saving for fire taxable vs deferred

[kingcanute]

So, I recently came upon this blog. I read through quite a few of the entries, and have dug around the forums a bit. Anyway, I don't want to get into too many details, but we have about $400 in retirement accounts, own a $200 house, and have around $300 in taxable accounts.

I read the post on 401k investing and saw where it said, "one could say this person already has too much in retirement accounts". If you actually want to achieve FIRE, shouldn't you have a 4% withdraw rate on your taxable accounts or maybe 5-6% given that the tax deferred accounts can take over eventually?  In order to achieve that should you keep your rate lower in the deferred accounts in order to save in the non-deferred accounts.  It seems like this would be necessary if you want to own rental units, or have enough in assets to live off the interest/dividends and some periodic asset sales.

I see there are tricky ways to roll over deferred accounts.  What's the consensus here? Does anyone else think that devoting more to the taxable accounts is a better idea if you think your deferred accounts are funded fairly well?

[Frankies Girl]

I honestly don't think it's possible (my opinion) to have too much in tax sheltered accounts like a 401K or IRA, due to the ability to roll the funds over to a Roth after retirement (early or otherwise). If you have a taxable account that you can draw off of for a 5-10+ year period, then that works out great, since you can use that for living expenses as you're doing the shifting and "aging" for the Roth pipeline method, but if you are planning on being in the same or lower tax bracket after FIRE, then I can't see how it hurts and it helps by reducing your tax NOW when you're working.

http://www.madfientist.com/traditional-ira-vs-roth-ira/

I don't plan on differentiating my tax deferred and taxable accounts for my SWR (safe withdrawal rate). All of my accounts are important to take into consideration, and I won't be using more than my overall minimum SWR from my taxable/Roth to live on once I'm RE. 

[kingcanute]

Good point about the lower tax bracket. I would have to assume I would certainly be in a lower tax bracket.  I never really thought of it that way.  However, this seems to ignore the 10% early withdrawal penalty.

I gather you get to the no penalty, by using the transfer method in the link, and subsequently removing the base that was put in as part of a withdrawal method. I wonder how easy it is to do the conversion totally tax free. It would seem to me not very easy. If I need $25k or more to live on, and I also want to convert money from traditional to ROTH. It doesn't seem like it would be very easy to convert very much tax free.  Of course I'm no tax expert.

Also, suppose you wanted to go the landlord route. Wouldn't you want to accumulate enough funds to fully own your rental properties ASAP and thus it would be preferable to get the cash and either buy the properties outright or pay off loans as quickly as possible.

The financial mechanics of all this seem a bit tricky.

[EscapeVelocity2020]

Sorry to be a shill for my own blog, it has no advertisement or reason to be, other than my own fascination with the mathematics of ER.  And yes, my friend, you can be overly geared for taxable savings.  I have felt great these last few years paying less taxes on income by contributing to a 401k.  Certainly the easiest move ever for the working class is tax deferred, matched savings.  (edited to remove some drunken rambling)

[kingcanute]

EscapeVelocity2020 - you seem to have actually forgotten to shill for your own blog - or are you the madfientist?...

Before I asked this question, I kind of assumed everyone here would tell me that deferred should be maxed out before non-deferred. But I wanted more details on why - and the transfer to roth, withdraw the base tax-free method certainly seems to make sense.

Now, lets say I want to buy a house in the near future (12-36). Lets say, I previously thought putting as much down as possible was the way to go (and that I still think that). First of all, if this means I'm not contributing the max to retirement accounts - is that dumb?  Secondly, is there an argument here as to why you shouldn't save enough to put 100% down (or as much down as possible)?

[EscapeVelocity2020]

Wish I was the MadFIentist, his blog is one of my favorites.  My blog is 'EscapeVelocity2020', not nearly so catchy name. 

