Retirement Accounts and Early Retirement

[heebygeeby]

Hey, everyone! I'm quite new to this place, but I've been browsing around, seeing what you guys have to say. Anyways, here's my question:


I have one semester of college left, and I recently opened a Roth IRA. After doing that, questions of all sorts started popping into my head. But the most prevalent one is: let's say our Roth IRA (or any retirement plan) does exceptionally well over, say, a 20 or 30 year period and we see early retirement as an option; however, because our money is essentially "locked up" in retirement accounts we can't exactly pull it out when we need it without stiff penalties. What do people do in this situation? Yes, I do know about the 72(t) option, but I'm not too fond of paying income taxes twice on my money, and I'd also like to hear what you guys have to say.

So, that leads me to another question about taxable accounts: seeing that I'm mostly interested in ETFs and index funds, many of which are quite tax efficient, would it make sense to start a taxable account filled with ETFs after maxing out our Roth [and 401(k)] if our goal IS early retirement?

Thanks!

 

[Rich_by_the_Bay]

But the most prevalent one is: let's say our Roth IRA (or any retirement plan) does exceptionally well over, say, a 20 or 30 year period and we see early retirement as an option; however, because our money is essentially "locked up" in retirement accounts we can't exactly pull it out when we need it without stiff penalties. What do people do in this situation? Yes, I do know about the 72(t) option, but I'm not too fond of paying income taxes twice on my money, and I'd also like to hear what you guys have to say.

If you stay serious about retirement once you enter the workplace (and I'm betting you will) there is a good chance that you will be investing more than you can shelter. That's where the money will come from to support yourself before age 59.5. And 401k/403b money can be withdrawn earlier (55, I think) in most cases if you have terminated from the employer.

It'll be a nice problem to have. You could just time your investments so that in the later but still pre-retirement years you set aside more in nonqualified accounts.

 

[eridanus]

You can withdraw Roth contributions at any time, tax free.

http://www.fairmark.com/rothira/taxfree.htm

 

[Meadbh]

What Rich said.

Meadbh

 

[CyclingInvestor]

But the most prevalent one is: let's say our Roth IRA (or any retirement plan) does exceptionally well over, say, a 20 or 30 year period and we see early retirement as an option; however, because our money is essentially "locked up" in retirement accounts we can't exactly pull it out when we need it without stiff penalties. What do people do in this situation? Yes, I do know about the 72(t) option, but I'm not too fond of paying income taxes twice on my money, and I'd also like to hear what you guys have to say.

The 72(t) option is mainly for accounts with pre-tax contributions. Even if there is
some post-tax $$ in the account, this forms a non-zero basis and is not
taxed again. I am retired, 48, and living on a combo of 72(t) from my rolled-over
401ks (and a few contributory $$) and dividends from my regular (non tax-
advantaged) stocks.

 

[Empty Pockets]

Fill 'em up. Like the others mention, don't discount 72t distributions in case you need an income stream prior to 59 1/2.

I learned early that for me, once the funds are placed into a retirement account they're out of my mind. I don't get the burning desire for a new car, or bigger house because I have the cash in the bank. I know it's locked up til 59 1/2 and that's fine with me because that was my intent in the first place.

I'm not sure what you mean when you talk about paying taxes twice

 

[figner]

So, that leads me to another question about taxable accounts: seeing that I'm mostly interested in ETFs and index funds, many of which are quite tax efficient, would it make sense to start a taxable account filled with ETFs after maxing out our Roth [and 401(k)] if our goal IS early retirement?

Yes, it can make a lot of sense! My taxable accounts are currently about twice the size of my retirement accounts. If you buy tax efficient funds/ETFs and plan to hold them a very long time, you're effectively creating your own tax-deferred portfolio, since you don't get taxed on the gains till you sell. Once you do start selling, those gains will be taxed at (currently more favorable) long term capital gains rates instead of income tax rates like a 401k/IRA. In some situations, you might even come out ahead with a taxable account (compared to a 401k/IRA, probably not with a Roth though), but this could vary wildly depending on your personal financial situation.

 

[heebygeeby]

If you buy tax efficient funds/ETFs and plan to hold them a very long time, you're effectively creating your own tax-deferred portfolio, since you don't get taxed on the gains till you sell.

Even though I would be holding the ETFs for the long-run, wouldn't you still get hit with taxes from dividends as well as from the turnover when the "manager" of the fund/ETF re-balances? (especially small cap ETFs/funds)

I've found several great ETFs that are quite tax-efficient (i.e. http://quicktake.morningstar.com/etfnet/Snapshot.aspx?Country=USA&Symbol=IWS&fdtab=snapshot), and although placing them in the Roth IRA seems like a no-brainer, it almost seems that it could be more beneficial to place them them in a taxable account where I'd get hit with minimal taxes and then the long-term cap. gains tax when I do decide to take it out.

Thanks for all input, everyone! I appreciate it.

 

[Peaceful_Warrior]

Generally speaking, it's usually better to put high dividend / fixed income or high turnover investments into your pre-tax accounts and then anything tax deferred (equities, low-cost funds, etc) into your post-tax.

 

[figner]

Even though I would be holding the ETFs for the long-run, wouldn't you still get hit with taxes from dividends as well as from the turnover when the "manager" of the fund/ETF re-balances? (especially small cap ETFs/funds)

Yup - that's why it's important to pick the tax-efficient funds, with fewer taxable div/gains distributions.