Saving too much (pretax)

[dallas27]

Fwiw, i try to save everything pre-tax. I don't have a fear of the 10% penalty, in fact i think it works in my favor including the penalty.

I think the work people do to avoid it is very often wrong and they are hurting themselves.


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[pb4uski]

No political jab intended. ....

Yeah, right. You could have made the same point without the first part of your earlier post, the part that started "Unless you're like Romney (with millions in IRA),". In fact, your point, which I think was that it is almost impossible to retire at 45 without substantial taxable savings, would have been clearer.

 

[jetpack]

Thanks guys, this has been helpful. I didn't know about the SEPP payments possibility, so you can always get some money. If there is any big purchase, you might have to bite the bullet.

For me, I had been maxing out my SEP-IRA, with $50k / year, and the returns have been good, so indeed, much of my wealth is pre-tax. I should be able to live off it, with out too much penalty.

One other thing to mention: We don't know what future tax rates are going to be. Indeed, 20 years down the road things could be a lot different. I can only think tax rates are going up.. especially if I'd have to make a big withdraw in one year.

 

[scrabbler1]

My guess is that it's purely a comment at the mathematics behind it.

In order to retire at 45, unless you only live on a $5,000 budget, you'll likely need a good $2MM to do so. Barring someone who has access to the ways that the super IRAs accumulate tens of millions of dollars, it's mathematically impossible for a "non-Romney" 45 year old to accumulate $2MM with a majority of it in IRAs, since you are only allowed to put in $17,000/year. In order to accumulate $2MM in IRAs with $17k annual contributions, you would need to quit your job and roll it over into a self-directed IRA to place excessively risky bets on penny stocks and long positions in options (and most IRAs prohibit owning long positions in options, usually just covered calls).

So the only other realistic way to accumulate a few million by age 45 is to earn quite a large salary, and save it - and with only $17k/year going to 401ks, you'd wind up with far more going to taxable savings.

Yes, there are ways to be self-employed with SEP IRAs, or even creating your own pension plan that you'd fund with ginormous contributions each year....but this is aimed at the 90%-95% of people who are able to retire at 45.

Not for me. When I ERed in late 2008 at age 45, I had about $840k with $600k of it in taxable accounts. This included the company stock I cashed out using NUA but did not reflect the income taxes I would eventually pay on it (about $75k). This was late 2008 when the markets were crashing and that was a terrific break for me because I was able to buy an extra 25% shares in the big bond fund whose monthly dividends support me today.

Without adding a single dollar from the outside, the Rollover IRA's value has doubled in the last 6 years. The taxable account's value has, despite having used a lot of its earnings to cover my ER expenses (about $21k per year), risen about 30%.

 

[swakyaby]

This has been a really informative thread!

Can anyone tell me if, between the years of early retirement and RMD, if there is a dollar limit on the amount of Roth conversions one can make each year? Can one convert from a SEP-IRA or a Rollover IRA? Or is it limited to conversions from a traditional IRA? About half my assets are tax-deferred.

 

[harley]

Fwiw, i try to save everything pre-tax. I don't have a fear of the 10% penalty, in fact i think it works in my favor including the penalty.

I think the work people do to avoid it is very often wrong and they are hurting themselves.


Sent from my iPhone using Early Retirement Forum

Just curious, got any logic to back this up? Or is it just a feeling you have? How can the 10% penalty work in your favor? What is wrong with avoiding the penalty, and especially what is wrong with saving outside the pre-tax vehicles?

 

[Alan]

This has been a really informative thread!

Can anyone tell me if, between the years of early retirement and RMD, if there is a dollar limit on the amount of Roth conversions one can make each year? Can one convert from a SEP-IRA or a Rollover IRA? Or is it limited to conversions from a traditional IRA? About half my assets are tax-deferred.

No restrictions at all as far as I am aware, on any of the types of IRA you mention. The more you convert in any given tax year the more tax you pay. It is the tax bands that cause folks to self limit what they convert.

 

[pb4uski]

I figure that I'm saving a ton in taxes by having deferred income to my 401k when working and my marginal tax rate was probably ~30%+ between federal and state and now I'm converting tIRA money to ,my Roth at ~11.5%.

I see nothing wrong with saving post-tax, but IMO it makes sense only if you have maxed out pre-tax (tax-deferred) savings first if you are in a high tax bracket. If you are not in a high tax bracket then the benefit is more modest.