The worry that I put forward in my blog was that people could have a large balance in their 401k which will all get taxed, either when it's withdrawn voluntarily (for living expenses or converted to Roth), or when they turn 70.5 and have to take 'required minimum distributions'.  Also, when you die, your heirs will pay regular income tax on that 401k balance (http://www.axa-equitable.com/plan/estate/401k-IRA-beneficiary.html).

Having money in taxed accounts gives you much more control over when you pay the taxes, and if it is inherited, then the tax basis is stepped up and a large amount (which has varied significantly over the last few years, but was 5.25 million dollars in 2013) is non-taxed.   

But if you are in a high tax bracket and expect your bracket to drop in retirement, saving in a 401k especially up to the company match is the best move.  The money can also be borrowed from as a loan to yourself, understanding that the money is no longer invested.  People don't advocate this because you are robbing your retirement funds and will have to pay the loan off if you lose your job.

I was just highlighting a case in my blog (where I'm figuring out my optimal retirement date) where RMD's could push you into an unexpectedly high tax bracket if you have a high 401k balance and wait until 59.5 to start drawing it down. 

[aj_yooper]

Good point about the lower tax bracket. I would have to assume I would certainly be in a lower tax bracket.  I never really thought of it that way.  However, this seems to ignore the 10% early withdrawal penalty.

I gather you get to the no penalty, by using the transfer method in the link, and subsequently removing the base that was put in as part of a withdrawal method. I wonder how easy it is to do the conversion totally tax free. It would seem to me not very easy. If I need $25k or more to live on, and I also want to convert money from traditional to ROTH. It doesn't seem like it would be very easy to convert very much tax free.  Of course I'm no tax expert.

Also, suppose you wanted to go the landlord route. Wouldn't you want to accumulate enough funds to fully own your rental properties ASAP and thus it would be preferable to get the cash and either buy the properties outright or pay off loans as quickly as possible.

The financial mechanics of all this seem a bit tricky.

You would take long term capital gains from the taxable to live on while you are, hopefully, in the 15% or lower marginal tax rate so the capital gains tax is 0.  You would need at least 5 years of seasoning on the Roths so rentals or your taxable account would be doing the work for you for the 5 years. 

[mgreczyn]

Any thoughts on the risks of a sudden tax law change?

[Spork]

Any thoughts on the risks of a sudden tax law change?

While that's something that can happen (and ... let's be honest... SOMETHING in the tax code will change between now and when we die) ...   I'm just not sure that's anything you can prepare for unless you have some sort of inside information.   It seems like it would be impossible to be prepared for the millions of possible scenarios.  And remember: we're talking about tax code.  Expecting some reasonable, explainable, predictable change is pure fantasy.

Am I wrong here?  It's not that I don't think anything will ever change, just that I don't think its something that can be prepared for, so I choose not to worry.

[matchewed]

Any thoughts on the risks of a sudden tax law change?

While that's something that can happen (and ... let's be honest... SOMETHING in the tax code will change between now and when we die) ...   I'm just not sure that's anything you can prepare for unless you have some sort of inside information.   It seems like it would be impossible to be prepared for the millions of possible scenarios.  And remember: we're talking about tax code.  Expecting some reasonable, explainable, predictable change is pure fantasy.

Am I wrong here?  It's not that I don't think anything will ever change, just that I don't think its something that can be prepared for, so I choose not to worry.

I don't think you're wrong. We factor in our plans what we know, try to control any unknowns that are in our control (how much we save in tax deferred, how much we save in general...etc.), and deal with unknowns that we don't control when they do change (tax laws). Unless you're a tax law lobbyist in that case the whole tax law thing goes into the second category.

I personally think your various taxable/tax deferred/Roth accounts should reflect your particular plan. How will you execute FIRE and how do those accounts support that? What does "fairly funded" mean? It will definitely mean something different to me than it will to you because I intend to do a Roth pipeline that won't require much in taxable accounts, just enough in a Roth and the rest in tax deferred.

[MissPeach]

I have also been debating how much to leave in regular taxable accounts versus a non tax deferred IRA (which I could backdoor covert). I do like the ability to have more control over than money and will need a certain amount in hand while a roth is seasoning.

