Author Topic: Breaking the taboo of the 10% early withdrawal penalty  (Read 7578 times)

sirdoug007

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Breaking the taboo of the 10% early withdrawal penalty
« on: June 17, 2015, 03:05:26 PM »
I was recently going over my current and project savings as I am a few months away from getting married and realized, the way things are shaping up, our budget will make it difficult to save 5 years of expenses in a taxable account.  A huge portion of our budget is going to our 401(k)s, HSAs, and to a 15 year mortgage at 3%.  I began thinking maybe I should throttle back on the 401(k) to get that 5 year nugget that will bridge us until the Roth Ladder allows unpenalized access to the 401(k) money...

As those of us who have been around here for any significant amount of time know, there are basically three ways to access your 401(k) money before 55:

1. Build a Roth ladder of Roth conversions and pay income tax on the amount converted.  After 5 years the contribution amount from 5 year ago will be available without any additional tax.  This strategy of annual roth conversions continues throughout early retirement.
2. Set up Substantially Equal Periodic Payments (SEPPs) or 72(t) payments.  This method allows you to access close to 4% of your 401(k) each year (calculations described here: http://www.bankrate.com/calculators/retirement/72-t-distribution-calculator.aspx).  However, big con: you are locked in until age 59.5.  If you decide to start another career or your side gigs start paying off you may be paying a lot of extra taxes.
3. The dreaded 10% extra penalty on early withdrawals!!!!!  Oh no!!!  All of your tax advantages just went down the drain right?

Seeing a significant hurdle to saving 5 years expenses in a taxable account while maxing the 401(k)s and HSAs, and wanting to avoid the inflexibility of SEPPs (early retirement is all about flexibility right!), I started to look closer at #3.  After doing the math, I was surprised to find the tax advantages to still outweigh even the supposedly painful penalty!

Let's take two scenarios.  The MMM-like $25k/year couple and the notso-MMM $40k/year couple. 

Let's say in both cases, the couples make $150k/year with two earners.  The marginal tax rate for the couples while working would be firmly in the 25% bracket so all 401(k) contributions would avoid this 25% tax and, therefore, any money not put into maxing out the 401(k) (including any Roth contributions) would pay this 25% tax. 

In the early years of retirement, the couples have a huge 401(k) balance but relatively little in outside accounts.  Wishing to avoid the handcuffs of the 72(t) rule SEPPs, the couples start a Roth ladder AND take out enough to cover living expenses for the first 5 years.

Here's how the taxes come out (using 2014 tax brackets):
MMM-like couple ($25k/year expenses) takes out $25k and rolls $25k to a Roth for $50k total: Federal income taxes are $3,551 + $5,000$2,500 penalty for a total of $8,551$6,061.  This is an effective tax rate of 17.1%12.1%
notso-MMM couple ($40k/year expenses) takes out $40k and rolls $40k to a Roth for $80k total: Federal income taxes are $8,051 + $8,000$4,000 penalty for a total of $16,051$12,051.  This is an effective tax rate of 20.0%15.1%   [Edited to correct penalty amount only on withdrawal, not Roth conversion]

Note, in both cases, the effective tax rate is less than the 25% tax they would have paid not maxing out their 401(k)s and contributing to a taxable account!  So where is the break point?  $133,000 or expenses of $66,500/year.  About $235,000 total withdrawal or $117,500/year in expenses!  Note the break point for those in the 15% marginal bracket is just under $40k/year in expenses as the notso-MMM couple is at 15.1% paying the "penalty."

So there you have it.  For high earning mustachian, max out your HSA and traditional 401(k) first before you put your money elsewhere (unless you have some awful investment options).  If you aren't maximizing your tax deferred accounts, you are likely giving the IRS more money than necessary.  Tax deferral is a wonderful thing for a high earning mustachian!  And then, of course, once those are maxed start putting money in your taxable account or Roth IRA.

Thoughts?  Does the tax advantage in spite of the penalty surprise anyone else?
« Last Edit: June 17, 2015, 03:42:30 PM by sirdoug007 »

sol

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #1 on: June 17, 2015, 03:11:06 PM »
I agree that just taking the penalty is the optimal solution for some people because of the up front tax savings.

