Confused as to how a Roth account won't let me FIRE, while a Traditional will?

[x02947]

EDIT:  Typo in the subject originally.

Okay guys and gals, I’ve done some reading here and on bogleheads, and now I’ve gone and confused myself.  I’m working on a full up case study for expenses and investments, but can y’all answer these questions first?

1)   Traditional vs Roth IRA/401k:  In all likelihood, I will remain in the 12% bracket until FIRE (or in worst/best case, bump into the next one for just a couple of years).  I’m looking to FIRE at about 40, so call it 20 years (for sake of easy example math) until I can take earnings from a Roth.  At estimated 40k/year FIRE expenses, that would mean I need 800k of contributions by the time I FIRE… So there’s no need for me to even look at a Roth because I *have* to do the Traditional to Roth conversion to capture all those gains while in a Traditional status, right?

2)   5 years after FIRE for doing Traditional/Roth conversion:  In short, I’m not (currently) saving enough to fill both an IRA and 401k, but will have enough to FIRE (thanks to a pension).  Given the above assumption that I have to contribute to traditional accounts now in order to make my money last to penalty free distributions, it seems that I *have* to contribute to a taxable account even though I’m not filling up my tax advantaged space, unless I want to lock myself into SEPPs for the next 20 years.  Yes?  I can’t “afford” to do Roth because I’m locking in all the gains until 59.5, but if I do taxable I can use those gains as part of my 5 year conversion. 

This just seems odd to me so I was hoping y’all could provide some guidance.  I hope this makes sense, and can provide any details if it makes things more clear.  Thank you very much!

Edited to include details requested by terran:

I'm 30 now.  Pension is not inflation adjusted until I start taking it.  I can take it at 100% starting at 62, or lose 10% a year to take it early.  Given that, I'm conservatively estimating it at 11k/year starting at 62.

Correct, that $40k expenses does not include taxes (MFJ) but is the total amount of income I would need from any/all accounts, pensions, SS, etc.

Right now I'm saving about $18k a year (will go up as I am currently doing Roth accounts and if this thread points me to Traditional, I will plow the tax savings into savings).  Paying just over minimum amount to the mortgage, so that won't be done for another 20 years.

Roth: $50k
Tax deferred: $0
Taxable: $38k
529: $23k (I know i know, it was before I found MMM and I am not contributing anymore...)
HSA: $2k (from an old HDHP, no more contributions)

[terran]

It's good that you're thinking about how you'll eventually withdraw.

Sorry if I missed this, but how old are you now? At what age will your pension start and how much will it be? And your $40k expenses probably doesn't include taxes, but is otherwise total in that you haven't already subtracted your pension? How much in total are you saving? And what are your current balances in tax deferred, taxable, and Roth?

[x02947]

Terran, I edited the original post to include the details you asked for.  Thanks!

[MDM]

Might be worth reviewing Investment Order, including the links in there regarding traditional vs. Roth.

After doing that, what do you think?

[ixtap]

You can rollover your Roth 401k into a Roth IRA, allowing you to capture the gains made while in the 401k.

[MDM]

You can rollover your Roth 401k into a Roth IRA, allowing you to capture the gains made while in the 401k.

Just to clarify, rolling the 401k to the IRA does not convert earnings into contributions.

See Tax treatment of Roth IRA withdrawals with ROTH 401k rollover - Bogleheads.org for details.

[teen persuasion]

We try to max DH's traditional 401k, for the tax benefits, especially the increased EITC and state 30% match of federal EITC.  Then those refundable credits we have used to fund Roth IRAs for both of us.

We are currently at about 1/3 Roth, 2/3 traditional.  I'm planning to use the Roth contributions to cover the first 5 years' spending in a Roth conversion ladder.  You can remove Roth contributions at any time, tax and penalty free, unlike earnings.

We've also been maxing the HSA, and paying medical expenses OOP.  We can reimburse ourselves for these later, if we need a bit more cash unexpectedly.

[terran]

I’m looking to FIRE at about 40,

At estimated 40k/year FIRE expenses

I'm 30 now. 

Pension ... I'm conservatively estimating it at 11k/year starting at 62.

Right now I'm saving about $18k a year

Roth: $50k
Tax deferred: $0
Taxable: $38k
529: $23k (I know i know, it was before I found MMM and I am not contributing anymore...)
HSA: $2k (from an old HDHP, no more contributions)

I think the reason you're not coming up with an answer that doesn't make sense when trying to figure out how to save enough in Roth/taxable to last five years and still contribute to traditional is that you're just not saving enough period. Ignoring the pension you'd need $1,050,000 to support $42k ($40k spending + $2k taxes) at a 4% withdrawal rate. Even if you say you took the pension from day one, you'd still need $775,000 to support $31k in addition to the pension at a 4% withdrawal rate.

By my math, with $50k + $38k = $88k of current retirement savings, a 7% rate of return and 10 more years of saving $18k you'll get to $422k by the time you're 40.

Those are the (some might say overly) optimistic withdrawal rates, and rates of return some on this forum would use. Personally I would use a 3.5% withdrawal rate (see https://earlyretirementnow.com/2016/12/07/the-ultimate-guide-to-safe-withdrawal-rates-part-1-intro/), a 5% rate of return (7% is the historical average, some slightly pessimistic people like the founder of Vanguard are projecting 3% given the current high valuations).

