Allocating Our Income - Need Help

[brettsam]

Hi Everyone,
My wife and I are planning our way to FIRE. I am 32 and she is 31, and we have questions on how best to allocate our income.

Our goal is to hit FIRE by 2028 and plan on retiring and geographic arbitraging to cut expenses to $40k a year, we really like Central America.

Currently I make about $150k a year and she makes $75k gross, and we probably spend about $60k in expenses, total net worth around $500k including equity in houses.

As of right now, these are the steps we are taking:
1. Company match Roth 401k - is 6% each, mine matches 4% and hers 3%
2. $6k year each for Vanguard Roth IRA
3. HSA max for me, she doesn't have this plan

We also have 1 rental property and are planning on moving within the next year and turning our current house into another rental. Then turning the 3rd property into a rental when we retire in 2028.

Our questions:
1. Should we even be contributing to a Roth 401k? I do not predict our income will be this high in the future, and a tax break now would be great. Although 3 rental properties paid off will have high cash flow plus drawing down on retirement funds could potentially have a high income as well.

2. Should we max out our work 401k plans or contribute to a taxable brokerage account with Vanguard?

Initially my plan was to pile money into the Roth IRA's and taxable brokerage accounts until retirement in 6 years. Then let the current 401k's sit and grow until 59.5 to start withdrawing on them penalty free. But now I have been reading about Roth conversion ladders and can't figure out what the best strategy would be.

My thoughts were, having 3 paid off rentals plus the 401k's in 30 years will be more than enough to live on. So we really only need to make it about 22 years until those would be available after we hit retirement date of 2028.

Any help would be appreciated. Really glad to have found this forum. All the podcasts and internet blogs I've come across haven't really addressed this specific of scenario that could answer this. Figured we would try a forum before hiring a CFP.

Thank you!!!

 

[Exchme]

The decision on Roths vs tax deferred is based on your tax rate now vs. in the future. So you answered your own question - if your income will not be as high in the future, then you should direct your money towards regular IRA's and 401K's now, maxing them out to get the tax deduction now, rather than doing Roths. You can do Roth conversions later to control the size of the RMDs if that makes sense for you.

Note that your rental plan has some downsides. Being a landlord is a lot of work and comes with surprise expenses and interruptions in cash flow. As you age, you may not want to be on call 24/7 to fix leaky toilets, evict deadbeat renters and replace carpets their incontinent Pit Bull raised a leg on. If you are far away from the property, then it's impractical to do and you need to pay a property manager. Also, if you sell your primary residence that you've lived in for 2 years, you can get $500,000 in capital gains out of it without being taxed on the gains. Once you convert it to a rental, then the time it spent as a rental is subject to capital gains if you decide to sell when you're older.

 

[pb4uski]

With $225k of gross income, you could save ~$10k in federal tax by each deferring the maximum of $20,500 in 2022... that's 24.5% of the amount deferred.

Let's say that later you are retired and your income is $50k of SS and $50k of 401k or tIRA withdrawals... your tax on that $50k of 401k or tIRA withdrawals would be 12.7%.

So you would save. OTOH, let's say you are hugely financiallly successful and your 401k grows gangbusters and your annual withdrawals can be $100k rather than $50k... your tax on that $100k of 401k or tIRA withdrawals would be 16.9%.

So yes, at your income level 401k tax-deferred savings is far better than Roth tax-free savings.

Play around with different scenarios on https://www.irscalculators.com/tax-calculator

I'm not a fan of residential rental property though I concede that it works for some people. One thing that you wshould know about rental properties is that when you sell there is what is called depreciation recapture where the lesser of your gain or the depreciation that you have taken is taxed at 25% and any gain in excess of depreciation taken is taxed at capital gains tax rates, which are generally 15%. So if after 25 years you have $200k of gain and have taken $100k in dpereciation, then you'll be facing a $40k tax bill.