Remember that you can also withdraw your existing roth ira principal contributions tax and penalty free, as part of your otherwise required Roth pipeline bridging funds.  They're only about 5k/year, but if you've been making them for a decade or more they may add up to a significant portion of your required five years of expenses.

forummm

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #2 on: June 17, 2015, 03:16:49 PM »
If you have a Roth IRA or Roth 401k you can pull out your contributions at any time. You could also take out a loan to fund your expenses (like refinancing your mortgage and putting all that money into a CD ladder). Even if both of those together don't equal 5 years of spending, at least you're only stuck with a shorter amount of 72t or penalties.

You probably would benefit from having a 30 year fixed rate mortgage anyway...

seattlecyclone

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #3 on: June 17, 2015, 03:24:49 PM »
Here's how the taxes come out (using 2014 tax brackets):
MMM-like couple ($25k/year expenses) takes out $25k and rolls $25k to a Roth for $50k total: Federal income taxes are $3,551 + $5,000 penalty for a total of $8,551.  This is an effective tax rate of 17.1%
notso-MMM couple ($40k/year expenses) takes out $40k and rolls $40k to a Roth for $80k total: Federal income taxes are $8,051 + $8,000 penalty for a total of $16,051.  This is an effective tax rate of 20.0%

I believe you're overstating the early withdrawal penalty. There is no penalty owed for the portion converted to Roth, meaning the couples in your example would only owe $2,500/$4,000 of penalty, lowering their effective tax rates to 12.1%/15.1%.

You're very right about the taboo surrounding this penalty. I've seen too many people completely dismiss the idea of paying an early withdrawal penalty, simply because the word "penalty" implies you're doing something you're not supposed to do, and most of us try to follow the rules. If you can structure things so you can max out your tax deductions while working and avoid paying early withdrawal penalties while you're retired, great! If not, do the math to see which option is best for you and don't let the word "penalty" scare you!
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sirdoug007

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #4 on: June 17, 2015, 03:31:18 PM »
You can pull out Roth contributions, but the math says you shouldn't make any Roth contributions until you max out your traditional contributions in the high earning (firmly 25%+ marginal) scenario. 

The obvious solution is to put a good chunk in a taxable/roth account AFTER maximizing the tax deferred accounts.  That said, many people think the Roth is some sort of super account.  In the vast majority of cases traditional 401(k)/IRA is the optimum tax minimization method and should be fully utilized before moving to other types of accounts.

sirdoug007

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #5 on: June 17, 2015, 03:32:45 PM »
Here's how the taxes come out (using 2014 tax brackets):
MMM-like couple ($25k/year expenses) takes out $25k and rolls $25k to a Roth for $50k total: Federal income taxes are $3,551 + $5,000 penalty for a total of $8,551.  This is an effective tax rate of 17.1%
notso-MMM couple ($40k/year expenses) takes out $40k and rolls $40k to a Roth for $80k total: Federal income taxes are $8,051 + $8,000 penalty for a total of $16,051.  This is an effective tax rate of 20.0%

I believe you're overstating the early withdrawal penalty. There is no penalty owed for the portion converted to Roth, meaning the couples in your example would only owe $2,500/$4,000 of penalty, lowering their effective tax rates to 12.1%/15.1%.

You're very right about the taboo surrounding this penalty. I've seen too many people completely dismiss the idea of paying an early withdrawal penalty, simply because the word "penalty" implies you're doing something you're not supposed to do, and most of us try to follow the rules. If you can structure things so you can max out your tax deductions while working and avoid paying early withdrawal penalties while you're retired, great! If not, do the math to see which option is best for you and don't let the word "penalty" scare you!

Ahh thanks, I'll edit the original post to correct this error. 

My point is exactly as you say, don't be scared by a "penalty" unless you determine it really is worse than your other options.

sol

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #6 on: June 17, 2015, 03:37:54 PM »
I read an article a few days ago about wealthy neighborhoods in California openly flaunting their new water restrictions due to the drought.  In a neighborhood where the average household income is over $200k/year, the $100 fines weren't turning out to be much of an incentive.

And OJ got off scott free. 

Sometimes paying the piper is the cheapest option.

dandarc

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #7 on: June 17, 2015, 03:39:25 PM »
If you have a Roth IRA or Roth 401k you can pull out your contributions at any time. You could also take out a loan to fund your expenses (like refinancing your mortgage and putting all that money into a CD ladder). Even if both of those together don't equal 5 years of spending, at least you're only stuck with a shorter amount of 72t or penalties.

