How do we convert our corporate 401Ks into income generating investments?

[LiseE]

My hubby and I are working toward being FIRE in 5 years.  I'm reading Crash Proof 2.0 (Peter Shiff) and between what I've read so far in his book and also reading through MMM articles and this forum it's clear to me that we need to be in some dividend generating investment (or bond yields) when we finally are able to put a fork in our corporate jobs.  My question is, how do we convert our 401K's into income generating investments?  We have a 140K investment account outside of our 401K's but this is bulk of our investments (645K right now).

So what do we do with our 401K's when we leave our jobs to turn them into income producing assets?  Is the income produced taxed as your new income?  (I realize that we will be in a much lower tax bracket but since we do our own taxes just wondering what it will look like to do taxes with income from investments)

- Lise

[skyrefuge]

You're really asking two unrelated things here:

1) How do we access money in our 401(k) before age 59.5 without paying penalties?
2) How do we use our investment portfolio to pay for things?

For #1, see http://www.mrmoneymustache.com/2011/11/11/how-much-is-too-much-in-your-401k/ for options. A Roth conversion will be taxed as ordinary income, as will SEPP.

For #2, use a total return approach (pdf). To "generate income", take whatever dividends/interest your portfolio naturally produces, and then simply sell shares after that until you've fulfilled your cash needs. No special focus on dividends or bond interest is necessary (and in fact, it can be suboptimal). The idea of generating income solely from dividends is a bit of a historical relic, from when dividend rates just happened to be high enough to produce sufficient income, and when the high transaction costs to sell shares made dividends a more efficient option. Both of those situations are no longer true.

During #1, whether you do Roth conversions or SEPP, that money will be taxed as ordinary income (at your new lower tax rate). For #2, dividends/interest will be taxed as dividends/interest, and sold shares will be taxed as capital gains.