 

[harley]

I figure that I'm saving a ton in taxes by having deferred income to my 401k when working and my marginal tax rate was probably ~30%+ between federal and state and now I'm converting tIRA money to ,my Roth at ~11.5%.

I see nothing wrong with saving post-tax, but IMO it makes sense only if you have maxed out pre-tax (tax-deferred) savings first if you are in a high tax bracket. If you are not in a high tax bracket then the benefit is more modest.

No argument there. But I suspect that only saving in pre-tax, even maxing it out, won't get you to ER. And even if it does, it complicates creating a draw down strategy set, even with the 72t. Max out your pre-tax if you are in high brackets, but supplement that with after tax. A higher savings rate, and flexibility in managing your draw down and your taxes.

 

[dallas27]

Just curious, got any logic to back this up? Or is it just a feeling you have? How can the 10% penalty work in your favor? What is wrong with avoiding the penalty, and especially what is wrong with saving outside the pre-tax vehicles?

By matching my 401k in my business, i avoid fica, which well exceeds 10%. So the 10% is not a significant deterrent.


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[pb4uski]

That makes sense, but would paying less self-employment tax have a second order effect of reducing the amount of SS retirement benefits that you are entitled to?

It would not make sense for anyone who is not self employed though so you need to be clear about that when posting.

 

[growing_older]

Annual 401 limit is 52,000 with employer match. 53 next year. Add in a roth, maybe a spouse, you can get to 2 million with compounding.

Never have I worked at (or even heard of) a company that matched 3x up to the annual limit, except small family businesses that were essentially an individual setting up their own plan for themselves in their own company. Even in the rare cases that I worked at a company that allowed after-tax contributions which theoretically meant you could approach the larger 52k limit, the HCE fairness rules (even if Safe Harbor, you still need to demonstrate HCE compliance for after-tax) never allowed anyone to contribute that much. Sure, the tax code allows it, but only people who control the company are likely to be able to setup the situation to make it possible.

Despite all that, since I know if I ER I will be able to access IRA through 72t (SEPP) substantially equal payments, I can easily avoid the penalty even if all my money is locked up under IRA rules. Further, it's virtually guaranteed that I will have some taxable savings, or even house equity, that I can tap until I reach age 59 1/2. In fact because I'm likely to be drawing on non-tax-advantaged savings during at least the early part of ER, I will also have a great opportunity for tax rate arbitrage by converting pre-tax IRA to post-tax IRA (Roth) during those years that my "taxable" income is low in ER because I'm essentially living off savings. Of course, all this changes somewhat if you have a pension to account for, but those are increasingly rare.

 

[Fermion]

Even in the rare cases that I worked at a company that allowed after-tax contributions which theoretically meant you could approach the larger 52k limit, the HCE fairness rules (even if Safe Harbor, you still need to demonstrate HCE compliance for after-tax) never allowed anyone to contribute that much. Sure, the tax code allows it, but only people who control the company are likely to be able to setup the situation to make it possible.

At the very large software company, you can contribute $18,000 to 401K, get about a $6,000 match, and make a after tax contribution of $20,000 to your 401K then do an immediate conversion of that to a Roth.

It isn't $52,000, but it is $44,000 a year which is not bad. I could see doing that for 20 years and having at least 1.5 million with even marginal market returns.

 

[gauss]

Never have I worked at (or even heard of) a company that matched 3x up to the annual limit, except small family businesses that were essentially an individual setting up their own plan for themselves in their own company. Even in the rare cases that I worked at a company that allowed after-tax contributions which theoretically meant you could approach the larger 52k limit, the HCE fairness rules (even if Safe Harbor, you still need to demonstrate HCE compliance for after-tax) never allowed anyone to contribute that much. Sure, the tax code allows it, but only people who control the company are likely to be able to setup the situation to make it possible.

More than a few people around here are contributing the 52k or so to their 401k combing pre-tax and after-tax contributions. DW and I have been doing this since around 2010 or so (until I FIRED). There is no need to have an abnormally large company match to get to the 52k level. You just need a plan that will accept after-tax contributions. These plans seem to be more common in the older large legacy corporations.

We have never had a problem with this, but I don't think either of us have risen to the level of (HCE) Highly Compensated Employee since then either.

Come to think of it, when DW was HCE in the past, they just limited her pre-tax contributions but allowed after-tax instead.

FWIW, both of our MegaCorps did limit our contributions to no more than 50% of our gross income.