You probably would benefit from having a 30 year fixed rate mortgage anyway...
If it is a Roth 401K, remember to roll it to a Roth IRA first.  Direct Roth 401K withdrawals are pro-rated between contributions and earnings, while Roth IRA withdrawals hit contribution amounts first.

forummm

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #8 on: June 17, 2015, 03:39:50 PM »
You can pull out Roth contributions, but the math says you shouldn't make any Roth contributions until you max out your traditional contributions in the high earning (firmly 25%+ marginal) scenario. 

The obvious solution is to put a good chunk in a taxable/roth account AFTER maximizing the tax deferred accounts.  That said, many people think the Roth is some sort of super account.  In the vast majority of cases traditional 401(k)/IRA is the optimum tax minimization method and should be fully utilized before moving to other types of accounts.

I would think firmly 25%+ bracket mustachian folks would all have Roths. You can't get deductible traditional IRA contributions and you make enough that you should have plenty of money to max out the 401ks and the Roths and even save more on top of that.

But your point about the penalty is well taken. I personally look forward to not having to pay it :)

MDM

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #9 on: June 17, 2015, 03:42:28 PM »
A huge portion of our budget is going to our...15 year mortgage at 3%.  I began thinking maybe I should throttle back on the 401(k) to get that 5 year nugget that will bridge us until the Roth Ladder allows unpenalized access to the 401(k) money...

In addition to the other good comments already made, you could invest in taxable accounts instead of overpaying the mortgage, thus keeping your money liquid and requiring even less in IRA withdrawals.

forummm

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #10 on: June 17, 2015, 03:45:48 PM »
And OJ got off scott free. 

Totally off topic. OJ's freeway chase was 21 years ago today.

sirdoug007

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #11 on: June 17, 2015, 03:48:32 PM »
I understand the advantages of a 30 year with the current low rates and have made a conscious choice to stick with the 15 year.  My point of the post was to openly discuss the real impact of the penalty.

I can likely find some more spending reductions and future raises to both fully fund the HSA/401(k)s and get a 5 year taxable or Roth account on the right track.  This exercise completely convinced me I should absolutely not back off on the 401(k) contributions to do so, which is the question I was pondering.
« Last Edit: June 17, 2015, 03:50:29 PM by sirdoug007 »

NathanP

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #12 on: June 17, 2015, 03:52:43 PM »
You can pull out Roth contributions, but the math says you shouldn't make any Roth contributions until you max out your traditional contributions in the high earning (firmly 25%+ marginal) scenario. 

The obvious solution is to put a good chunk in a taxable/roth account AFTER maximizing the tax deferred accounts.  That said, many people think the Roth is some sort of super account.  In the vast majority of cases traditional 401(k)/IRA is the optimum tax minimization method and should be fully utilized before moving to other types of accounts.

I would think firmly 25%+ bracket mustachian folks would all have Roths. You can't get deductible traditional IRA contributions and you make enough that you should have plenty of money to max out the 401ks and the Roths and even save more on top of that.

But your point about the penalty is well taken. I personally look forward to not having to pay it :)

This is not true for many "firmly" 25% couples. In 2015 the 25% bracket starts around $75k of taxable income for a married couple, but the deductible IRA phaseouts are around $100k (for those with workplace retirement accounts). My wife and I usually fall into this gap where we can partially fund deductible IRAs and then Roth the rest.

I just wanted to clarify this in case anyone else falls into this income range after the many pre-tax deductions (401k * 2 + HSA + Childcare).

MDM

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #13 on: June 17, 2015, 03:53:34 PM »
I would think firmly 25%+ bracket mustachian folks would all have Roths. You can't get deductible traditional IRA contributions....

Maybe, maybe not.

Assuming standard deduction and 2 exemptions for MFJ status, the AGI that translates to the 25% marginal bracket is $95,600 to $171,800.
The tIRA is fully deductible up to $98,000 (M)AGI, leaving a small window of possibility.... :)

But yes, if by "firmly" ones means something such as "more than 10% above the minimum" then deductible tIRAs would not be feasible.

dandarc

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #14 on: June 17, 2015, 03:59:38 PM »
I would think firmly 25%+ bracket mustachian folks would all have Roths. You can't get deductible traditional IRA contributions....

