Author Topic: How do tax advantaged accounts figure into 4% rule?  (Read 1901 times)

Captain Cactus

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How do tax advantaged accounts figure into 4% rule?
« on: February 27, 2018, 05:19:30 PM »
As I strive toward investments totaling 25 times annual expenses, how does the 401k, Roth and trad IRA figure into that number?  Do they count?  Do I only count them in my Total if I plan on doing a Roth conversion ladder?  I'm 37 years old so won't have immediate access to the tax advantaged funds without the obvious trickery.  Thanks!

Eric

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Re: How do tax advantaged accounts figure into 4% rule?
« Reply #1 on: February 27, 2018, 05:26:17 PM »
Only so far as it affects the taxes you'll owe, and therefore your expenses that you need to cover.  Withdrawals/conversions from your pre-tax accounts are taxed at ordinary income levels, from taxable accounts at capital gains levels, and Roth accounts aren't taxed at all.

Captain Cactus

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Re: How do tax advantaged accounts figure into 4% rule?
« Reply #2 on: February 27, 2018, 05:40:40 PM »
Thanks Eric.  I guess what I'm looking for is a nice clean number to shoot towards that includes those tax advantaged accounts...say I need $40k/year from a $1 million stash.  70% of stash is in tax advantaged accounts...I don't really have 25 times my expenses because I'm not 59 1/2.

I suppose it depends on my particular details.

somers515

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Re: How do tax advantaged accounts figure into 4% rule?
« Reply #3 on: February 27, 2018, 05:52:49 PM »
As I strive toward investments totaling 25 times annual expenses, how does the 401k, Roth and trad IRA figure into that number?  Do they count?  Do I only count them in my Total if I plan on doing a Roth conversion ladder?  I'm 37 years old so won't have immediate access to the tax advantaged funds without the obvious trickery.  Thanks!

I could be misreading your question but it appears you are unaware that you can withdraw from your 401k before you turn 59 1/2.  Yes all your investments "count" to reaching your 25x annual expenses number.  Having some money in a 401k and some in Roth will give you more flexibility which is great.

https://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

Eric

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Re: How do tax advantaged accounts figure into 4% rule?
« Reply #4 on: February 27, 2018, 06:09:00 PM »
Thanks Eric.  I guess what I'm looking for is a nice clean number to shoot towards that includes those tax advantaged accounts...say I need $40k/year from a $1 million stash.  70% of stash is in tax advantaged accounts...I don't really have 25 times my expenses because I'm not 59 1/2.

I suppose it depends on my particular details.

It does depend on your details, but your age is mostly irrelevant.  Even if you were over 59.5, you'd still pay taxes on the withdrawals and would need to factor their tax treatment into your spending. 

The good news is that if your spending is low enough, it may not matter much as your tax bill will also be low.  You'll also have the flexibility to basically add/subtract as needed, in case things like the ACA are still around and rely on your income for subsidies for example.

Captain Cactus

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Re: How do tax advantaged accounts figure into 4% rule?
« Reply #5 on: February 28, 2018, 08:16:46 PM »
Hello, yes I am aware that early withdrawal is a possibility.  From what you are saying one would simply regard the 10% early withdrawal penalty as a tax?

nereo

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Re: How do tax advantaged accounts figure into 4% rule?
« Reply #6 on: March 01, 2018, 07:01:20 AM »
Hello, yes I am aware that early withdrawal is a possibility.  From what you are saying one would simply regard the 10% early withdrawal penalty as a tax?
...or you could avoid the penalty entirely (in many cases).

I'm still a bit confused at your situation - if you are planning on *spending* $40k/year, you will need to rough-calculate how much taxes you will need to pay in order to determine how much you actually withdraw (which ultimately is what determines your WR). 

Simple example:  suppose you expect your tax rate (State and Federal) to be 15%; you'll need to withdraw $47,058 to have $40k in money to spend. That would be $1,176MM in your total stash (assuming your tax rates were similar from year to year.
If your tax rates will change dramatically (for example, if you plan on doing a ROTH where you will pay ~0% taxes after x # of years) your WR change.  You can simulate such things in cFireSim

somers515

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Re: How do tax advantaged accounts figure into 4% rule?
« Reply #7 on: March 01, 2018, 07:17:08 AM »
Hello, yes I am aware that early withdrawal is a possibility.  From what you are saying one would simply regard the 10% early withdrawal penalty as a tax?

No, it doesn't appear you read even the title of the link I attached for you.

TheAnonOne

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Re: How do tax advantaged accounts figure into 4% rule?
« Reply #8 on: March 01, 2018, 09:01:01 AM »
It's important to note that most here wouldn't pay taxes even on traditional 401ks and IRAs due to our spending being pretty low and therefor our need to withdraw is also low (which is what your 'income' is)

Ultimately, taxes are an expense that need to fit into your "spending" and 4% rule. If you spend 30k you can almost forget taxes even exist. If you spend 100k, you will need to support 115k->120k via the 4% rule.

VoteCthulu

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Re: How do tax advantaged accounts figure into 4% rule?
« Reply #9 on: March 01, 2018, 12:16:16 PM »
It's important to note that most here wouldn't pay taxes even on traditional 401ks and IRAs due to our spending being pretty low and therefor our need to withdraw is also low (which is what your 'income' is)
I think that's overstating it a bit, most people will want to withdraw more than $12k per person per year from their 401k/IRA, so will pay some tax on it. But the point is still true that we will pay relatively low tax rates, and there should be no need to pay penalties.

