FI taxable funds versus retirement funds

[just_hatched]

From reading "Your Money or Your Life", one of the main ideas is that you can FI when you have enough taxable funds that can generate enough income to cover expenses assuming a "safe" investment such as 30-year treasury bonds.

So, the idea is that once you've reached that magic point on the huge graph paper posted in your closet where your taxable nest egg is paying all of your expenses and keeping up with inflation and is not in a risky investment vehicle (is that possible to have both?), then you go out a celebrate!!! (as long as you don't bust your budget...)

Anyway, as I'm looking at my mix of taxable versus retirement fund balances, I understand the idea of tax-deferred savings and getting 401k matching, etc. but putting money into retirement accounts delays the date for FI.

It would almost seem why not take the 10% penalty and tax hit and transfer retirement savings into taxable accounts if it will help to achieve FI faster because once you've hit FI, then will it matter what you have in your retirement accounts? You've already FIed!

I'm not going to do that, but someone please point out the error(s) in this strategy.

Thanks!

[maddythebeagle]

but putting money into retirement accounts delays the date for FI.

It would almost seem why not take the 10% penalty and tax hit and transfer retirement savings into taxable accounts if it will help to achieve FI faster because once you've hit FI, then will it matter what you have in your retirement accounts? You've already FIed!

I'm not going to do that, but someone please point out the error(s) in this strategy.

I dont think you are thinking in 4 dimensions. I dont understand your logic?

Also, Condider this:

http://www.retireearlyhomepage.com/wdraw59.html

[Dry Socks]

Hi just-hatched,

It seems to me the premise of your question might be wrong. I don't understand how one can make the calculation of where future inflation will be.

If you put everything in 30yr treasuries today and we have high inflation over the next 10-20 years, you might be in big big trouble.

-Dave

[flipstress]

Originally Posted by just_hatched

Anyway, as I'm looking at my mix of taxable versus retirement fund balances, I understand the idea of tax-deferred savings and getting 401k matching, etc. but putting money into retirement accounts delays the date for FI.

It would almost seem why not take the 10% penalty and tax hit and transfer retirement savings into taxable accounts if it will help to achieve FI faster because once you've hit FI, then will it matter what you have in your retirement accounts?* You've already FIed!

The link given earlier to the retireearlyhomepage site will let you know of a way to withdraw your 401K money without the 10% penalty when you roll over your 401k money to an IRA after termination of employment.* At that point, when you start withdrawing via the 72t exception with SEPP (substantially equal periodic payments), then your rollover IRA becomes taxable but you'll avoid the 10% penalty.

So putting your money in tax-deferred accounts like a 401K plan during the accumulation period is not delaying your FI date.* As ex-Jarhead explained, it will most likely even accelerate your FI date because of the tax deferral benefits.*

[uncledrz]

The problem (I prefer this over error) in paying a 10% penalty to have funds available for early retirement is that it:
1. pays tax not required to be paid;
2. loses continued tax deferral;
3. is not necessary.

If you are at a point where the numbers are going to work, and you don't want to continue working past when the numbers work, then as you approach, stop funding deferred options and leave those funds available for near term expenses, then tap the deferred funds once the penalty doesn't apply (at 59.5 years, or when rule 72t can be use).
Uncledrz

[GTM]

Originally Posted by just_hatched

From reading "Your Money or Your Life", one of the main ideas is that you can FI when you have enough taxable funds that can generate enough income to cover expenses assuming a "safe" investment such as 30-year treasury bonds.

I don't understand this logic. If you need $40,000 per year to live and you have $1 million tax fee in Treasuries at 4% you are OK the first year since the interest on the T bonds meet your $40,000 requirement.

What about inflation and protection of principle?
After the first few years you will need more than $40,000 per year but your $1 million at 4% will not do it.

I think the way to calculate is to use a retirement payout calculator which will account for inflation and reduction of principal in your withdrawals.
This will calculate how many years $40,000 in todays dollars will last when your principle becomes 0 (zero).

[just_hatched]

Thanks for all the responses. BTW, I'm 34 and am not nearing any retirement yet.

The reason for the question are really 2 things:

1. If I remember the book YMOYL correctly, I think it is mainly referring to the point when you become FI which seems to imply you get there on taxable funds. I then make the assumption that once you're FI and continue to keep your expenses as low as possible (yet it seems expenses rising with inflation must also be assumed, which is unpredictable), then you will not need tax-deferred savings.
It's possible I'm misinterpreting the author and/or just missing something.