Maybe, maybe not.

Assuming standard deduction and 2 exemptions for MFJ status, the AGI that translates to the 25% marginal bracket is $95,600 to $171,800.
The tIRA is fully deductible up to $98,000 (M)AGI, leaving a small window of possibility.... :)

But yes, if by "firmly" ones means something such as "more than 10% above the minimum" then deductible tIRAs would not be feasible.
We were close to this exact scenario for 2014 - after $7460 in tIRA contributions (most we could deduct - rest went to Roth), taxable income was $74,700 - a bit into the 25% bracket.  I know a lot of people like to be all or nothing on the tIRA vs. rIRA each year, but that partial deduction was pretty valuable for us - $1800 lower tax bill for 2014.

skyrefuge

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #15 on: June 17, 2015, 04:27:50 PM »
Good post. I've made the same argument before, and it's nice to have the irrationality of the taboo highlighted in its own thread.

It makes me wonder what other cases there might be where artifacts of language subconsciously bias our financial decisions (e.g., "penalties" are things that must be avoided at all costs!) One possibility I can think of is the discussion around stock buybacks, where the phrase "poorly-timed buybacks destroy shareholder value" is frequently uttered. I wonder how much more favorably buybacks would be viewed that word "destroy" was replaced with a more-benign-sounding synonym, like "diminish" or "reduce".

As I said in my post, I think the 401(k) "penalty" taboo is actually an awesome success story, because the impression that 401(k) money is untouchable is precisely what we as a society want the general public to believe. It's brilliant that we were able to instill that belief using mostly language (as opposed to jacking the penalty up to 50%), because it gets the main message across while still allowing flexibility for hackers like us who can see that the bars holding our money in are not actually as impenetrable as most believe.

forummm

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #16 on: June 17, 2015, 04:43:57 PM »
Good post. I've made the same argument before, and it's nice to have the irrationality of the taboo highlighted in its own thread.

It makes me wonder what other cases there might be where artifacts of language subconsciously bias our financial decisions (e.g., "penalties" are things that must be avoided at all costs!) One possibility I can think of is the discussion around stock buybacks, where the phrase "poorly-timed buybacks destroy shareholder value" is frequently uttered. I wonder how much more favorably buybacks would be viewed that word "destroy" was replaced with a more-benign-sounding synonym, like "diminish" or "reduce".

As I said in my post, I think the 401(k) "penalty" taboo is actually an awesome success story, because the impression that 401(k) money is untouchable is precisely what we as a society want the general public to believe. It's brilliant that we were able to instill that belief using mostly language (as opposed to jacking the penalty up to 50%), because it gets the main message across while still allowing flexibility for hackers like us who can see that the bars holding our money in are not actually as impenetrable as most believe.

How about "voluntary early access incentive remittance"?

Bob W

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #17 on: June 17, 2015, 05:12:25 PM »
Ref I for 30.  You can thank me in 15 years when inflation is 6%,  home loans are 10% and your stock investments have doubled.
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clifp

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #18 on: June 17, 2015, 05:44:54 PM »
I am trying hard to understand how somebody who is making a $150k and able to live on $40K isn't saving a huge amount in an after tax account 150K -40k living expense- 36K 401K contributions -11K Roth leaves 64K/year to pay taxes, work related expense that's plenty to establish several years of living expenses.  Still for the sake off argument lets says that you can't. I still think you are much better off using 72(t) and back door roth conversions then paying the penalty.

Let assume a 50 year old couple with 900K in 401K and 100K in IRA started 5 years ago. If they set up a SEPP/72(t) with say $750K of their 401K that would allow them to withdraw $30,676 per year. They also withdraw say $10K of contributions from their ROTH IRA.  And they do a back door ROTH conversion of an additional 10K. They don't owe much taxes on 40K AGI (the roth contribution withdrawal is tax free.)