I use the 401K as a way to defer taxable income as well as getting a match. I'm not a huge fan of the 401K otherwise because many of them have huge fees attached (2% where I work). I'm planning at some point to quit my high paying job and roll it into an IRA. I'm hoping the roth (backdoor) at some point will also still be an option when my income is lower. I'm also hoping this will help me save more in the long run. There are some interesting blogs about how not paying tax upfront and investing it can gain more income.

[mgreczyn]

Any thoughts on the risks of a sudden tax law change?

While that's something that can happen (and ... let's be honest... SOMETHING in the tax code will change between now and when we die) ...   I'm just not sure that's anything you can prepare for unless you have some sort of inside information.   It seems like it would be impossible to be prepared for the millions of possible scenarios.  And remember: we're talking about tax code.  Expecting some reasonable, explainable, predictable change is pure fantasy.

Am I wrong here?  It's not that I don't think anything will ever change, just that I don't think its something that can be prepared for, so I choose not to worry.

I don't think you're wrong at all.  I guess the question should have been qualified with "in the context of retiring early with the expectation that you can fund your retirement via Roth conversions".  It's neat and all that I can convert a large 401k to a roth and then use a lower taxable income number to do tax-free withdrawals from the Roth, but if I retire with that as Plan A, B and C and then 10 years later the rules change, I am then 10 years out of the workforce with a severely curtailed income.  Just my train of thought.  I think that goes to the point of having safety margins: http://www.mrmoneymustache.com/2011/10/17/its-all-about-the-safety-margin/

[foobar]

You could argue the IRA gives you more control over when you pay taxes than a taxable account up until age 70 (and even after then to some extent). You want to rebalance your taxable account. Pay the tax man. Your fund issues a div. Pay the tax man. And so on.   RMD's suck  but when you can take 100k/y out of that 401(K) at <15% tax rate, most people that retire by 50 will have a lot of time to reduce that balance.

Paying taxes isn't a big deal. Not having the money you need is. Avoiding taxes when you can helps you accumulate more money but the goal isn't to avoid taxes. It is to end up with enough money. If you tell me you have 2 million plus in your 401(k) and zero dollars in taxable funds and want to retire in 5 years, then yeah investing in taxable products is the way to go.


For the OP, no you don't need 4% in taxable accounts. You need enough in taxable accounts to make it until you can get access to those retirement accounts (either roth pipleline, 72(t), or heck if you have enough cash pay the 10% penalty. ).  If you start plugging numbers into firecalc, you will see that 7-8% withdrawl rates have decent success if you only need the money to last 15 years.

And yeah tax law changes can happen. For a change the world case, think about what would happen if we abolished the income tax and went to a national sales tax. Roth IRAs get screwed, traditional wins big.

Wish I was the MadFIentist, his blog is one of my favorites.  My blog is 'EscapeVelocity2020', not nearly so catchy name. 

The worry that I put forward in my blog was that people could have a large balance in their 401k which will all get taxed, either when it's withdrawn voluntarily (for living expenses or converted to Roth), or when they turn 70.5 and have to take 'required minimum distributions'.  Also, when you die, your heirs will pay regular income tax on that 401k balance (http://www.axa-equitable.com/plan/estate/401k-IRA-beneficiary.html).

Having money in taxed accounts gives you much more control over when you pay the taxes, and if it is inherited, then the tax basis is stepped up and a large amount (which has varied significantly over the last few years, but was 5.25 million dollars in 2013) is non-taxed.   

But if you are in a high tax bracket and expect your bracket to drop in retirement, saving in a 401k especially up to the company match is the best move.  The money can also be borrowed from as a loan to yourself, understanding that the money is no longer invested.  People don't advocate this because you are robbing your retirement funds and will have to pay the loan off if you lose your job.