CCCA

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Re: How do tax advantaged accounts figure into 4% rule?
« Reply #10 on: March 01, 2018, 12:23:58 PM »
It's important to note that most here wouldn't pay taxes even on traditional 401ks and IRAs due to our spending being pretty low and therefor our need to withdraw is also low (which is what your 'income' is)
I think that's overstating it a bit, most people will want to withdraw more than $12k per person per year from their 401k/IRA, so will pay some tax on it. But the point is still true that we will pay relatively low tax rates, and there should be no need to pay penalties.


Yes, also depends if you have additional deductions over the standard one.  But beyond that, even if you take out very little before hitting retirement age, by the time you reach 70, you'll need to take out at least what the government requires (via RMD) and that could very well lead to significant taxes (especially if you have SS income as well). 

Mississippi Mudstache

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Re: How do tax advantaged accounts figure into 4% rule?
« Reply #11 on: March 01, 2018, 12:42:25 PM »
It's important to note that most here wouldn't pay taxes even on traditional 401ks and IRAs due to our spending being pretty low and therefor our need to withdraw is also low (which is what your 'income' is)
I think that's overstating it a bit, most people will want to withdraw more than $12k per person per year from their 401k/IRA, so will pay some tax on it. But the point is still true that we will pay relatively low tax rates, and there should be no need to pay penalties.

Hardly an overstatement for anyone who retires with dependent children.

aceyou

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Re: How do tax advantaged accounts figure into 4% rule?
« Reply #12 on: March 01, 2018, 12:58:51 PM »
The answer is that there is no nice clean number.  Not all dollars are created equal. 

Roth A dollar in a roth is like superman...it is worth 100% of it's full value.  Those are the best dollars I own. 

Traditional:A dollar in a Traditional account is not as valuable, so you likely discount it...but even then you will find that different people will have to discount it a different amount.  For example...
   - My wife and I are teachers and will get pensions.  Those pensions will likely fill up our low tax brackets, so any time we want to take money out of the traditional accounts, it is likely to come out at a very high rate.  I have to heavily discount my traditional accounts. 
   -  The millionaire educator and his wife have tiny pensions that haven't kicked in yet, but a large amount in their traditional accounts. Plus, they only live off about 20k/year. So, they are able to withdraw their traditional funds basically tax free.  They don't have discount their accounts much at all...they are loving their 403B's:)
Notice that we are both in the exact same profession, we live very similar lives, and still our situations are completely different...imagine if we had very different lives. 

real estateA dollar in real estate will have to be discounted by the realtor's fees due at closing.  So, perhaps a 6% discount.  If their home, however, is not their homestead, then they will have to pay that 6% fee, plus capital gains...so that real estate might be discounted even more. 

These are just a few examples, but hopefully you get the point.  There's no simple answer.  You have to look at your own situation, make projections, and do your best.

Mighty-Dollar

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Re: How do tax advantaged accounts figure into 4% rule?
« Reply #13 on: March 01, 2018, 02:50:24 PM »
4.5% if tax-free and 4.1% for taxable.
https://en.wikipedia.org/wiki/William_Bengen

nereo

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Re: How do tax advantaged accounts figure into 4% rule?
« Reply #14 on: March 01, 2018, 03:26:55 PM »
4.5% if tax-free and 4.1% for taxable.
https://en.wikipedia.org/wiki/William_Bengen
wait, so under the "Bengen rule" your SWR (or SAFEMAX) is already above 4% used in this post?

Proud Foot

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Re: How do tax advantaged accounts figure into 4% rule?
« Reply #15 on: March 01, 2018, 03:41:29 PM »
Thanks Eric.  I guess what I'm looking for is a nice clean number to shoot towards that includes those tax advantaged accounts...say I need $40k/year from a $1 million stash.  70% of stash is in tax advantaged accounts...I don't really have 25 times my expenses because I'm not 59 1/2.

I suppose it depends on my particular details.

The 4% would take into account all of your accounts and any income taxes should be included in calculating your annual spend. Assuming you don't take the steps to access your traditional pre-tax retirement money before 59 1/2 you would need to make sure you have enough allocated to your taxable account and Roth contributions to last you from when you FIRE and when you reach 59 1/2. While you will be drawing down more than 4% from your taxable account you will still be only at 4% overall. From your example 30% in taxable accounts would be $300k so your 40k/year will last you 7.5 years assuming no growth in that account. As you are drawing down the taxable account the tax advantaged accounts will keep growing.

VoteCthulu

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Re: How do tax advantaged accounts figure into 4% rule?
« Reply #16 on: March 01, 2018, 08:26:45 PM »
It's important to note that most here wouldn't pay taxes even on traditional 401ks and IRAs due to our spending being pretty low and therefor our need to withdraw is also low (which is what your 'income' is)
I think that's overstating it a bit, most people will want to withdraw more than $12k per person per year from their 401k/IRA, so will pay some tax on it. But the point is still true that we will pay relatively low tax rates, and there should be no need to pay penalties.

Hardly an overstatement for anyone who retires with dependent children.
Do you really think over 50% of the people on this forum have enough children to reduce their taxes to 0 after retiring? With all the posts I've seen from people who are single or have zero or one child or have well over a million dollars around here I find it highly unlikely.

des999

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Re: How do tax advantaged accounts figure into 4% rule?
« Reply #17 on: March 02, 2018, 11:04:06 AM »
I think the trick is to have a good amount (at least 5 years expenses) in something other than tax advantaged accounts.  Most of mine is in tax advantaged, so I need to build up my brokerage account to have enough to get me through the roth conversion ladder.