Now let say for what ever reason you decide to go back to work. You can reset your 72(t) (once) back to the minimum level which is 22K. Even if you both go back to work and start making 150K, you'll pay taxes of say 25% on the 22K = $5,500 not a lot more than $4,000 you paid in penalties for an early withdrawal. If only one of you go back  to work you'll like be in the 15% bracket and you'll only pay 15% of the 22K =$3,300 less than $4K penalty you paid
« Last Edit: June 17, 2015, 05:57:25 PM by clifp »

sirdoug007

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #19 on: June 17, 2015, 05:50:25 PM »
Sounds like a nice crystal ball you have Bob.  Can you tell me what the price of the S&P500 will be in 2030 too?  How about tesla stock? ;)

I just refi'd from 4.5% to 3% so I'm not super eager to pay more origination fees.  15 year may not be perfect but it ain't bad. Especially at 3%.  Having a paid off house before 50 will be a nice thing.   

The real thing you guys should be facepunching me for is saying I will have trouble saving another $12k/year beyond 2x 401(k)s and a HSA with a $150k+ household income :)


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seattlecyclone

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #20 on: June 17, 2015, 06:03:17 PM »
I would think firmly 25%+ bracket mustachian folks would all have Roths. You can't get deductible traditional IRA contributions....

Maybe, maybe not.

Assuming standard deduction and 2 exemptions for MFJ status, the AGI that translates to the 25% marginal bracket is $95,600 to $171,800.
The tIRA is fully deductible up to $98,000 (M)AGI, leaving a small window of possibility.... :)

But yes, if by "firmly" ones means something such as "more than 10% above the minimum" then deductible tIRAs would not be feasible.

The 25% bracket + deductible IRA window is bigger for single people. Assuming standard deduction and one exemption, the 25% bracket is $47,750 to $101,050 AGI. The traditional IRA is fully deductible up to $61k and phases out up to $71k. That's a pretty big window where you can deduct both.

To clifp's point, I would also expect most single Mustachians with gross income over $65k (the minimum to max out your 401(k) and still be in the 25% bracket) would also be able to max out an IRA and save something in a taxable account on top of that. That taxable account will then reduce or eliminate the need to pay early withdrawal penalties in retirement. But for the person with a few anti-Mustachian spending habits who can't quite max out their 401(k) and IRA, they'll likely be better off if they look past the taboo and pay the penalty rather than scaling their tax-advantaged contributions back while working to build up a larger taxable stash.
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Daisy

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #21 on: June 17, 2015, 07:04:04 PM »
Good point.

An addendum is that you really only have to do this for 5 years until your Roth conversion pipeline is all set up. If you have some taxable investments you may not need to do it all 5 years either.

Addendum #2, once you hit the age of 59.5, then there's no need to convert to the Roth IRA anymore as you can pull money out of the traditional IRA without penalty. However, you may still decide to convert some money to Roth if your expenses are less than the max 15% tax bracket and you want to take advantage of that 15% tax bracket space to get some more money growing tax free in your Roth.

You could also decide to alternate years. One year you convert $40k to a Roth and use taxable investments or a part-time job. Next you you can pull $40k from traditional IRA to live on.

If you do double up on Roth conversion and IRA withdrawal in one year (your $80k example), then might as well take advantage of the standard deduction games http://forum.mrmoneymustache.com/ask-a-mustachian/standard-deduction-games/ to maximize your deductions the year you have $80k income vs. the $40k income years. The years with lower income you take just the standard deduction.

(Hey if skyrefuge can reference his own posts then so can I)
« Last Edit: June 17, 2015, 07:06:21 PM by Daisy »

Cathy

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #22 on: June 17, 2015, 07:58:16 PM »
There is no 10% penalty for early distributions from a qualified retirement plan, according to the IRS and at least one judge of the Tax Court. (See my previous post for details.) There is, however, a 10% "additional tax" that may apply.
« Last Edit: June 17, 2015, 08:02:08 PM by Cathy »
This post contains only general information on the issues raised by this topic. This post does not provide help tailored to your specific situation. There are many facts that could be relevant to your specific situation and I am not in possession of those facts. If you need help tailored to your specific situation, you should retain an appropriate professional and not rely on this post.

sirdoug007

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #23 on: June 17, 2015, 08:17:22 PM »
Notice how the IRS is careful to say "additional tax" and media outlets and banks say "penalty".

http://lmgtfy.com/?q=10%25+early+withdrawal+penalty


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Bob W

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #24 on: June 17, 2015, 08:27:37 PM »
Sounds like a nice crystal ball you have Bob.  Can you tell me what the price of the S&P500 will be in 2030 too?  How about tesla stock? ;)

I just refi'd from 4.5% to 3% so I'm not super eager to pay more origination fees.  15 year may not be perfect but it ain't bad. Especially at 3%.  Having a paid off house before 50 will be a nice thing.   