I was just highlighting a case in my blog (where I'm figuring out my optimal retirement date) where RMD's could push you into an unexpectedly high tax bracket if you have a high 401k balance and wait until 59.5 to start drawing it down.

[kingcanute]

Interesting - how do you take out 100/y at < 15%. Is that the RMD rate?

We have around $400k in various retirement accounts, around $300k in non-retirement accounts (200k cash), and my former house is now a rental. It's worth $200k. We would like to move to a new city in the near future, and that is one big reason why we maybe have too much cash. I would like to do the FIRE thing, though at this point it won't be extreme (20s-30s) it would be  more just early (40s).

[kpd905]

Interesting - how do you take out 100/y at < 15%. Is that the RMD rate?

A married couple withdrawing $100k per year with no other income would pay 11.9% federal tax on that amount.

[EscapeVelocity2020]

Uh, where?  and if it is in the US, also include the fact that ACA is in effect, so they would pay a substantial difference in medical insurance premium...

[foobar]

Not really. If I take sell 50k of taxable funds or if I take 50k out of my IRA, in the end I have 50k of AGI. That is a bit simplistic (there is some start up and shut down effects  and the cost basis is different but if you doing this for like 30 years they are pretty minimal) but without a lot of details on family size and expected withdrawals I wouldn't hazard to guess an exact number. But yeah there are some reasons why you  might not want to max out the 0% and 10% OI brackets every year.

Can you have too much deferred? Sure. If you want to live on 40k/yr and you have 1 million in an IRA, your in trouble until your 59. On the other hand if you are like 250k taxable/750 ira, you can do the various games to shift the money to where you need it. In reality I don't think very many savers get close to not having enough taxable income as the 401(k) limits are pretty low.

RMD's start at about 4% at 70 and go up as you age.  The are a pain to calculate but that is about it. If you happen to have 4 million bucks (in todays dollars) and only need 25k, don't lose any sleep over having to pay taxes.  Focus on the part where you have plenty of cash for what you need and realize you wouldn't have had those 4 million bucks without the tax deferral.

Uh, where?  and if it is in the US, also include the fact that ACA is in effect, so they would pay a substantial difference in medical insurance premium...

[EscapeVelocity2020]

You will also start claiming Social security at some point, which further adds to taxable income.

[aj_yooper]

Not really. If I take sell 50k of taxable funds or if I take 50k out of my IRA, in the end I have 50k of AGI. That is a bit simplistic (there is some start up and shut down effects  and the cost basis is different but if you doing this for like 30 years they are pretty minimal) but without a lot of details on family size and expected withdrawals I wouldn't hazard to guess an exact number. But yeah there are some reasons why you  might not want to max out the 0% and 10% OI brackets every year.

Can you have too much deferred? Sure. If you want to live on 40k/yr and you have 1 million in an IRA, your in trouble until your 59. On the other hand if you are like 250k taxable/750 ira, you can do the various games to shift the money to where you need it. In reality I don't think very many savers get close to not having enough taxable income as the 401(k) limits are pretty low.

RMD's start at about 4% at 70 and go up as you age.  The are a pain to calculate but that is about it. If you happen to have 4 million bucks (in todays dollars) and only need 25k, don't lose any sleep over having to pay taxes.  Focus on the part where you have plenty of cash for what you need and realize you wouldn't have had those 4 million bucks without the tax deferral.

Uh, where?  and if it is in the US, also include the fact that ACA is in effect, so they would pay a substantial difference in medical insurance premium...

If you are in the 15% tax bracket, taking out money that is long term capital gains in taxable is 0% tax so there is a big difference than taking out from tax advantaged. 

[EscapeVelocity2020]

Not really. If I take sell 50k of taxable funds or if I take 50k out of my IRA, in the end I have 50k of AGI. That is a bit simplistic (there is some start up and shut down effects  and the cost basis is different but if you doing this for like 30 years they are pretty minimal) but without a lot of details on family size and expected withdrawals I wouldn't hazard to guess an exact number. But yeah there are some reasons why you  might not want to max out the 0% and 10% OI brackets every year.