-gauss

 

[2017ish]

Never have I worked at (or even heard of) a company that matched 3x up to the annual limit, except small family businesses that were essentially an individual setting up their own plan for themselves in their own company. Even in the rare cases that I worked at a company that allowed after-tax contributions which theoretically meant you could approach the larger 52k limit, the HCE fairness rules (even if Safe Harbor, you still need to demonstrate HCE compliance for after-tax) never allowed anyone to contribute that much. Sure, the tax code allows it, but only people who control the company are likely to be able to setup the situation to make it possible.

///.

Pretty common in professional corporations (or LLCs, etc.) in the Med/Law fields, where the funds over the 401k limits are put into owners accounts as before-tax pension/profit sharing. Granted, these are, almost by definition, outliers.

Also, from financial advising conversations with DS, I gather that substantial aftertax contributions are frequently allowed in silicon valley (and, at least in some cases, that is after 1 for 1 pre-tax match).

 

[Winemaker]

One can receive payments from a 401k without the 10% penalty if you are over 55 and have had a separation of service.

 

[Lucantes]

My company provides 100% matching, up to 9%, and allows after tax contributions up to the IRS annual limit ($53K for 2015).

 

[flyingaway]

No restrictions at all as far as I am aware, on any of the types of IRA you mention. The more you convert in any given tax year the more tax you pay. It is the tax bands that cause folks to self limit what they convert.

I know you can convert money from tIRA to Roth IRA. Can you covert money from 401(k) directly to Roth IRA (without roll over to tIRA first)?

 

[pb4uski]

I know you can convert money from tIRA to Roth IRA. Can you covert money from 401(k) directly to Roth IRA (without roll over to tIRA first)?

No, I pretty sure you can't.

 

[pb4uski]

One can receive payments from a 401k without the 10% penalty if you are over 55 and have had a separation of service.

If your plan allows it. Many do, but some do not so be sure to check if you are relying on this strategy.

 

[bingybear]

When I originally read this a few days ago, I thought this question was a retirement time bomb question... the tax trap at RMD time. With the availability of provision 72T, there is a way to access the tax deferred funds somewhat early.

I see my investments as one entity... not divided by goal. I've believed that some diversification in tax treatment of assets. Presently I have 1%/44%/55% roth/ira-401k/after tax. ok, a bit light on the roth, but ER will give me the opportunity to roll some over at relatively low tax rates.

One has to remember when counting the pennies you've saved in IRA/401k... it is not all yours. The government still has a tax interest in it. So don't count your pennies before they're taxed. But with some planning you may have some control on how that happens.

ER provides more options than for those who choose... or have to work until RMD time.

 

[gauss]

I know you can convert money from tIRA to Roth IRA. Can you covert money from 401(k) directly to Roth IRA (without roll over to tIRA first)?

Yes -- I have done it before.

In the past this was prohibited, but the Pension Protection Act of 2006 reformed this. Here is an article that discusses this.

-gauss
http://www.investopedia.com/articles/retirement/08/convert-401k-roth.asp

 

[pb4uski]

Yes -- I have done it before.

In the past this was prohibited, but the Pension Protection Act of 2006 reformed this. Here is an article that discusses this.

-gauss
http://www.investopedia.com/articles/retirement/08/convert-401k-roth.asp

Interesting. Learn something new every day. I guess the real benefit is avoiding the pro-rata rule.

 

[growing_older]

So don't count your pennies before they're taxed.

Is this a new retirement planning aphorism. Love it.

 

[photoguy]

When I originally read this a few days ago, I thought this question was a retirement time bomb question... the tax trap at RMD time. With the availability of provision 72T, there is a way to access the tax deferred funds somewhat early.

As an early retiree, I consider the 72T withdrawal process as a very last resort due to it's requirement to continue until 59 (~20 years for me). I suppose as I get closer to this age I will have less reservations about being locked in.

However another drawback of 72t is that you can't easily vary the withdrawal size on a yearly basis (set according to life expectancy). This may be an issue if you are managing income for various ACA subsidy thresholds.

This overall lack of flexibility is scary to me. Therefore I prefer to spend down taxable or use withdrawals of Roth contributions.

I see my investments as one entity... not divided by goal. I've believed that some diversification in tax treatment of assets. Presently I have 1%/44%/55% roth/ira-401k/after tax. ok, a bit light on the roth, but ER will give me the opportunity to roll some over at relatively low tax rates.

I have a similar distribution with very low percentage in roth (never met income limits while working and didn't want to use conversions). However now that i'm fired, will definitely convert more IRA assets to roth.