Author Topic: Getting Rich: from Zero to Hero in One Blog Post  (Read 10308 times)

Justaerin

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Getting Rich: from Zero to Hero in One Blog Post
« on: May 06, 2013, 04:05:58 PM »
Can someone clarify a few things for me?  I'm doing a LOT of reading, trying to plan my investing and retiring future for FIRE.  One thing that eludes me though, and would perhaps become more clear to me through my own experience and gaining knowledge, is how exactly to plan savings and then access it once I have enough for the 4% SWR.  I understand people say 25-33x yearly spending, adjusting based on how much they plan to spend.  I also understand that people do this different ways across taxable and tax deferred accounts, in different orders for different reasons.   MMM also mentions how to use a few 401k loopholes to access that money earlier... but I guess some of this stuff is still unclear to me.  I'm freshly out of debt and frugal (though I'm working on my Stoicism) and looking to plan my investing strategy to retire in 10 if possible.

I'm single, 32, and gross around $70k/yr depending on OT and bonuses - which I'm working to boost with new certifications. 

  • Is this ~25-33x spending savings accumulated across ALL savings accounts?  If so, once you hit that mark, do you channel all to one account to live off the SWR?  Or is that 4% SWR from all your accounts, i.e. 1% from one account, 3% from another?
  • Say i have an e-fund and am contributing to my match in a 401k - would it then be wiser to fund taxable accounts for ease of access once I hit ~25x?  Or should I max 401k, then a traditional IRA, then a Roth, then taxable account and then...?  I'm still having trouble understanding if I need to change this accounts in some way to access these funds for use.
  • Is there any type of general guideline for which types of accounts to fund in which order, and a list of milestones that you reach in savings at which point you stop funding one account in favor of another, or transfer funds, in full or in part, to another?  (I've read the "How much is too much..." post)


I'm really trying to follow the simply laid out plans, while still educating myself to develop my more personalized strategy, but the posts of "simply do this and that" leave out details that I think may be assumed or SOP to more experienced investores, but to newbs like me there's always this "how?" sitting there.

Step 1.  Save here and here
Step 2. ???
Step 3.  Profit!

I don't want to get to a point in ten years and discover I have been severely shorting myself with a poorly planned attack strategy, either prolonging my working career or making retirement less well funded.

gianetta

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Re: Getting Rich: from Zero to Hero in One Blog Post
« Reply #1 on: May 07, 2013, 01:33:45 PM »
Given that there are many things that we can't predict about the future (tax rates, inflation, health, interests & hobbies, etc.), I'm hedging my bets by using several methods - saving in a regular (employer match) and Roth (my contributions) 401k and focusing on paying down debt fast.  When the debt is gone, we'll max out the 401k contributions (not quite there yet), but also start saving in accounts that are easier to access for early retirement.

the fixer

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Re: Getting Rich: from Zero to Hero in One Blog Post
« Reply #2 on: May 07, 2013, 02:44:15 PM »
Save as much as you can in a 401(k) while your income is high, probably until you have "too much." Save additionally in the Roth if you're eligible, then in taxable. If you want to get pedantic about it, you should discount the balance of your traditional 401(k) or IRA by at least a minimal tax rate of ~15% because you're probably going to pay at least that much for each dollar you take out.

At retirement, I figure you'd strategically pick a funding source one year at a time. So at the end of a year when I have little income, I'd sell some taxable investments for next year at 0% tax on the gains, then do a partial Roth conversion on my IRA to take advantage of very low taxes. In a year where I had a decent income, I either wouldn't need to draw down the Stash at all or I'd pull money out of the Roth.

I don't think it's necessarily to understand all these ins and outs while you're in the accumulation phase; all you have to do is ensure you're giving yourself lots of different options for where to pull money from, and that you're saving enough.

sol

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Re: Getting Rich: from Zero to Hero in One Blog Post
« Reply #3 on: May 07, 2013, 04:55:26 PM »
This is a complicated questions with no single easy answer.  People save in all kinds of different places for different reasons. 

The key is making sure you have access to your money when you expect to need it.  For some people, this means only investing in taxable accounts or real estate, which have no restrictions.  For others, it means taking full advantage of tax-advantaged retirement accounts like a 401k plan and then finding ways to work around the age-based withdrawal restrictions.  I fall in the latter camp.

For an early retiree who will be spending much less in retirement than he currently earns, the tax benefits of a 401k are enormous.  You 100% avoid paying taxes now while your income is high, and then you instead pay taxes later when your spending is lower, so you pay a much smaller amount.  In some cases, you can end up never paying taxes at all if your deductions are greater than your spending, which is pretty easy to do with a family.

