who responds on this forum to help people think through their financial and life situations.


Life Situation:
Married filing jointly, live in a fairly high cost-of-living city, and we plan to stay here. No dependents, not yet decided if we'll have a kid. DW and I are in late-30s / early 40s, own our home (with mortgage), no other property and no interest in being landlords (we did it previously and I found it too stressful). I'm a software engineer and am planning to retire in two months, but getting up my nerve to tell my boss. DW plans to continue working. I've been talking about ER for a few years and DW is supportive of my doing it.

I have always earned more than DW and so have paid more for (first) rent and (later) mortgage, and paid all the utilities. In support of my ER, DW is now happy to start paying all the mortgage and utilities, while I'll continue paying my part of shared day-to-day expenses (eg. groceries) and my personal expenses, averaging about $1k / month.

I have lots of (zero- or low-cost) hobbies and interests outside of work and am looking forward to spending more time on them and simply having a life change.

Gross Salary/Wages:
me: $140k
DW: $110k

Average annual expenses:
A long time ago we tracked everything we spent money on, but I could tell it was a burden on DW who isn't as into bean counting as I am, so I simplified our tracking. For the past 10 years, on the first of every month, we record the balances of all our accounts, and we record the total "money out" from our credit card / checking accounts, separating out utilities, home improvement, and property taxes and property insurance. The annual averages of these buckets for the past five years are:

groceries, hobbies, travel, personal expenses: $27k
utilities: $3k
home improvement: $5k
total: $35k

Mortgage - recently refinanced to a 30-year 2.75% fixed
Monthly payment is about $1800: $580 principal, $730 interest, $470 escrow (taxes + insurance)

Expected Early Retirement expenses:
$400 / month for adding me to DW's employer health / dental / vision insurance

Assets:
$875k tax-sheltered: 401(k)s ($557k), IRAs ($9k), and Roth IRAs ($310k)
$1.2M non-tax-sheltered savings

All ($2M+) except checking accounts ($22k) invested in FSKAX or similar; we do not get skittish when the market drops (at least we haven't when we are both earning steady incomes...)

Liabilities:
None other than mortgage.


In order to calm my worries about no longer having a paycheck, I cut the numbers this way:
- For take-home pay, I get $6k, DW gets $5k
- Our (average monthly) passive change in investment value over the past 6 calendar years was: $1k, $4k, $13k, -$5k (2018), $25k, and $30k (2020) **
- Our "expenses" (cashflow out) are $2900 + $1800 (mortgage) = $4700 (this will increase $400 / mo (pre-tax out of DW's paycheck) when we have to pay for my health insurance)

So, roughly speaking, DW's paycheck almost covers our expenses, and passive income will usually dwarf it anyway.

** 2020 was an anomaly because I did a non-mustachian thing and sat on cash from our rental property sale for 9 months and invested it all when the market tanked at the beginning of COVID.


Specific Questions:

1. Based on our current savings and expenses, I think both of us could retire today. DW's income will be nice insurance as our 'stash increases. Does that look correct?

2. When I stop working, I'll lose my employer health insurance. DW's employer health insurance will cost us $400 / month (pre-tax) and will increase the deductible / OOP max from $1500 / $3000 to $3000 / $6000.  As far as I can tell, if I bought my own health insurance, whether through the open marketplace or DPC / Sedera, we would not be able to deduct the premiums, and the cost of premiums for those options are comparable to or more than DW's employer health insurance. So I should go with DW's employer health insurance, right?

3. How should I go about drawing off my savings to pay my $1k / month in my share of expenses? I would like to increase that in a year or so to again contribute to mortgage / utilities -- once we're into the 2022 tax year, our household income is lower, and I'm more comfortable with not having my paycheck. I remember reading the MMM article on Roth IRA ladder conversion, and I'm reading in other case studies here about converting 401(k)s into IRAs.  I like to keep things as simple as possible. I need to find out if our Fidelity accounts support FIFO / LIFO for whenever I need to sell a small number of shares, and I'm not sure which one is best in terms of taxes.

Thank you!!!
« Last Edit: March 26, 2021, 03:05:06 PM by onelesscar »

jeroly

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Re: Case Study - sanity check before I pull the trigger
« Reply #1 on: March 11, 2021, 04:58:12 AM »
You have around $56k of expenses not counting health insurance, and $2mm in investable assets?  Even if you need to pay $15k/yr. each for healthcare you should be okay.

You can look into a Roth conversion ladder so that you can have penalty-free access to your retirement accounts - though it might not work well if you file jointly and your wife continues to earn $110k/yr... probably will work better when both of you are retired.

If you plan to withdraw only $12k/yr you will be very fine just cashing in your taxable investments - you'll only be paying CGT on the gains, and you won't run out of taxable assets at that withdrawal rate.

zolotiyeruki

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Re: Case Study - sanity check before I pull the trigger
« Reply #2 on: March 11, 2021, 09:20:24 AM »
Yeah, you're way past having enough to both retire.  There's no financial reason for either of you to wait, at least from the information you've provided.