Can you have too much deferred? Sure. If you want to live on 40k/yr and you have 1 million in an IRA, your in trouble until your 59. On the other hand if you are like 250k taxable/750 ira, you can do the various games to shift the money to where you need it. In reality I don't think very many savers get close to not having enough taxable income as the 401(k) limits are pretty low.

RMD's start at about 4% at 70 and go up as you age.  The are a pain to calculate but that is about it. If you happen to have 4 million bucks (in todays dollars) and only need 25k, don't lose any sleep over having to pay taxes.  Focus on the part where you have plenty of cash for what you need and realize you wouldn't have had those 4 million bucks without the tax deferral.

Uh, where?  and if it is in the US, also include the fact that ACA is in effect, so they would pay a substantial difference in medical insurance premium...

If you are in the 15% tax bracket, taking out money that is long term capital gains in taxable is 0% tax so there is a big difference than taking out from tax advantaged.

OK, I have no idea where this thread is going.  I am only speaking from my perspective, which I am thinking about thoroughly, which is being a 40 y.o. with a majority of their retirement funds in 401k's (being married with an additional 401k balance from a formerly working wife).  We could be like the previous generation, working into our early 50's and calling that early retirement, or we could be like 'early retirees today that downshift into real estate or YouTube channels' or whatever, but I have ruled those out for me.  I want to get a relatively clear framework for judging when my net worth will meet my income needs.  I think I am good to move on with my life, I don't need to leave an inheritance bonanza, but I'm surprised how little people have thought about 'their number' and how to reach it efficiently.
Like me, I think Mustachian's have a tilt toward the tax-advantaged.  This actually makes it more efficient to retire early, because if I keep building into my traditional retirement age, I won't have time to spend it before the tax man makes me realize that I worked way too long into my life...  I hope people start to think about what age is best to retire, which has been lacking if you are not getting into real estate or blogging or making a non-passive income and diving headlong into your passions of maybe Engineers Without Borders, Peace Corps, or whatever... 

In summary, having a 401k puts an additional ball in your court, that you need to determine if it makes sense to work into your 50's and 60's...

[foobar]

As far as the ACA there is no difference (AFAIK) between capital gains and OI. The point is solid though that their are always other thing to think about than just immediate taxes. Have a kid going to college in 5 years? 1 million a 401(k) is treated a heck of a lot differently than 1 million in your taxable account.  Get a 2 million dollar judgement against you? You would much rather your assets to be in a 401(k) than a taxable account. Want to sell 80k per year (as your only income)? Capital gains are a win.

Not really. If I take sell 50k of taxable funds or if I take 50k out of my IRA, in the end I have 50k of AGI. That is a bit simplistic (there is some start up and shut down effects  and the cost basis is different but if you doing this for like 30 years they are pretty minimal) but without a lot of details on family size and expected withdrawals I wouldn't hazard to guess an exact number. But yeah there are some reasons why you  might not want to max out the 0% and 10% OI brackets every year.

Can you have too much deferred? Sure. If you want to live on 40k/yr and you have 1 million in an IRA, your in trouble until your 59. On the other hand if you are like 250k taxable/750 ira, you can do the various games to shift the money to where you need it. In reality I don't think very many savers get close to not having enough taxable income as the 401(k) limits are pretty low.

RMD's start at about 4% at 70 and go up as you age.  The are a pain to calculate but that is about it. If you happen to have 4 million bucks (in todays dollars) and only need 25k, don't lose any sleep over having to pay taxes.  Focus on the part where you have plenty of cash for what you need and realize you wouldn't have had those 4 million bucks without the tax deferral.

Uh, where?  and if it is in the US, also include the fact that ACA is in effect, so they would pay a substantial difference in medical insurance premium...

If you are in the 15% tax bracket, taking out money that is long term capital gains in taxable is 0% tax so there is a big difference than taking out from tax advantaged.