The real thing you guys should be facepunching me for is saying I will have trouble saving another $12k/year beyond 2x 401(k)s and a HSA with a $150k+ household income :)
Shit 3%,  why didn't you say so.   Tesla stock will be close to worthless by 2030.  It appears that driverless cars rule the day by then and only 1/10th the cars are needed with a membership on demand auto model being dominated by Uber/Google.   Alas Elon died in a freak accident in 2019 and the company lost vision.

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Daisy

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #25 on: June 17, 2015, 08:43:44 PM »
Just thought of a downside to this - too much income in one year will take you out of ACA subsidy land.

So be careful on doubling up on Roth conversion and traditional IRA withdrawal in one year that may end your ACA subsidies.

CorpRaider

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #26 on: June 18, 2015, 06:06:27 AM »
Good post to highlight that this commonly cited reason for being reticent to heavily contribute to tax advantaged accounts is really sort of a red herring.  In your situation, it seems you could easily access your equity in your home to fund any short term liquidity shortfalls while getting your roth conversion ladder going.  If you don't want to hold up on your aggressive investments in your sub 1% after tax, real (but guaranteed) investment in early retirement of your mortgage, you could always take out a HELOC or something to pull some of that cash out of your real estate/home.  I would expect the after tax, real rate on that to be lower than the combined effective tax rate on the early withdrawals.
« Last Edit: June 18, 2015, 06:28:34 AM by CorpRaider »

brooklynguy

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #27 on: June 18, 2015, 08:06:51 AM »
There is no 10% penalty for early distributions from a qualified retirement plan, according to the IRS and at least one judge of the Tax Court. (See my previous post for details.) There is, however, a 10% "additional tax" that may apply.

Interesting.  So, at least originally, it wasn't a case of language influencing perception, but perception influencing language (though now that use of the "penalty" label has become so widespread, language may in turn be influencing perception).

I think a better explanation for the "taboo," though, is that it is an example of loss aversion run amok, where people's tendency to want to avoid paying costs (whether labeled as a "penalty," "tax" or otherwise) ironically causes them to incur unnecessary higher costs.  Another example is in the context of the mega back door Roth, where a common initial reaction is to park funds in a low-growth investment vehicle (like a money market fund) pending the rollover to avoid incurring gains in order to avoid payment of any taxes on the earnings, even though that would result in a lower net total amount (it's better to have taxed earnings than no earnings!).  In that context, it can't be artifacts of language that are driving the behavior (even if people sometimes use the "penalty" label for the tax on the earnings), because anyone willing to engage in a financial shenanigan like the mega back door Roth clearly has no qualms about conducting tax avoidance to the fullest extent permitted by the law!

Fuzzy Buttons

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #28 on: June 18, 2015, 09:01:49 AM »
This is exactly what I began doing with my IRA last year.  I'm in that window of the early 25% bracket for single filers, and I chose a traditional IRA instead of a roth.  My spending is easily down in the 15% range.  Every now and then I find myself thinking "Maybe I should do roth instead so the contributions are available" and I have to remind myself "They're still available in the traditional, dummy!  That's the whole point of that math!"

The only time it will work out poorly is if I have to withdraw from the IRA while still earning regular income, so that I'd have to pay in the 25% bracket as well as the additional 10%.  But I don't see what sort of financial emergency that would be that would also allow me to keep my job.  Losing my job is the emergency.  Even huge medical bills would likely result from something that would put me out of work as well.

forummm

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #29 on: June 18, 2015, 10:55:04 AM »
This is exactly what I began doing with my IRA last year.  I'm in that window of the early 25% bracket for single filers, and I chose a traditional IRA instead of a roth.  My spending is easily down in the 15% range.  Every now and then I find myself thinking "Maybe I should do roth instead so the contributions are available" and I have to remind myself "They're still available in the traditional, dummy!  That's the whole point of that math!"

The only time it will work out poorly is if I have to withdraw from the IRA while still earning regular income, so that I'd have to pay in the 25% bracket as well as the additional 10%.  But I don't see what sort of financial emergency that would be that would also allow me to keep my job.  Losing my job is the emergency.  Even huge medical bills would likely result from something that would put me out of work as well.

