Taxable income post fire and paying on debts

[mistymoney]

I am likely two years away from fire/fir right now, and wanted to get any insight on moves I can make or things I should think about tax wise.

Currently, my finances are leveraged with mortgage, car, and student loan payments. Will definitely pay the car off in next two years.  I have a side gig with variable income that I can use toward debts or extra savings.  There are 7 separate student loans with varying interest rates and monthly payments, current total is around 93k. The most likely scenario is that I could pay 2-3 of those off by retirement while maintaining my 401k/HSA, if in fact that is my best way to go. All interest rates are below 7%, but higher than tbill interest.

85% of my money is in 401k, so future taxable income. Will be 59/60 at fire, and waiting till 70 for soc sec. So I will potentially be pulling a lot from 401k for first 10 years. The other 15% is in roth, taxable, ibonds, and HSA. All of which I would like to not tap on the usually yearly spend.

What is my best move for the next two years?

Current MO, continue maxing 401k and HSA, pay off a few of the student loans as I go, and post fire withdraw what is needed from all/mostly 401k. This money is going in off the 24% tax bracket. But with larger debt payments, the debt payment money would be coming out in the 22% tax bracket, so not much of a difference....although the brackets would likely get a bit larger across the few years while the debt payments remained constant. Hard for me to think of the 2% plus any pretax growth here as a huge win....what do you experts think?


Alt1: Don't pay any extra on any student loans and get payments lowered under income based repayment plan with lower income in FIRE and just pay longer. Interest at <7% seems preferrable to taking money out at 22% tax rate....am I missing anything? So limit what I am pulling from 401k to get a lower income and lower payment. May need to save some extra in taxable to make all the payments for 1-2 years until I have a tax return with lower income? Another angle here is to maybe lower income would make the interest tax deductible?

Alt2: Aggressively pay off student loans before fire, even lowering 401k contributions to do so. (Sidebar: Even if I lower 401k to only get the match, with 24% fed and state income taxes, would only net about 15-16k to go towards the loans from ~21k less into 401k each year.) Again, seems like shuffling things around without or little real benefit....

on the current MO, I would be pulling a lot out of the 401k, and then would likely not end up on the wrong side of RMDs with heavier taxes later.

Mortgage balance is about 300k at 2.75%, so carrying that like luggage forever......Can't think of a single good way or huge benefit on trying to pay that off......unless got the senior freeze on property taxes fro low income, which seems like an iffy thing for me to try.

Interested in any thoughts.

[reeshau]

With 2 years to go, there isn't much that will make a huge difference.  Differences of a few percent take time, and show themselves by compounding over long times--over your working career, for example.  So, a big part of the answer is which makes you more comfortable: having the debts paid off, or having the extra cash available for whatever.

But, there is one question that could magnify the benefit.  What is your strategy for health care before Medicare?  If it is using the Affordable Care Act, the subsidies available (or not, at higher incomes) can make a big difference.  And if the income cliff returns, that would be a particularly dangerous line to cross.

If you haven't looked into it yet, @seattlecyclone 's blog is a good place to start learning.

[secondcor521]

Miscellaneous thoughts:

What are the interest rates and terms on the student loans?

What is your intended asset allocation at FIRE?

I would think you would get any property tax benefits due to seniors in your area regardless of mortgage or not, so I wouldn't factor that in without verifying one way or the other.

Your comment about the 7% interest rate vs 22% tax rate seems to be comparing apples to oranges.  Unless the SL is forgiven, you have to get the dollars from somewhere to pay those debts at some point.  If they come from your 401(k), then they'll be taxed; at some rate probably in the mid 20's%.  The real comparison to be made, IMHO, is between the after-tax risk-adjusted rate on the SLs (and mortgage) against your portfolio AA expected return long term.  Thus the questions above.  If you can make arbitrage on the SL and/or mortgage on an after-tax risk-adjusted basis and want to manage that, then go ahead.  Otherwise, make a plan to pay it off.

You probably can make the arbitrage work on the mortgage.  The SL's, maybe not so much, especially if you have a conservative AA and/or SL rates above ~5%.  Based on what you've said, I'd be inclined to pay off the SLs unless you can make a reasonable play for forgiveness somehow or can get the SL interest tax deduction.  The SL interest tax deduction is a maximum of $2500 per year and there are income phaseouts that depend on your filing status - see IRS Pub 970 Chapter 4 for details.

I wouldn't reduce the 401(k) contribution below the match amount to pay off the SLs, but I would probably reduce it to pay them off if they were in the 5% or more range.  Maybe even 4% range depending on the above questions.

I hope in your planning that results in a two year target that you've accounted for the debts and their repayments when you put your data into FIREcalc or cFIREsim or whatever.

Will your 401(k) plan allow your withdrawals the way you want?  They have to allow access, but they can (and do sometimes) apply various restrictions on withdrawals.  Check with your HR department if you haven't already.