One common plan for utilizing a 401k while still retiring early is the 5 year pipeline rollover method.  You need to have five years of retirement spending saved up in non-restricted accounts like a savings account, taxable investment account, or Roth IRA (contributions only, not earnings since those are restricted).  Then the plan goes like this.

1.  Retire, dropping down to a much lower tax bracket.
2.  Convert one year's worth of your lower expenses from your 401k to your Roth IRA, paying the taxes immediately.
3.  Repeat that conversion every year for five years while living off of your non-restricted savings.
4.  After the first year's rollover conversion from your 401k to your Roth has seasoned for 5 years, it counts as principal and can be withdrawn penalty free and tax free from the Roth IRA.
5.  Every year you roll over another year's expenses for five years down the road, while withdrawing one year's expenses from the Roth from 5 years ago. 

This system requires you like doing paperwork or have a good accountant, but it allows you to access your 401k money tax free and penalty free at any age.  Depending on your 401k rules, you may have to convert from 401k to traditional IRA to Roth IRA instead of converting straight to Roth.

Summary:  I suggest maxing your savings to your 401k or other tax-advantaged accounts as long as you can also manage to put away 5 years of expenses in non-restricted accounts.

Justaerin

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Re: Getting Rich: from Zero to Hero in One Blog Post
« Reply #4 on: May 07, 2013, 11:57:30 PM »
Thanks all for the responses, I appreciate the insight and clarity.  They definitely help my education so far in this area as I appreciate the different perspectives.

Sol - I also really appreciate you breaking down the pipeline idea.  I remember that passage from one of MMM's posts and have it saved in my Evernote notebook fore FIRE :) But you really helped clarify it as I wasn't solid on the why and how it works.  However when you say "as long as you can also manage to put away 5 years of expenses in non-restricted accounts." I am a little confused, as I thought the five years of living expenses could be from the Roth as long as they've been there five years... so would my yearly expenses come from a combination of taxable and Roth accounts?  Or is that an incorrect understanding of how it works?

I think so far I'm leaning toward a solid e-fund, then maxing 401k (I'm already matching).  Then putting the max in a traditional IRA, then Roth and any leftover into a taxable account.  Is there anything redundant or foolish in that approach?  I believe I can roll the traditional IRA to the Roth later on down the road. 

sol

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Re: Getting Rich: from Zero to Hero in One Blog Post
« Reply #5 on: May 08, 2013, 10:42:27 AM »
However when you say "as long as you can also manage to put away 5 years of expenses in non-restricted accounts." I am a little confused, as I thought the five years of living expenses could be from the Roth as long as they've been there five years

If the money from the Roth was contributed annually and not rolled over from another retirement account, then the amount of your contributions is unrestricted.  It's a little known fact about the Roth IRA that you can get back out any money you have contributed (but not the earnings) at any point, for any reason, just like a savings account.  So in a sense, you can use your Roth IRA like an emergency fund.  The only consequence is that if you remove contributions, you can't ever put them back in.

So yes, your 5 years of living expenses can technically come from your Roth IRA.  The problem is that the contribution limit to the Roth is only $5.5k/year, which means that it will generally take more time to save up 5 years of expenses than most early retirees intend to work, unless your expenses are super super low.  For example, if your expenses are $22k/year, you'd need to contribute to your Roth for 20 years (20*5.5k=5*22k).

Quote
I think so far I'm leaning toward a solid e-fund, then maxing 401k (I'm already matching).  Then putting the max in a traditional IRA, then Roth and any leftover into a taxable account.  Is there anything redundant or foolish in that approach?

The only hiccup I see here is with the contribution limits and eligibility rules.  I'm not sure if the 401k and trad IRA share a contribution limit, but it's possible that contributing to one might reduce your available contributions to the other.  And then there are income restrictions on who can have a traditional IRA.  Teachers and some public officials have other account options that are pretty sweet, too.

My plan has always been 401k at least up to the match, then max the low-limit Roth, then max out the 401k, then anything left over goes to the taxable account.

Justaerin

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Re: Getting Rich: from Zero to Hero in One Blog Post
« Reply #6 on: May 08, 2013, 11:12:59 AM »
Excellent, thanks again.  Your responses have really helped!

secondcor521

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Re: Getting Rich: from Zero to Hero in One Blog Post
« Reply #7 on: May 08, 2013, 01:28:02 PM »
4.  After the first year's rollover conversion from your 401k to your Roth has seasoned for 5 years, it counts as principal and can be withdrawn penalty free and tax free from the Roth IRA.