Hopefully you have health insurance. That would cap your medical bills.

Fuzzy Buttons

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #30 on: June 18, 2015, 01:15:16 PM »
Hopefully you have health insurance. That would cap your medical bills.

Maybe, maybe not.  Balance billing and other quirks are always there.  I don't trust the health insurance industry a bit.  But hopefully, yes.

forummm

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #31 on: June 18, 2015, 01:26:12 PM »
Hopefully you have health insurance. That would cap your medical bills.

Maybe, maybe not.  Balance billing and other quirks are always there.  I don't trust the health insurance industry a bit.  But hopefully, yes.

Balance billing is a pain. Generally you can get rid of it (as the article mentions) or just choose not to pay. It damages your credit of course if they send it to collections. But as a retiree maybe you don't need new credit. I don't trust the health industry either. They just throw those other names on the bill to pad their profits.

Fuzzy Buttons

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #32 on: June 18, 2015, 01:33:22 PM »
Hopefully you have health insurance. That would cap your medical bills.

Maybe, maybe not.  Balance billing and other quirks are always there.  I don't trust the health insurance industry a bit.  But hopefully, yes.

Balance billing is a pain. Generally you can get rid of it (as the article mentions) or just choose not to pay. It damages your credit of course if they send it to collections. But as a retiree maybe you don't need new credit. I don't trust the health industry either. They just throw those other names on the bill to pad their profits.

You are correct, in the article I linked the insurance did cover the unexpected bill.  That one just stuck in my memory, but I didn't reread it before posting.  My bad.  Not a good example, though many others can be found as you mentioned.  And it is of course not just the health insurance companies, but the medical providers as well. 

I guess mostly it's just that the entire medical-industrial complex gives me a feeling of being vulnerable.  But, as to the original point of the thread, not enough that I think it's likely.  Just something that gives me stress if I think about it.  :(

forummm

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #33 on: June 18, 2015, 01:59:15 PM »
Hopefully you have health insurance. That would cap your medical bills.

Maybe, maybe not.  Balance billing and other quirks are always there.  I don't trust the health insurance industry a bit.  But hopefully, yes.

Balance billing is a pain. Generally you can get rid of it (as the article mentions) or just choose not to pay. It damages your credit of course if they send it to collections. But as a retiree maybe you don't need new credit. I don't trust the health industry either. They just throw those other names on the bill to pad their profits.

You are correct, in the article I linked the insurance did cover the unexpected bill.  That one just stuck in my memory, but I didn't reread it before posting.  My bad.  Not a good example, though many others can be found as you mentioned.  And it is of course not just the health insurance companies, but the medical providers as well. 

I guess mostly it's just that the entire medical-industrial complex gives me a feeling of being vulnerable.  But, as to the original point of the thread, not enough that I think it's likely.  Just something that gives me stress if I think about it.  :(

You are right to feel vulnerable. It's a swamp. But the ACA has helped. Hopefully further regulatory activity will lead to more improvements. It's just not right for a customer to have effectively no control over what products and services they are purchasing and to have literally no price tag attached to those products and services until after they are already delivered.

sisto

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #34 on: June 18, 2015, 03:52:19 PM »
I would think firmly 25%+ bracket mustachian folks would all have Roths. You can't get deductible traditional IRA contributions....

Maybe, maybe not.

Assuming standard deduction and 2 exemptions for MFJ status, the AGI that translates to the 25% marginal bracket is $95,600 to $171,800.
The tIRA is fully deductible up to $98,000 (M)AGI, leaving a small window of possibility.... :)

But yes, if by "firmly" ones means something such as "more than 10% above the minimum" then deductible tIRAs would not be feasible.
Something that might often be overlooked in situations like this is if only 1 spouse is working a tIRA can be setup for the non-working spouse and still getting at least a partial deduction. I utilize this strategy myself. It's always best to at least see if it's deductible before assuming and going to straight to the Roth. Turbo Tax is great for scenario testing.
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TomTX

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Re: Breaking the taboo of the 10% early withdrawal penalty
« Reply #35 on: June 19, 2015, 02:09:57 PM »
Remortgage the house or get a home equity loan.  You should only need to bridge for 2-3 years.

Remember if you do your Roth conversion December 31, "1 year" of your 5 year waiting period has elapsed the next day, effectively making it a 4 year.
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