2. I am glad to have built up a 401k and have no intention of tapping it early (although I'm learning from you that it may be possible without penalty under certain conditions) but in my spreadsheet I have a projection of how much income could be generated from my taxable savings assuming some growth rate of say 5%, where the growth itself may pay for my expenses while the principal is still preserved.
(hmm... no inflation assumption though...)
So the income number goes up faster if I were to decide to put future savings into taxable accounts instead of 401k, at least until I can tap the 401k.

Originally Posted by GTM

What about inflation and protection of principle?

Inflation is unpredictable I agree, I guess it's assumed that a conservative rate of return can still cover inflation and live off the growth, therefore protecting principal.
This is probably not a good assumption however. (is that an understatement?)

Originally Posted by uncledrz

The problem (I prefer this over error) in paying a 10% penalty to have funds available for early retirement is that it:
1. pays tax not required to be paid;
2. loses continued tax deferral;
3. is not necessary.

If you are at a point where the numbers are going to work, and you don't want to continue working past when the numbers work, then as you approach, stop funding deferred options and leave those funds available for near term expenses, then tap the deferred funds once the penalty doesn't apply (at 59.5 years, or when rule 72t can be use).

Right, I was leaving out the 72t as an option because I'm not near enough to retirment to consider using it. However, it does allow another option that my question didn't mention - my question was too much "either/or" to transfer the 401k money to taxable and pay the penalty.

Perhaps a better question is: how to know when to stop funding deferred options?
That depends on the goal, which for sake of the original question is: how early can I achieve FI?
Maybe the book YMOYL defines FI differently than most people here do? (maybe it doesn't
consider inflation for example?)

Maybe the answer is to keep funding tax-deferred accounts as long as possible anyway.

Originally Posted by flipstress

So putting your money in tax-deferred accounts like a 401K plan during the accumulation period is not delaying your FI date. As ex-Jarhead explained, it will most likely even accelerate your FI date because of the tax deferral benefits.

Then it seems I can have the cake and eat it too and didn't know it?
(well, someday...) because so far, I have both taxable and 401k (and Roth).

Originally Posted by ex-Jarhead

JustHatched: First off, I'll make a comment on the failure of the new generation (my kids are age 38, and age 32) not appreciating or understanding what a gift towards retirement they've been handed, by the various tax deferral possibilities that are available today.
Incidentally, they have stretched out the MWD at 70.5 to 26 years. (The previous was about 16 years, so if you can get by on the lower required amount, it is quite an improvement).

I think most people over, say, 50 have DB pension plans that should make retirement planning easier for them, but I am glad that 30-somethings have access to tax-deferred plans and I do use it. I have no plans to touch it at all yet, and plan to continue contributing at least to get the match, if not more.

I knew about 401ks having mandatory withdrawals, but 70.5 still seems pretty far away to me at the moment so I never really considered it much. Although, even if they have improved it for 401ks, the fact that it's there seems like a good reason to put the savings either in Roth or taxable accounts so no need to worry about mandatory withdrawals.

I apologize if it seems I'm going in circles. I will most likely continue to contribute to taxable and tax-deferred accounts. But I wanted to know if anyone started ramping down their contributions to tax-deferred accounts simply because it no longer became necessary? (i.e. acheived FI)
I suppose by that point, you still contribute so you can reduce taxes, or you retire and no longer have the option to contribute anyway.

[rmark]

You might want to read some of the free articles over at analyzenow.com.

[maddythebeagle]

Perhaps a better question is: how to know when to stop funding deferred options?

I think this is an individual answer. The deferred stuff can function as a way to avoid taxes now, so if you are in a high tax bracket, makes sense to use it to drop you down. You have a spreadsheet, right? I think you also need to make some projections on when you want to withdraw and how much annually and starting when. As well as make a projection of how much income you will take from other sources (taxable, pensions, ss, etc.). I personally plan to minimize taxes when I take out as well.

what age are you planning to retire and what are you doing for your taxable investments. Are you saying that you want to take dividend income from your taxable accounts and leave the rest to grow. That is a good strategy.

