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Learning, Sharing, and Teaching => Investor Alley => Topic started by: FirePaddle on November 12, 2013, 12:35:09 AM

Title: Roth IRA contribution transfer to after tax account: Request for advice
Post by: FirePaddle on November 12, 2013, 12:35:09 AM
Hi all,

The wife and I are currently 33/34 years old.  After seeing the light via MMM, we've got a plan to retire at 40.  The hard part will be making it from 40-60.  Age 60 is when most of our current investments will become available.

We've got about $113k in our 2 Roth IRAs ($74k of contributions), and another $325k in various work retirement accounts not available without penalty until ~ age 60.  I'm not too worried about age 60 to 90, because if we let the $325 ride in index funds until age 60, it should build up to about $2.5M (7% return).  The part I'm hoping to figure out is how to build up an accessible account to get us from 40-60, understanding that it will be ok to spend this account out in full.  My plan right now is to transfer all the Roth IRA contributions into an after tax account, invest in index funds, and keep feeding it all of our savings each year (estimated to be ~$40k).  This could build to about $356k by age 40 (7% return, $40k added to it each year).

In your opinion, is that a decent plan?

I'm now rethinking the transfer of Roth IRA contributions right now, since I may as well take the 6 years of gains tax free, but those gains would not be available until age 60, where they will not really be needed, versus between age 40 and 60, where there's more risk in my mind.  I could always do the transfer of all contributions when we retire at age 40, which would be about $150k at age 40.

Thoughts?

For more detail, see this post, spreadsheet link included!

https://forum.mrmoneymustache.com/ask-a-mustachian/am-i-crazy-do-my-numbers-really-make-sense/

Thanks,
Tom
Title: Re: Roth IRA contribution transfer to after tax account: Request for advice
Post by: sherr on November 12, 2013, 09:27:22 AM
There's no reason to transfer money out of your Roth right now, you should wait until you need it. Furthermore it's entirely possible to access money you have in 401k / Traditional IRA accounts before you turn 60 without paying the 10% penalty. You can search for "Roth Pipeline" for more info, but the basic idea is:
1) you start with 5 years worth of expenses in either after-tax or Roth accounts.
2) each year after you have retired you transfer your yearly expenses from your 401k to you Roth IRA. You will have to pay income taxes on this withdrawal at whatever your post-retirement rate is. The transfer will count as a contribution to your IRA.
3) you let the contribution sit for 5 years in the Roth to avoid paying an early-withdrawal penalty
4) you withdraw the money from the Roth to pay for your expenses. It is a withdrawal of a contribution, which is allowed, and no additional taxes are owed.

All that to say that you don't need 20 years of expenses in after-tax / Roth accounts, only 5. So invest enough to cover those first five years in after-tax / Roth accounts, but then continue investing wherever it is maximally tax-efficient, because it doesn't matter after that.
Title: Re: Roth IRA contribution transfer to after tax account: Request for advice
Post by: Eric on November 12, 2013, 10:53:01 AM
My plan right now is to transfer all the Roth IRA contributions into an after tax account, invest in index funds, and keep feeding it all of our savings each year (estimated to be ~$40k).  This could build to about $356k by age 40 (7% return, $40k added to it each year).

In your opinion, is that a decent plan?

Your Roth IRA already is an after tax account.  You should have that invested in index funds now.  So continue to max that out.  Then in addition, invest the remainder of your savings in a regular after tax account.

You really only need 5 years of living expenses, not 20, to be accessible.  As already mentioned, do some searching for the Roth Pipeline for more detailed discussions.  Have you read the below article?  You're using option 1, but it may be advisable to consider option 2 instead or in addition to.

http://www.mrmoneymustache.com/2011/11/11/how-much-is-too-much-in-your-401k/
Title: Re: Roth IRA contribution transfer to after tax account: Request for advice
Post by: FirePaddle on November 12, 2013, 06:04:15 PM
Yes, my Roth is invested in index funds now.  It has been for several years.