Sol, can you point to a authoritative (IRS) cite for this?  (Or give me a pointer to where to look in the IRS rules?)

Sounds interesting but I always like to check everything to make sure it will in fact work before I try doing it :-)

matchewed

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secondcor521

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Re: Getting Rich: from Zero to Hero in One Blog Post
« Reply #9 on: May 08, 2013, 10:45:24 PM »
@matchewed, if that's a reply to my post (which I'm guessing it is), it doesn't seem like it says what I thought sol was saying.

Here's the thing.  I'm 44 years old and might be interested in the pipeline approach.  I've got a Roth IRA that's been in existence for five years already.  What I'd like to do is take some money from my traditional IRA, convert it over to my Roth, and use it for my spending, say, when I'm 49.

I read the link you posted, and it seems like withdrawing that conversion amount would not qualify as a qualified distribution because it does not meet rule 2(b), the 59.5 year old rule, and the rule you cite says it has to meet both criteria to be a qualified distribution.  Reading the next section ("Additional tax on early distributions"), it seems like there would be a 10% penalty on that money, which doesn't meet the "penalty free and tax free" phrase that sol used.

Color me unconvinced but still interested.  Maybe I'll google up on it.

sol

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Re: Getting Rich: from Zero to Hero in One Blog Post
« Reply #10 on: May 08, 2013, 10:55:37 PM »
Sol, can you point to a authoritative (IRS) cite for this?  (Or give me a pointer to where to look in the IRS rules?)

Sounds interesting but I always like to check everything to make sure it will in fact work before I try doing it :-)

Fact checking is always a good idea, especially with internet strangers.

This link runs through the IRS rules for you:  http://www.mymoneyblog.com/can-i-really-withdraw-my-roth-ira-contributions-at-any-time-without-tax-or-penalty.html

Alternative fact checking strategy: ask your accountant.
« Last Edit: May 08, 2013, 11:06:22 PM by sol »

secondcor521

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Re: Getting Rich: from Zero to Hero in One Blog Post
« Reply #11 on: May 08, 2013, 10:57:25 PM »
I'm rereading the IRS pub 590 carefully and I may have misinterpreted it in my earlier post.  It's a little bit unclear.

sol, thanks, I'll take a look at that article.

sol

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Re: Getting Rich: from Zero to Hero in One Blog Post
« Reply #12 on: May 08, 2013, 10:59:30 PM »
What I'd like to do is take some money from my traditional IRA, convert it over to my Roth, and use it for my spending, say, when I'm 49.

I read the link you posted, and it seems like withdrawing that conversion amount would not qualify as a qualified distribution because it does not meet rule 2(b), the 59.5 year old rule, and the rule you cite says it has to meet both criteria to be a qualified distribution.

You can only withdraw contributions from a Roth IRA without penalty.  I don't know the rules about a traditional IRA because I don't have one, but I suspect the same withdrawal loophole is not present.  If you want to withdraw from your traditional IRA you will probably pay a penalty.

But you can avoid that by not withdrawing it, but instead just rolling it over into your Roth IRA.  The paperwork is a bit more complicated, but basically you avoid having the funds labelled a "withdrawal" because they are never in your possession.  They have to transfer directly from your trad IRA to your Roth IRA.

sol

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Re: Getting Rich: from Zero to Hero in One Blog Post
« Reply #13 on: May 08, 2013, 11:05:06 PM »
Another detail:  you may not be able to withdraw your Roth IRA principal penalty-free if you invested it in a non-liquid asset like CDs that have yet to mature.

I suspect most people here are investing in mutual funds, though, so probably not an issue.

secondcor521

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Re: Getting Rich: from Zero to Hero in One Blog Post
« Reply #14 on: May 08, 2013, 11:08:39 PM »
What I'd like to do is take some money from my traditional IRA, convert it over to my Roth, and use it for my spending, say, when I'm 49.

I read the link you posted, and it seems like withdrawing that conversion amount would not qualify as a qualified distribution because it does not meet rule 2(b), the 59.5 year old rule, and the rule you cite says it has to meet both criteria to be a qualified distribution.

You can only withdraw contributions from a Roth IRA without penalty.  I don't know the rules about a traditional IRA because I don't have one, but I suspect the same withdrawal loophole is not present.  If you want to withdraw from your traditional IRA you will probably pay a penalty.