I wouldn't look at the aspect of pulling lots from the 401(k) to pay off SLs in your 60s and therefore avoiding RMD high taxation later as a benefit.  Your current MO exposes you more to SORR risk.  And if you're at risk of high taxation of RMDs, you can just do strategic partial Roth conversions to address that problem separately.

Agree with @reeshau about ACA and health insurance.

[mistymoney]

Miscellaneous thoughts:

What are the interest rates and terms on the student loans?

What is your intended asset allocation at FIRE?

I would think you would get any property tax benefits due to seniors in your area regardless of mortgage or not, so I wouldn't factor that in without verifying one way or the other.

SL - 5.5% to 6.9%

AA at fire 80/20

Re: senior property tax freeze: My thought was if I maintain the mortage need to withdraw higher amounts from 401ks to pay P&I which puts my income above the threshold for the freeze. So I could look at paying it off over a period of 5 years by taking more money out of 401k, and then by the time I hit the age to be able to claim the sen freeze I would be able to have a lower income. This seems undoable to me. For this year, the lookback is at 2021 income. With car and SL paid off maybe I could squeak by under the threshold and with the mortgage, but it might be close. Maybe a better plan would just be to move a larger portion into taxable for a few years? But then I am looking at doing so at at least 22% tax if not 24%, so would need to think about that a lot....how worth it it may be.

[mistymoney]

With 2 years to go, there isn't much that will make a huge difference.  Differences of a few percent take time, and show themselves by compounding over long times--over your working career, for example.  So, a big part of the answer is which makes you more comfortable: having the debts paid off, or having the extra cash available for whatever.

But, there is one question that could magnify the benefit.  What is your strategy for health care before Medicare?  If it is using the Affordable Care Act, the subsidies available (or not, at higher incomes) can make a big difference.  And if the income cliff returns, that would be a particularly dangerous line to cross.

If you haven't looked into it yet, @seattlecyclone 's blog is a good place to start learning.

Good point. Was thinking to cobra if cheaper for the first 18 months. Will check into ACA stuff too.

[mistymoney]

Your comment about the 7% interest rate vs 22% tax rate seems to be comparing apples to oranges.  Unless the SL is forgiven, you have to get the dollars from somewhere to pay those debts at some point.  If they come from your 401(k), then they'll be taxed; at some rate probably in the mid 20's%.  The real comparison to be made, IMHO, is between the after-tax risk-adjusted rate on the SLs (and mortgage) against your portfolio AA expected return long term.  Thus the questions above.  If you can make arbitrage on the SL and/or mortgage on an after-tax risk-adjusted basis and want to manage that, then go ahead.  Otherwise, make a plan to pay it off.

You probably can make the arbitrage work on the mortgage.  The SL's, maybe not so much, especially if you have a conservative AA and/or SL rates above ~5%.  Based on what you've said, I'd be inclined to pay off the SLs unless you can make a reasonable play for forgiveness somehow or can get the SL interest tax deduction.  The SL interest tax deduction is a maximum of $2500 per year and there are income phaseouts that depend on your filing status - see IRS Pub 970 Chapter 4 for details.

I wouldn't reduce the 401(k) contribution below the match amount to pay off the SLs, but I would probably reduce it to pay them off if they were in the 5% or more range.  Maybe even 4% range depending on the above questions.

I hope in your planning that results in a two year target that you've accounted for the debts and their repayments when you put your data into FIREcalc or cFIREsim or whatever.

Will your 401(k) plan allow your withdrawals the way you want?  They have to allow access, but they can (and do sometimes) apply various restrictions on withdrawals.  Check with your HR department if you haven't already.

I wouldn't look at the aspect of pulling lots from the 401(k) to pay off SLs in your 60s and therefore avoiding RMD high taxation later as a benefit.  Your current MO exposes you more to SORR risk.  And if you're at risk of high taxation of RMDs, you can just do strategic partial Roth conversions to address that problem separately.

Agree with @reeshau about ACA and health insurance.

So - was looking for ways to stay out of the 22% tax bracket as much as I could. Not that I know how it all works, lol! So looking at 2024 tax info, says the std deduction is 14.6k and the 12% bracket goes up to 47.15k. I am correct in thinking this means that if I pull 61.75k from 401ks that my highest marginal rate is 12%? If so then I think there is a chance I could finaggle my way into that, which roughly corresponds to the income cutoff for the senior freeze.

yes - have included these in  my models.

Can you tell me what you mean by if my 401k allows withdrawls the way I want? What am I wanting that is odd? I will be 59.5 so I figured free access, and most are in rollovers already.

[secondcor521]

Miscellaneous thoughts:

What are the interest rates and terms on the student loans?

What is your intended asset allocation at FIRE?

I would think you would get any property tax benefits due to seniors in your area regardless of mortgage or not, so I wouldn't factor that in without verifying one way or the other.

SL - 5.5% to 6.9%

AA at fire 80/20

OK.  Most people I know would not want to have 20% of their AA earning maybe 5% pretax to pay SLs at 5.5%+ after tax.  You're guaranteeing losses that way.

