Author Topic: 5 year cushion  (Read 2248 times)

MelodyG

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5 year cushion
« on: May 11, 2020, 08:51:42 AM »
I currently have more than enough to retire, except for my 5 year cushion.  Most of my 'stache is in my 401k and IRA.

Where did/do you keep your 5 year cushion until you can access your retirement accounts prior to age 59-1/2?  Is there something you would have done differently?

Right now I have a plan to rent my house and I have the rest in stocks.  I feel that keeping it in stocks is a little precarious, but I'm not really interested in keeping ~$150k in a savings account.  Plus, I need to investment returns to have enough.

Thank you for any wisdom you can share!

seattlecyclone

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Re: 5 year cushion
« Reply #1 on: May 11, 2020, 10:48:50 AM »
You do realize a five-year cushion isn't strictly required, right? You'll just be paying an extra 10% until you get enough seasoned Roth conversions. Depending on your tax bracket now and in retirement, this could even be a better deal than doing more post-tax saving before retirement. If you're past your number but for this factor, I wouldn't let it hold you back.

What you can do to get yourself on track for the long run: retire now, withdraw year 1 expenses (paying 10% early withdrawal tax), convert year 6 expenses. Next year withdraw year 2 expenses and convert year 7 expenses. After five years you won't have to pay early withdrawal tax anymore.

A variation on the above: put part (maybe half?) of your pre-tax IRA into a separate account and start doing SEPP withdrawals from there. These withdrawals will be free of the 10% early withdrawal tax, but likely not enough to pay all your bills. You'll pull the remainder from the other IRA (paying the 10% tax), and convert a similar amount to Roth so you don't have to pay that tax in year 6. This might be a more appealing option than the above if realizing 2x your spending as income in years 1-5 would put you in a higher tax bracket than you would like. With the SEPP scenario you would realize less income in the early years, at the expense of less withdrawal flexibility until you turn 59.

This year there's even a special provision if you're affected by covid-19. You'll be able to withdraw $100k free of the early withdrawal tax, optionally spreading the income over three tax years, if any of the following apply:
* You, your spouse, or a dependent get a positive covid-19 test result, or
* You experience adverse financial consequences due to a job loss, reduction in hours, reduction of business income, quarantine, or loss of child care due to covid-19.
More information about this here.

I personally don't have to worry about this situation as we were able to save more than the tax-deferred limits for several years so we naturally built up quite a cushion in taxable and mega backdoor Roth accounts. We do have an 80/20 stock/bond allocation across all our accounts because, like you, I feel that a 100% stock allocation is a recipe for bad results in a market downturn. So far this has served us well during the pandemic. On the way down we sold shares of our bond funds to pay our bills, and even had to rebalance a few bonds into stocks to keep at our 80/20 ratio. Then on the way back up it looks like we'll be doing some of the opposite. Buy low, sell high.

nereo

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Re: 5 year cushion
« Reply #2 on: May 11, 2020, 11:03:36 AM »
Where did/do you keep your 5 year cushion until you can access your retirement accounts prior to age 59-1/2?  Is there something you would have done differently?


You might want to review this sticky on how to access funds in your 401(k)/IRA before age 59.5 penalty free:

https://forum.mrmoneymustache.com/taxes/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-ag-39647/

MelodyG

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Re: 5 year cushion
« Reply #3 on: May 11, 2020, 01:03:18 PM »
Where did/do you keep your 5 year cushion until you can access your retirement accounts prior to age 59-1/2?  Is there something you would have done differently?


You might want to review this sticky on how to access funds in your 401(k)/IRA before age 59.5 penalty free:

https://forum.mrmoneymustache.com/taxes/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-ag-39647/

Yep.  Already all over this one.  It's why I need a 5 year cushion and not a 20 year cushion :)

Monkey Uncle

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Re: 5 year cushion
« Reply #4 on: May 11, 2020, 01:12:31 PM »
A variation on the above: put part (maybe half?) of your pre-tax IRA into a separate account and start doing SEPP withdrawals from there. These withdrawals will be free of the 10% early withdrawal tax, but likely not enough to pay all your bills. You'll pull the remainder from the other IRA (paying the 10% tax), and convert a similar amount to Roth so you don't have to pay that tax in year 6. This might be a more appealing option than the above if realizing 2x your spending as income in years 1-5 would put you in a higher tax bracket than you would like. With the SEPP scenario you would realize less income in the early years, at the expense of less withdrawal flexibility until you turn 59.