Ah, yes, the Roth pipeline.  I do remember that article, and have looked into it and read lots of other posts on it as well.  The part that I'm not sure about is:

Does a rollover contribution from a pre-tax retirement account not count towards my annual contribution limit (currently $5500)?  I'm guessing it doesn't.  The only catch is that it must sit for 5 years before being able to be spent penalty free, hence the "pipeline".

hmm, I found this snippet in this...http://www.irs.gov/pub/irs-pdf/p590.pdf, which I think explains how a Roth pipeline is actually possible.
===============
page 30
"Converting From Any Traditional IRA Into a Roth IRA
Allowable conversions. You can withdraw all or part of the assets from a traditional IRA and reinvest them (within 60 days) in a Roth IRA. The amount that you withdraw and timely contribute (convert) to the Roth IRA is called a con- version contribution. If properly (and timely) rolled over, the 10% additional tax on early distributions will not apply."
===============
Which says nothing about waiting for 5 years...

but then this is thrown in:
===============
page 70
"Distributions of conversion and certain rollover con- tributions within 5-year period.
If, within the 5-year pe- riod starting with the first day of your tax year in which you convert an amount from a traditional IRA or rollover an amount from a qualified retirement plan to a Roth IRA, you take a distribution from a Roth IRA, you may have to pay the 10% additional tax on early distributions. You gener- ally must pay the 10% additional tax on any amount attrib- utable to the part of the amount converted or rolled over (the conversion or rollover contribution) that you had to in- clude in income (recapture amount). A separate 5-year period applies to each conversion and rollover. See Or­dering Rules for Distributions, later, to determine the re- capture amount, if any.

The 5-year period used for determining whether the 10% early distribution tax applies to a distribution from a conversion or rollover contribution is separately deter- mined for each conversion and rollover, and is not neces- sarily the same as the 5-year period used for determining whether a distribution is a qualified distribution"

===============

which makes it sound like 5 years of waiting might actually be needed, which seems to be the consensus of most people.

The other part I have not calculated out yet, is how using that pipeline money from IRA to Roth IRA from year 5 of retirement to age 60 would affect the gains on the remaining money to be used from age 60-90.  I estimate $2.5M with no pipeline, but that would be reduced if a pipeline existed from age 45-60.

Sometimes you just need to talk it out, although the two points above are still not crystal clear to me.  Do I need to wait for 5 years?  I've had the Roth IRA open for more than 10 years already.

Tom

Title: Re: Roth IRA contribution transfer to after tax account: Request for advice
Post by: FirePaddle on November 12, 2013, 06:07:35 PM
All that to say that you don't need 20 years of expenses in after-tax / Roth accounts, only 5.

That lit up a lightbulb in my head!

Thanks for helping me realize this.

Tom
Title: Re: Roth IRA contribution transfer to after tax account: Request for advice
Post by: sherr on November 18, 2013, 11:28:04 AM
The first reference in the IRS documentation you mention is talking about *withdrawing* from your *traditional* IRA and *contributing* (a conversion contribution) to your *Roth* IRA. So the 5 year waiting period from withdrawing from your Roth is not mentioned, because they're not talking about withdrawing from a Roth.

The second reference (page 70) specifies that you need to wait 5 years before withdrawing the conversion contribution from the Roth. So yes, you do need to wait 5 years or the 10% penalty will apply. And the 5 years is from the year you contributed the money you want to withdraw, not the year you first opened your Roth IRA. So you have to wait 5 years and there's no getting around it without the penalty.

Beyond that, I think you may be over-thinking pipeline / non-pipeline scenarios. What's really important is that:
1) on the day you retire you need to have enough money invested (total, in all the different types of accounts) to fund your retirement (assuming reasonable things like 7% interest and 3% inflation).
2) you need to have enough money in after-tax / Roth accounts to fund the first 5 years of retirement as your pipeline fills up.

If you meet both those criteria you should be fine.
Title: Re: Roth IRA contribution transfer to after tax account: Request for advice
Post by: FirePaddle on November 18, 2013, 03:24:41 PM
sherr,

Thanks for bringin' back home for me.  I think I've read enough now to understand that it can be simple, and I think you got me there.

I have exactly those assumptions, and if they hold true, and we save as planned, we'll have $1M in retirement accounts and about $250k in after tax accounts at 40 years old, spending from 40-45k depending on where we live.  I hope to get those spending numbers much below that too, to up the happiness/freedom factors.  This allows be conservative estimates with room for unknowns.

Tom