Once you retire and only DW is working, if she maxes out her 401k ($19,500) and you max out two IRAs ($6k each) and take the standard deduction ($25k), you're looking at roughly $53k or taxable income.  With the top of the 12% tax bracket at roughly $81k, you could convert $28k of your tax-deferred (401k/tIRA) holdings to a Roth while only paying 12% tax.

Having such a large amount in your Roth is going to be a boon to you.  Here's how:

If you both decide to retire, there's a good chance you have enough Roth IRA contributions to cover the first five years of living expenses.  Which means that, with a standard deduction, you could convert a whopping $105k/year from your 401k/IRA to your Roth and stay in the 12% bracket.  Once you've converted all your tax-deferred accounts (it'll take about 5.5 years), you can pay your living expenses each year by withdrawing a portion of those conversions, tax-free.  And *that* means that you can start capital gains harvesting--each year, sell enough taxable assets to have a $105k capital gain, take the standard deduction to stay in the 0% LTCG tax bracket, and pay zero taxes.

onelesscar

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Re: Case Study - sanity check before I pull the trigger
« Reply #3 on: March 13, 2021, 06:25:22 PM »
@jeroly - Thank you for your reassurance and suggestions on drawing off our savings.

@zolotiyeruki - this is an extremely helpful, personalized roadmap, and gets at exactly the issues I was foggy on -- thank you so much for spelling it out for me! I need to learn more about how income tax works and the techniques you recommend, but having your outline will really help me with that learning. A couple follow-up questions:

As for keeping our taxable income below $81k, don't I also have to watch out for ordinary dividends from our non-tax-sheltered index funds? That was about $12k for us last year. It seems like this would make it tricky to know how much to convert of our tax-deferred holdings to Roth in a given year since I wouldn't know our ordinary dividends before the end of a given tax year; though I would have a good idea in December and could do the conversion then?

Quote
If you both decide to retire, there's a good chance you have enough Roth IRA contributions to cover the first five years of living expenses.

What is the relevance of the "five years" in this scenario?  I know there are a couple "five-year" restrictions related to IRAs, but I'm not sure which is relevant to this situation.

Thanks again!

zolotiyeruki

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Re: Case Study - sanity check before I pull the trigger
« Reply #4 on: March 14, 2021, 11:15:23 AM »
As for keeping our taxable income below $81k, don't I also have to watch out for ordinary dividends from our non-tax-sheltered index funds? That was about $12k for us last year. It seems like this would make it tricky to know how much to convert of our tax-deferred holdings to Roth in a given year since I wouldn't know our ordinary dividends before the end of a given tax year; though I would have a good idea in December and could do the conversion then?
I believe ordinary dividends are basically treated the same as other income, so you'd need to adjust the size of your conversion down by the amount of the dividends.  You can probably make a pretty close estimate of what the dividends will be. If you're off by a little, and your income is a little over, it's not a huge deal--you'll just be paying an extra 10% tax on that little-bit-over.
Quote

Quote
If you both decide to retire, there's a good chance you have enough Roth IRA contributions to cover the first five years of living expenses.

What is the relevance of the "five years" in this scenario?  I know there are a couple "five-year" restrictions related to IRAs, but I'm not sure which is relevant to this situation.
Roth contributions can be withdrawn penalty- and tax-free at any time.  Conversions, on the other hand, have to sit in the Roth IRA for five years before they can be withdrawn penalty-free.  It's pertinent to building a Roth Pipeline.  Normally, the Roth Pipeline is done in order to access retirement savings in 401k's and traditional IRAs before the age of 59.5.  In your case, it can also be a powerful tool for minimizing your tax exposure.

MMMWannaBe

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Re: Case Study - sanity check before I pull the trigger
« Reply #5 on: March 19, 2021, 08:41:29 AM »
If you both decide to retire, there's a good chance you have enough Roth IRA contributions to cover the first five years of living expenses.  Which means that, with a standard deduction, you could convert a whopping $105k/year from your 401k/IRA to your Roth and stay in the 12% bracket.  Once you've converted all your tax-deferred accounts (it'll take about 5.5 years), you can pay your living expenses each year by withdrawing a portion of those conversions, tax-free.  And *that* means that you can start capital gains harvesting--each year, sell enough taxable assets to have a $105k capital gain, take the standard deduction to stay in the 0% LTCG tax bracket, and pay zero taxes.

