Liquidate taxable to fund tax advantaged accounts?

[Just_Me]

Hi there

I have a question regarding optimal use of W2 dollars. If you are familiar with some of my recent posts I am going to 3/4 time which will still pay all the bills and allow us to save some, but not to the extend of maxing tax advantaged accounts and invest extra in a taxable account. We have ~$150k in taxable brokerage account, recent additions do not have a lot of capital gains.

Does it make sense for us to max out tax advantaged accounts and draw from the taxable account when needed to meet monthly spend? Or do we leave taxable as is and lower contributions to retirement plans? Both 401ks and IRAs have low fees (vanguard/tsp) and we are not looking at early retirement any time soon.

[terran]

I would (do) max tax advantaged accounts even if that means withdrawing from taxable. This is the natural extension of the recommended investment order as not maxing tax advantaged accounts while you have money in taxable is basically the same as contributing to taxable before maxing out tax advantaged. The only exception to this for me would be if you expect to retire before you have 5 years worth of spending in a combination of Roth contributions and taxable with which to start a Roth conversion ladder. The solution to that is more likely to be to prioritize Roth contributions than to keep money in taxable, though. 

[Dicey]

I always thought it was a good idea. At one point, it was my plan, too. I decided to try to make living on the lower amount a game and had such huge success that I never needed to deploy this strategy.

I'm FIRE now, mostly posting to see what others advise.

[Just_Me]

Thank you Terran and Dicey. I thought it was like the natural extension of the investment order, as long as we did not need the funds to bridge the 5 year conversion strategy. It was my default assumption to do this but had a random "what if it's not the right thing to do" alarm bell go off, so I figured I'd post and ask.

[zolotiyeruki]

You haven't mentioned how much you currently have saved in tax-advantaged accounts, but *IF* you have significant tax-deferred savings already, AND if you plan to retire significantly earlier than 59.5, then I disagree with Dicey and terran.  Here's why:

You're apparently already aware of the Roth Pipeline, and the need for 5x expenses.  If your $150k is already more than 5x your annual expenses, then sure, go ahead and liquidate some of it (but keep 5x!), contribute to a tax-deferred account, and take the deduction.  If it's less than 5x, then don't touch it, let it grow, and put all your savings (from wages) in tax-deferred accounts.

Depending on where your income lies in the various tax brackets, some other strategies might also be appropriate:
--If you're in the 12% bracket, and have space before you hit the 22% bracket, you could harvest some capital-gains to set a new, higher cost basis.  This could prove important if current tax proposals pass into law and hike the LTCG tax rate.
--Similarly, if your savings rate isn't enough for you to max out your IRAs, and you have space in the 12% tax bracket, you could harvest capital gains and contribute to Roth IRAs, with the attendant tax benefit.

[Just_Me]

You haven't mentioned how much you currently have saved in tax-advantaged accounts, but *IF* you have significant tax-deferred savings already, AND if you plan to retire significantly earlier than 59.5, then I disagree with Dicey and terran.  Here's why:

You're apparently already aware of the Roth Pipeline, and the need for 5x expenses.  If your $150k is already more than 5x your annual expenses, then sure, go ahead and liquidate some of it (but keep 5x!), contribute to a tax-deferred account, and take the deduction.  If it's less than 5x, then don't touch it, let it grow, and put all your savings (from wages) in tax-deferred accounts.

Depending on where your income lies in the various tax brackets, some other strategies might also be appropriate:
--If you're in the 12% bracket, and have space before you hit the 22% bracket, you could harvest some capital-gains to set a new, higher cost basis.  This could prove important if current tax proposals pass into law and hike the LTCG tax rate.
--Similarly, if your savings rate isn't enough for you to max out your IRAs, and you have space in the 12% tax bracket, you could harvest capital gains and contribute to Roth IRAs, with the attendant tax benefit.

$150k is about 3.75 years expenses for us excluding child care, which will be phased out over the next few years. Our tax deferred savings are about $350k traditional + $30k HSA. We don't plan to retire significantly before 59.5, but who knows how we will feel when we actually approach the 25x number. Simple Math puts that somewhere in 5-10 years.

This year we will have no problem contributing the maximum to tax deferred accounts. AGI is projected to be $85k with $60k taxable if we leave IRA contributions as ROTH for this year. That leaves a lot of room to harvest capital gains, though an extra $20k in income this year will drive up our child care costs for next year by about $3,500 due to the sliding tuition scale the school uses based on total taxable income (not AGI, so tIRA and i401k contributions don't factor into their calc, but w2 deductions do). Next year we would have only 1 kid in daycare, and potentially DW back at W2 contributions/higher income, which then increases tuition anyway. Once they're out of daycare I can see us leveraging the capital gains harvesting to the max before incurring the 15% rate.

This is all making me wonder though, whether the i401k contributions this year out to go in as ROTH instead of traditional since there's no downside to the tuition. 12% is not a bad rate to pay.

Edit: change total taxable income to total income. Vastly different.

[zolotiyeruki]

This is all making me wonder though, whether the i401k contributions this year out to go in as ROTH instead of traditional since there's no downside to the tuition. 12% is not a bad rate to pay.

Good catch, and I think that's worth exploring more.