I overhauled my long-term FIRE spending/tax model today and it revealed some things I was not prepared for. Even though some of the data is specific to my personal situation, I think it's a valuable process to share. Having a large enough W2 income to retire in your 30s probably means a small Roth balance, and large taxable and tIRA balances. So I'm guessing there'd be others out there in a similar situation as us. Our portfolio split is currently ~60% tIRA/35% taxable/5% Roth.
If you want to download and dig into the specific data of the model, feel free, but I'm going to talk about the broader trends here because that is what was so surprising.
I first made this model because I knew that continuing to create an income just big enough for us to live on would inevitably lead to obscene account balances in old age. The question I wanted to answer was, "How large
could our income be during the younger years of our lives (when we'd be more likely to spend it) while being as tax efficient as possible over the long term?"
A couple of general points about the data before I dive into the trends.....
- I used a 5% growth rate, which is a bit conservative since the long-term figure in the US is closer to 7% before inflation
- State taxes are specific to North Carolina
- ACA premiums are specific to the bronze and silver plans I've chosen based on my County of residence
- I consider ACA premiums a "tax" because we could lower them to $0, but Medicare premiums are not since base premiums are a set amount. So ACA premiums are reflected in the overall tax percentage but Medicare premiums are not.
- The percentage of our taxable accounts that are long-term capital gains are specific to us
- Assumes one child and the associated child tax credit
- Income tax thresholds are Married Filing Jointly
At first, I thought making our tax rate as even as possible over our lifetimes would be best. However, it became apparent that doing this would leave a huge portfolio balance in old age. The model quickly struck down that idea.
I also assume that we will spend less in old age (50k), and I'm probably being overly generous with that figure as it's more than we spend now. After watching my very healthy grandparents age, it's quite evident that spending really falls off in your 80s and beyond (maybe even 70s depending on health), unless it's increased healthcare spending. As we get into our 70s and 80s, Social Security and a bit of rental income will cover about half of our planned spending. The model indicates that 500k in our tIRAs will be enough to cover the remainder of our spending in old age (~25k), while growth keeps our tIRA balance healthy enough to cover long term care costs at the end of our lives.
So once we hit 72, Social Security, some rental income, and our RMDs are enough to cover all spending, essentially leaving our remaining Roth IRA funds to compound untouched until we die. So with that trend in mind, I started to examine how we could increase our Roth conversions and spending earlier in life to bring down the balance of our Roth IRA fairly low by the age of 72.
A side effect of having exhausted our taxable accounts by the age of 72 and having only small RMDs is that our taxable income in our 70s and beyond is basically nothing. As far as I can tell, this is simply the way it has to be if we want to maximize the access we have to our money when we're younger.
As I started increasing our Roth conversions over the next 20-30 years, it became evident that the real pinch point was going to be the age of 60 because we don't have access to Roth gains prior to that without penalty. Bearing that in mind, I started pulling larger Roth conversion amounts forward, even closer to now, than I had originally planned for. It got to a point where the model indicated that having maximum access to our money over the next 30 years meant immediately increasing Roth conversions to 70-80k per year. In doing so, our AGI rises to ~120k for almost a decade until our taxable accounts are exhausted and there are no more long-term capital gains to be had. After that, our AGI drops to ~85k per year for another decade until we finally reach the point that it doesn't make sense to do any more Roth conversions because we want to leave enough tIRA money for those RMDs to cover our spending in old age. Plus we can't convert everything to Roth IRAs before we get on Medicare or we'll have no way to create income since we exhausted taxable accounts already.
Immediately maximizing Roth conversions while still maintaining a consistent, low overall tax rate from year to year does eventually have the side effect of "running out" of convertible money. Once we hit that point, we only convert the minimum needed to qualify us for private ACA insurance. Once our income becomes minimal, estimated to be in our late 50s, we basically pay no taxes. So we actually end up with a model that shows us paying little to no tax from our late 50s through the end of our lives. Taxable accounts have been exhausted, most all tIRA money has been converted to Roth, and what tIRA money remains barely goes above income tax exemptions. Again, this seems to be something that has to happen if we're to maximize access to our money while young.
So....shortcomings of the model. Our portfolio is obviously not going to grow at 5% every year. Sequence of returns is going to affect this. But 5% is also a bit conservative, historically speaking, so maybe our spending could be even higher than this. Future legislation could require the model to change.
And of course, the obligatory note that this is just a model that I created to gain better insight into long-term trends for income and tax efficiency. This will not dictate our spending but it can be a very useful guide.
And if anyone should find an error, please let me know!
I suppose I shouldn't be surprised that the model shows large, immediate Roth conversions are needed to maximize access to our money when 60% of it currently sits in tIRAs. We could choose to not convert that much money, leaving higher account balances in old age but why? It seems the prudent approach, given that the future is unknown, would be to maximize access to our money at any given time, even if it means paying a little bit more tax than we'd have to only covering our base expenses. I do have to say I was pleasantly surprised to see that we could spend 80-100k over the next 30 years while having a marginal tax rate of only ~12%. And that includes ACA insurance premiums. That's pretty damn good.
Edit: Attachment of my model was removed due to a request for an updated/improved version, which can be found downthread
here