I just want to say thank you!  I am a lurker, but this helps me with our retirement planning.  We have an enormous amount in our 401K's/ Rollovr IRA's.  I am fearful of the tax consequences when we get to RMD's much further down the road.  We have about $500K in our Roth accounts so we should likewise be able to employ this methodology and just keep annually converting our pre-tax IRA's once the husband stops working.

zolotiyeruki

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Re: Case Study - sanity check before I pull the trigger
« Reply #6 on: March 19, 2021, 09:24:20 AM »
If you both decide to retire, there's a good chance you have enough Roth IRA contributions to cover the first five years of living expenses.  Which means that, with a standard deduction, you could convert a whopping $105k/year from your 401k/IRA to your Roth and stay in the 12% bracket.  Once you've converted all your tax-deferred accounts (it'll take about 5.5 years), you can pay your living expenses each year by withdrawing a portion of those conversions, tax-free.  And *that* means that you can start capital gains harvesting--each year, sell enough taxable assets to have a $105k capital gain, take the standard deduction to stay in the 0% LTCG tax bracket, and pay zero taxes.

I just want to say thank you!  I am a lurker, but this helps me with our retirement planning.  We have an enormous amount in our 401K's/ Rollovr IRA's.  I am fearful of the tax consequences when we get to RMD's much further down the road.  We have about $500K in our Roth accounts so we should likewise be able to employ this methodology and just keep annually converting our pre-tax IRA's once the husband stops working.
Happy to help!  Keep in mind that it's only your Roth contributions that can be withdrawn penalty-free, while any gains need to stay put until you're 59.5.  You need 5x expenses in "accessible" places (taxable accounts, cash, Roth contributions) to cover your needs while you start your conversions.

It's worth pointing out that the opportunity to convert up to $105k each year with a 12% marginal rate is a recent thing, due to the tax law changes in 2017.  Before then, it was a steeper 15% tax up to $75k and 25% above that, with only a $12k standard deduction.

MMMWannaBe

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Re: Case Study - sanity check before I pull the trigger
« Reply #7 on: March 19, 2021, 09:36:34 AM »
If you both decide to retire, there's a good chance you have enough Roth IRA contributions to cover the first five years of living expenses.  Which means that, with a standard deduction, you could convert a whopping $105k/year from your 401k/IRA to your Roth and stay in the 12% bracket.  Once you've converted all your tax-deferred accounts (it'll take about 5.5 years), you can pay your living expenses each year by withdrawing a portion of those conversions, tax-free.  And *that* means that you can start capital gains harvesting--each year, sell enough taxable assets to have a $105k capital gain, take the standard deduction to stay in the 0% LTCG tax bracket, and pay zero taxes.


Happy to help!  Keep in mind that it's only your Roth contributions that can be withdrawn penalty-free, while any gains need to stay put until you're 59.5.  You need 5x expenses in "accessible" places (taxable accounts, cash, Roth contributions) to cover your needs while you start your conversions.

It's worth pointing out that the opportunity to convert up to $105k each year with a 12% marginal rate is a recent thing, due to the tax law changes in 2017.  Before then, it was a steeper 15% tax up to $75k and 25% above that, with only a $12k standard deduction.

Thanks for the clarification.  I did not realize this opportunity arose with the tax law changes in 2017 - hope the change is here to stay.  We do have some taxable accounts and savings so I think we should be okay.  For now the husband is working, but I want to be prepared should he decide tomorrow he is done. 

zolotiyeruki

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Re: Case Study - sanity check before I pull the trigger
« Reply #8 on: March 19, 2021, 09:54:00 AM »
If you both decide to retire, there's a good chance you have enough Roth IRA contributions to cover the first five years of living expenses.  Which means that, with a standard deduction, you could convert a whopping $105k/year from your 401k/IRA to your Roth and stay in the 12% bracket.  Once you've converted all your tax-deferred accounts (it'll take about 5.5 years), you can pay your living expenses each year by withdrawing a portion of those conversions, tax-free.  And *that* means that you can start capital gains harvesting--each year, sell enough taxable assets to have a $105k capital gain, take the standard deduction to stay in the 0% LTCG tax bracket, and pay zero taxes.


Happy to help!  Keep in mind that it's only your Roth contributions that can be withdrawn penalty-free, while any gains need to stay put until you're 59.5.  You need 5x expenses in "accessible" places (taxable accounts, cash, Roth contributions) to cover your needs while you start your conversions.

It's worth pointing out that the opportunity to convert up to $105k each year with a 12% marginal rate is a recent thing, due to the tax law changes in 2017.  Before then, it was a steeper 15% tax up to $75k and 25% above that, with only a $12k standard deduction.

Thanks for the clarification.  I did not realize this opportunity arose with the tax law changes in 2017 - hope the change is here to stay.  We do have some taxable accounts and savings so I think we should be okay.  For now the husband is working, but I want to be prepared should he decide tomorrow he is done.
I may have left a false impression--the Roth Pipeline has been a possibility for a long time.  It just became even more powerful/lucrative/efficient/whatever with the 2017 tax law changes.

 

Wow, a phone plan for fifteen bucks!