[just_hatched]

Originally Posted by maddythebeagle

You have a spreadsheet, right? I think you also need to make some projections on when you want to withdraw and how much annually and starting when. As well as make a projection of how much income you will take from other sources (taxable, pensions, ss, etc.). I personally plan to minimize taxes when I take out as well.

what age are you planning to retire and what are you doing for your taxable investments. Are you saying that you want to take dividend income from your taxable accounts and leave the rest to grow. That is a good strategy.

Oh yeah - that withdraw part.

I've done 3 separate types of retirement analysis.

1. I have access to the Financial Engines forecast through my 401k, but it seems to have 2 modes that I can tell so far: One for retiring immediately (not ready to do that) and the other for retiring at some 60ish age and getting social security, pension, etc. assuming I'm still at my current job for the next 25+ years (maybe, but I doubt it)
It simply says that assuming I get raises, keep contributing and working til 65, I'll have some huge amount that will easily cover 85% or so of my projected final salary, based on monte carlo scenarios, etc.
I even get a forecast picture like a sunny day. My retirement feels like a sunny beach already...

2. I downloaded the spreadsheet from the retire early homepage and punched in some numbers and it says I can retire in 8 years at 42 years old with retirement assets of $1.25 million (which excludes home equity, social security, and pension) with annual pre-tax withdrawal of $47k and after-tax living expenses of $43k per year. I assume 8% investment growth and 4% inflation.

3. I have my own spreadsheet/workbook that has 3 sheets. One for income, one for budget, and one for NW projection. It doesn't consider inflation, but assumes a 7% investment growth. Nor does it include any projections for withdrawal, only accumulation.

I think 8 years is pretty far to project the future, but methods 2 and 3 match up pretty well, for example at age 42. My own spreadsheet breaks down my projected NW at 42 to be:
$1.67 million total NW
- $355k home equity (assumes 5% house appreciation)
- $71k pension
= $1.24 million of taxable and retirement accounts, almost exactly the method 2 projection.

The $1.24 million would break down roughly:
$200k cash (I'll probably not have that much, but rather put some into taxable index funds instead)
$250k taxable index stock funds, US and international
$650k 401ks (mostly stocks)
$120k Roths (mostly stocks)

Or I could go with the 4th method, the back-of-the-envelope estimate of 25x expenses, which I'd say is around $40k expenses per year in today's dollars, so that's 25x40 = $1 million if I had that today.

So even though I don't know when I'll actually retire (maybe 45 - 50?) I know that I'd like to have it as an option. Now what to do with future savings? I plan to stick with what I'm doing, but it is interesting that method 2 for example doesn't seem to say how to retire at 42 if a lot of the money is tied up in 401ks. I guess that answer lies with many of the answers in this thread so far, which is where I would need some education in the next 8 years at least if I want to actually try to FIRE at 42.

All of these projections of course assume I don't get divorced (from too much time on spreadsheets and this board) or don't get fired from my job (from too much time on spreadsheets and this board - actually I do neither of them at work) or any other crazy market crashes, crazy inflation, etc.

[Martha]

A year or two ago, I plugged in all our information into Financial Engines, which is available to me for free through work. I am 50 years old and my spouse is 53 and retired. Financial Engines suggested not contributing to the 401(k) anymore, unless necessary to get an employer match.

I say baloney. Given our tax bracket anything to save taxes now makes sense to me.

[MRGALT2U]

Hello just_hatched.....good list of possible "ER derailers".
Being a bit older (I was hatched before TV - do you believe that?)
I could add a lot to your list. No need. Just remember not to wait too long. In fact, that is my advice to all of you.

Elvis has left the building................

JG

[SteveR]

Originally Posted by Martha

A year or two ago, I plugged in all our information into Financial Engines, which is available to me for free through work.* I am 50 years old and my spouse is 53 and retired.* Financial Engines suggested not contributing to the 401(k) anymore, unless necessary to get an employer match.

I say baloney.* Given our tax bracket anything to save taxes now makes sense to me.*

Martha,

I would agree. I ERd from one megacorp after 24 years and rolled over my 401k inot an IRA. So did my wife after 34 years with the same company. My current employer has only a 401k and I invest just enough of the match. Free money and lower taxes is too good to pass up. When I ER again in 2 years I will roll this 401k over into a differnet IRA and then I can stop saving and start spending. I will have saved several thousand $ in taxes and will have accelerated my current 401k by several percent by not having to pay taxes until I start taking distributions. That adds up to a lot of $$$.