But you can avoid that by not withdrawing it, but instead just rolling it over into your Roth IRA.  The paperwork is a bit more complicated, but basically you avoid having the funds labelled a "withdrawal" because they are never in your possession.  They have to transfer directly from your trad IRA to your Roth IRA.

sol, you suspect correctly.  If you roll over an amount from a traditional IRA to a Roth IRA it is considered taxable income in the year of the rollover -- see conversions section in pub 590 here: http://www.irs.gov/publications/p590/ch02.html#en_US_2012_publink1000231030.  It also says a bit later that 401k to Roth IRA conversions are treated the same way for taxation purposes.

sol

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Re: Getting Rich: from Zero to Hero in One Blog Post
« Reply #15 on: May 08, 2013, 11:13:05 PM »
If you roll over an amount from a traditional IRA to a Roth IRA it is considered taxable income in the year of the rollover -- see conversions section in pub 590

Thanks for the clarification.  I had forgotten where the taxation was going to take place.  I intend to convert money from my TSP to a traditional IRA (apparently tax free) and then from the trad IRA to my Roth IRA (apparently taxable).  I knew I would pay tax on the conversion at some point along the line, but for some people the details could be important.

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Re: Getting Rich: from Zero to Hero in One Blog Post
« Reply #16 on: May 08, 2013, 11:29:13 PM »
I understand wanting to do your own research.  I did the same.  After reading arcane IRS publications, I determined that I can count on:

1)  Withdrawing original roth contributions (pemalty/tax free) at any time
2)  Withdrawing roth conversions  (penalty/tax free) any time after 5 years from conversion YEAR

As always, do your own diligence, but don't ask me for an authoritative cite because the IRS won't come out and say it simple-like, and can you trust some random blog?

matchewed

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Re: Getting Rich: from Zero to Hero in One Blog Post
« Reply #17 on: May 09, 2013, 04:57:56 AM »
@matchewed, if that's a reply to my post (which I'm guessing it is), it doesn't seem like it says what I thought sol was saying.

Here's the thing.  I'm 44 years old and might be interested in the pipeline approach.  I've got a Roth IRA that's been in existence for five years already.  What I'd like to do is take some money from my traditional IRA, convert it over to my Roth, and use it for my spending, say, when I'm 49.

I read the link you posted, and it seems like withdrawing that conversion amount would not qualify as a qualified distribution because it does not meet rule 2(b), the 59.5 year old rule, and the rule you cite says it has to meet both criteria to be a qualified distribution.  Reading the next section ("Additional tax on early distributions"), it seems like there would be a 10% penalty on that money, which doesn't meet the "penalty free and tax free" phrase that sol used.

Color me unconvinced but still interested.  Maybe I'll google up on it.

Yeah I'm sorry for just dropping the link and running. I've had difficulty finding a simple declarative statement myself and the publication 590 is a valuable read for nearly anyone in the US. I'm under the same impression that sol is.

As I near my FI date I'll be hitting up a tax expert/accountant myself for confirmation. It is far out enough for me that although it is the current plan, if things change on me I may miss them and be left with a large amount of "old man" money with unknown ways of getting access to it.

secondcor521

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Re: Getting Rich: from Zero to Hero in One Blog Post
« Reply #18 on: May 09, 2013, 07:40:32 AM »
Thanks everyone.  I think for now I'll consider the conversion pipeline idea to be a good idea worth looking into.  From my quick read of pub 590 last night, it looked like it was saying that if you take out the conversion amount before 5 years it is taxable, but it didn't say that if you took it out after five years that it wasn't taxable.

icefr

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Re: Getting Rich: from Zero to Hero in One Blog Post
« Reply #19 on: May 09, 2013, 10:00:53 AM »
Thanks for the clarification.  I had forgotten where the taxation was going to take place.  I intend to convert money from my TSP to a traditional IRA (apparently tax free) and then from the trad IRA to my Roth IRA (apparently taxable).  I knew I would pay tax on the conversion at some point along the line, but for some people the details could be important.

TSP -> Traditional IRA = rollover
401(k) -> Traditional IRA = rollover
Traditional IRA -> Roth IRA = conversion

Rollovers are really just transfers in kind, so that's why there are no taxes due! You pay taxes on a conversion since you're moving it to a different type of account.

the fixer

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Re: Getting Rich: from Zero to Hero in One Blog Post
« Reply #20 on: May 09, 2013, 02:46:59 PM »
Something worth mentioning here is that the 5-year Roth IRA pipeline hack is just that, a hack, and there's no guarantee legislation won't get passed to change it. I personally think it's pretty unlikely to change, but anyone relying on this should look at the situation and assess the risk.