You can do that?  I thought SEPP had to be calculated across all of your traditional IRA accounts.

bacchi

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Re: 5 year cushion
« Reply #5 on: May 11, 2020, 01:16:52 PM »
A variation on the above: put part (maybe half?) of your pre-tax IRA into a separate account and start doing SEPP withdrawals from there. These withdrawals will be free of the 10% early withdrawal tax, but likely not enough to pay all your bills. You'll pull the remainder from the other IRA (paying the 10% tax), and convert a similar amount to Roth so you don't have to pay that tax in year 6. This might be a more appealing option than the above if realizing 2x your spending as income in years 1-5 would put you in a higher tax bracket than you would like. With the SEPP scenario you would realize less income in the early years, at the expense of less withdrawal flexibility until you turn 59.

You can do that?  I thought SEPP had to be calculated across all of your traditional IRA accounts.

Nope, it can be split.

And the distribution can be changed -- one time only -- to the RMD method from either of the other two methods.

seattlecyclone

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Re: 5 year cushion
« Reply #6 on: May 11, 2020, 01:24:49 PM »
A variation on the above: put part (maybe half?) of your pre-tax IRA into a separate account and start doing SEPP withdrawals from there. These withdrawals will be free of the 10% early withdrawal tax, but likely not enough to pay all your bills. You'll pull the remainder from the other IRA (paying the 10% tax), and convert a similar amount to Roth so you don't have to pay that tax in year 6. This might be a more appealing option than the above if realizing 2x your spending as income in years 1-5 would put you in a higher tax bracket than you would like. With the SEPP scenario you would realize less income in the early years, at the expense of less withdrawal flexibility until you turn 59.

You can do that?  I thought SEPP had to be calculated across all of your traditional IRA accounts.

Yep, this is possible. Your SEPP withdrawals have to be calculated based on the entire balance of the account you're withdrawing from, but there's nothing stopping you from splitting your IRA into two separate accounts before starting SEPP so that only part of your overall balance is used for these payments. See here and here for a couple of well-researched articles mentioning this tactic.

MelodyG

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Re: 5 year cushion
« Reply #7 on: May 11, 2020, 02:22:49 PM »
This is awesome information.  Thank you!!!

Monkey Uncle

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Re: 5 year cushion
« Reply #8 on: May 11, 2020, 05:56:48 PM »
Thanks, Bacchi and Seattlecyclone.  Although that particular SEPP rule doesn't affect to my situation, I find such rule intricacies interesting nonetheless.

rmorris50

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Re: 5 year cushion
« Reply #9 on: May 12, 2020, 05:57:21 PM »
Couple of questions/thoughts, because I am in a very similar situation to OP.

1. Does each roth conversion have to be 5 years old to avoid the penalty, or just the roth account? I already have a backdoor roth, so if I were to do conversions going forward I'd just put it into this account I presume.

2. OP, are you married with a working spouse? I am, and so doing conversions in my situation doesn't seem that advantageous as long as he is working.

terran

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Re: 5 year cushion
« Reply #10 on: May 12, 2020, 09:27:46 PM »
There is a 5 year clock that starts from the date an individual's first Roth account is opened, but the one involved with the conversion ladder for penalty free early withdrawal is for every conversion (or more accurately for all conversions in every year). Here's an article that might help: https://www.kitces.com/blog/understanding-the-two-5-year-rules-for-roth-ira-contributions-and-conversions/

MelodyG

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Re: 5 year cushion
« Reply #11 on: May 13, 2020, 06:28:16 AM »
Rmorris -
I am not married.

If I understand it correctly, it's the seed money that you put into the Roth that has to be 5 years old.  The gains on that money can't be touched without 10% penalty prior to 59-1/2.  I may be wrong on this!  You pay tax on the conversion, so you could do it now but you'd pay taxes on that money, which may not be a good idea if you're still making an income elsewhere.

NWOutlier

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Re: 5 year cushion
« Reply #12 on: May 15, 2020, 02:32:11 PM »

Where did/do you keep your 5 year cushion until you can access your retirement accounts prior to age 59-1/2?  Is there something you would have done differently?


taxable account.. index funds... I don't have much in cash... I will, but not 5 years... 1-3 years maybe at the minimum per year spend...

bmjohnson35

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Re: 5 year cushion
« Reply #13 on: May 15, 2020, 02:50:21 PM »

We have around 3 yr cash cushion.  The investments are 80% stocks / 20% bonds, both index funds.  I also have $10k in stocks that recently bought due to the recent "sale."  Stock market conditions and Obamacare income requirements influence our draw down for expenses. 

BJ