Re: senior property tax freeze: My thought was if I maintain the mortage need to withdraw higher amounts from 401ks to pay P&I which puts my income above the threshold for the freeze. So I could look at paying it off over a period of 5 years by taking more money out of 401k, and then by the time I hit the age to be able to claim the sen freeze I would be able to have a lower income. This seems undoable to me. For this year, the lookback is at 2021 income. With car and SL paid off maybe I could squeak by under the threshold and with the mortgage, but it might be close. Maybe a better plan would just be to move a larger portion into taxable for a few years? But then I am looking at doing so at at least 22% tax if not 24%, so would need to think about that a lot....how worth it it may be.

Ah, OK, I see what you're saying now.  My guess would be that the freeze is worth less than the arbitrage opportunity of a 2.75% fixed rate loan over the rest of the mortgage term, but you'd have to run numbers.

[secondcor521]

So - was looking for ways to stay out of the 22% tax bracket as much as I could. Not that I know how it all works, lol! So looking at 2024 tax info, says the std deduction is 14.6k and the 12% bracket goes up to 47.15k. I am correct in thinking this means that if I pull 61.75k from 401ks that my highest marginal rate is 12%? If so then I think there is a chance I could finaggle my way into that, which roughly corresponds to the income cutoff for the senior freeze.

yes - have included these in  my models.

Can you tell me what you mean by if my 401k allows withdrawls the way I want? What am I wanting that is odd? I will be 59.5 so I figured free access, and most are in rollovers already.

As for your first question, one would think so.  But it's almost certainly not true if you're using ACA (and in some other situations).  ACA subsidy loss acts like a secondary parallel tax and the rate can be as high as 15% or so in addition to the 12%, so there are ranges where it can look like you're in the 12% bracket range but your actual marginal rate is more like ~27%.  That's why @reeshau and I have commented on ACA a few times.  @seattlecyclone's personal blog has a good couple of articles on this.

For the second question, it is my understanding that 401(k) providers can restrict the timing and amounts of your retirement withdrawals in ways that may make them not work for you.  For example, they may say that your withdrawals are limited to once per year, or are limited to the entire balance remaining in the account.  This may or may not apply to you; it will depend on your specific 401(k) plan.  Since you're >59.5, one simple solution to this is to roll the 401(k) to a traditional IRA and then take withdrawals from there in any way and timing that you wish.  Or just figure out what amounts and timing of 401(k) withdrawals you plan to do, then check with your 401(k) plan administrator and run it by them and make sure they support what you want to do.

[mistymoney]

I wouldn't look at the aspect of pulling lots from the 401(k) to pay off SLs in your 60s and therefore avoiding RMD high taxation later as a benefit.  Your current MO exposes you more to SORR risk.  And if you're at risk of high taxation of RMDs, you can just do strategic partial Roth conversions to address that problem separately.

Not so much a benefit as a consolation prize?

Agree on the SORR. Plan to begin with at least 3 years worth in cash equivalents, at least 2 within 401k, and then regular savings and ibonds. So - that is my hedge on SORR, ripped off of Nords plan and added a year as I have no pension. Maybe more if I can manage it. I haven't worked out exactly what my whole withdrawal plan will be if the market is up, but if market is down will take from the cash until that runs out or the market recovers. When I get to 70 soc sec will cover alot of the expenses and then won't need the cash hedge so much. Its that bridge of 10 years that is difficult to plan. So 10 years to get there, 3 years in cash, medicare hits after 5, and early soc sec could be an option if things look bad.....but if things look bad....seems holding out for higher soc sec could also be a good move.......too many things to consider!


In terms of planning and getting ready...."Three hundred lives of men I have walked this earth and now I have no time"!

[mistymoney]

With 2 years to go, there isn't much that will make a huge difference. 

lol - while a relatively casual comment here, this has been kind of haunting me the past two days.....:P

To the point of wondering.....how far does that logic goes, how much can I do or accomplish over the next 2 years and would hanging it up in a few month not be a huge difference.....Now what the comment was meant to convey, I know! But as one gets to the end, it seems something to think about.

Going to lay out some milestones I am envisioning over the next 2 years and see how much of a difference that may make to my long term security....

[reeshau]

@mistymoney , I'm not put off at all with that interpretation.  It was casual, but it is also everything you say!  Compounding is nonlinear, and humans are not good at thinking in that way.

In the context of a full life, the $1 you contribute in your 20's (assuming retirement at 65) is worth 10x the $1 you contribute in your 50's.  The rub is, of course, that most people have more dollars in their 50's.  But the worst thing you can do when trying to build independent wealth is start late, in terms of making it more difficult.

The converse is also true.  If you are close to your goals, you will have considerable momentum built.  So, the differences of a year or two can be quite small.  I think of it as a natural milestone, when your accounts are earning more return than your contributions.  At that point, those contributions start to lose importance; just a smidgen, but eventually quite a bit, in the same nonlinear way.

"The best time to plant a tree is 20 years ago.  The second best time is today."