I also probably wouldn't consider the pension, just as I don't consider social security. You could play around with http://www.cfiresim.com/ but I'm guessing the difference between the amount needed to last 22 years before getting an $11k pension and the amount needed to last indefinitely without the pension is not that much. Also 32 years is a long time from now, and who knows what might happen to your employer between now and then. Even some government pensions aren't too healthy right.

So based on my (some might say overly pessimistic) more "realistic" assumptions, I'd want to see you maxing out your 401(k) ($19k starting in 2019), your Traditional IRA for both you and your spouse ($6k each starting in 2019), and adding $53k to taxable for a total annual savings of $84k, which would give you $1,200,000 10 years from now, which would support a $42k/year withdrawal at a 3.5% withdrawal rate. Given that you'd have more than enough in taxable to handle getting the 5 year Roth conversion ladder started.

If you keep going at $18k/year you're looking at more like 25-26 years based on these same assumptions (although at that point counting on the pension might be more realistic, so you might be able to shave a bit off of that). In this case you will want to put some in roth to last the 5 years until you can withdraw from tax deferred penalty free, but it doesn't need to be the whole $18k since you'll be saving a lot longer.

Either way, this is why the typical response to people asking "how will I have enough to last the 5 years to get the Roth conversion ladder going if I max out tax deferred?" is "Don't worry about it, to reach FI you'll need to save way more than your tax deferred limits anyway, so you'll have plenty in taxable." This isn't always true (in my case I have a ton of available tax advantaged space for a couple of reasons, so I need to think about it a little more carefully), but it is true for most people.

Before you get discouraged, realize that $18k/year is awesome, and puts you way ahead of most the country. Retiring at 55 also puts you way ahead of most of the country. The thing is, mustachians are the badass special forces of retirement saving. There's no shame in not keeping up. It takes sacrifice, hard work, and not a small amount of luck and natural talent. Either we live on half of your $18k savings a year and so we need hardly anything saved, or we save your $18k (or more) in a couple of months, so we can get to a $40k spend (or more) relatively quickly. Lots of people just don't think it's worth it, and some who do still might not be able to get their for whatever reason.

If you want to try to get to mustachian levels of spending (lower) and saving (higher), then posting a case study as you planned to would be a great idea! In the meantime, don't worry about having enough for the Roth conversion ladder too much. Either you'll be at this a lot longer than you thought or you'll be saving so much that it just won't matter.

[x02947]

First, thank you everybody!  It is nice to be able to find friendly, helpful people on the internet.  A bit of fresh air.

MDM- I have been reading it and am still working to digest all of it.  I admit that my first question of T vs R is answered right in the beginning (estimate your tax brackets, flip a coin if they are the same) so I should probably do a mix as my state tax bracket will remain the same (AL- 5% for above $3k) and in leanFIRE years I will dip below 12% federal.  So that leaves my second question of why it seems to me I should break the investment order guidelines by contributing to taxable accounts before filling my tax advantaged/deferred space.  But Terran addresses that a bit.

Ixtap- yes, but as MDM pointed out, that won’t necessarily let me pull my earnings out, so I’m still stuck with contributions only in that case.

Teen persuasion- I imagine I will probably end up doing a mix as well.  I haven’t looked yet at the full tax implications of my lower income with a Traditional. 

Terran- In essence, you are right.  I think I’ve probably been a bit... rosy in my assumptions regarding future pay increases, SS and such and that probably makes the difference. I don’t think I’m quite as willing to say no SS and no pension though :)  I’m having trouble quantifying my future income though because DW will probably get a job once all the kids are in school, and I have all expectations of doing odds and ends that make money (I really want to teach intro engineering at the local college, for example).  So I’m being a bit optimistic on the front end and hoping things come out a wash in the end, i guess.  I will definitely need to be more detailed about that as things go on, though. 
No discouragement whatsoever!  Facts are facts!  Obviously things can/will change, but right now I absolutely love my job and I’m willing to give up promotions to make sure I stay the engineering peon doing actual work.  The problem is that there is SO MUCH other stuff in this world I want to learn and do, and giving up 40-50 hours a week doesn’t give my enough time to do it all.  So I’m by no means tied to FIREing by a certain date per say- I just say 40 because that would work out nicely with the kiddo’s ages.   

I’m definitely impressed looking around the forum and seeing the dedication and talent that y’all have- it is something to aspire to!  Thanks everybody again!

[chasesfish]

Don't worry about it, to reach FI you'll need to save way more than your tax deferred limits anyway, so you'll have plenty in taxable."

This happened to be the exact case for me.  Each person's situation varies, but I got pretty serious about early retirement in 2013 and our taxable accounts have grown dramatically.

Different options we have beyond our taxable account and a unique company deferred retirement plan:

72t my 401k (something you should consider with your pension benefit)
Roth Conversion Ladder
Side Income

[MDM]

...that won’t necessarily let me pull my earnings out, so I’m still stuck with contributions only in that case.

On the positive side, this is only until age 59.5, and contributions will likely be the majority of the balance until then anyway.

See How to withdraw funds from your IRA and 401k without penalty before age 59.5 for more.