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Is it time to cut back on pre-tax savings?
Old 01-29-2020, 02:01 PM   #1
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Is it time to cut back on pre-tax savings?

Long time lurker, infrequent poster. I have a question for the collective experienced.

For about 20 years I've been working against a plan for early retirement. The plan has mostly been about maximizing pre-tax savings for my spouse and I (403b and 401k respectively) and paying down debt. The plan should net us close to $2M by the time I retire (in 4yrs and 11mo) which is a couple months after I turn 55. My wife will work for a couple more years to maximize her pension (which should cover only about 15% of retired budget income, but help immensely with health insurance).

My question relates to our current "lack of cash". Yes, we have an emergency fund and very little debt, but with our current spending and maxing out both pre-tax, there isn't much left to grow after tax. I'm concerned what I'll need to do if a 72-t isn't an option (if it's not offered by the plan, I need to get that question answered)

Should I take some tax "penalty" now to hedge against the 10% penalty before 59.5? Have you?

Alternatively, given the 2020 tax brackets gap of 10% is it better (if nothing in tax law changes ) to stay the current course? (Given we'll be in the 24% bracket with monies not saved pretax)

Tax rateMarried filing jointly or qualifying widow
10%$0 to $19,750
12%$19,751 to $80,250
22%$80,251 to $171,050
24%$171,051 to $326,600

Thanks for taking the time to read, I appreciate all that I've learned here.
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Old 01-29-2020, 02:07 PM   #2
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Congratulations on being so close!

Investigate to see if your 401(k) allows for rule of 55, penalty free withdrawal if you retire after turning 55.
Make sure you understand distribution limitations on your 401(k) plan, is a one time withdrawal, or can you withdraw whenever you would like...
See if you can do a partial rollover to an IRA if your 401(k) doesn't allow for the rule of 55 withdrawals.
You would not be allowed to do a 72T from your 401(k), I think they are only allowed from your IRA.
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Old 01-29-2020, 02:26 PM   #3
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Originally Posted by 2k6_TX_Dad View Post
Long time lurker, infrequent poster. I have a question for the collective experienced.

For about 20 years I've been working against a plan for early retirement. The plan has mostly been about maximizing pre-tax savings for my spouse and I (403b and 401k respectively) and paying down debt. The plan should net us close to $2M by the time I retire (in 4yrs and 11mo) which is a couple months after I turn 55. My wife will work for a couple more years to maximize her pension (which should cover only about 15% of retired budget income, but help immensely with health insurance).

My question relates to our current "lack of cash". Yes, we have an emergency fund and very little debt, but with our current spending and maxing out both pre-tax, there isn't much left to grow after tax. I'm concerned what I'll need to do if a 72-t isn't an option (if it's not offered by the plan, I need to get that question answered)

Should I take some tax "penalty" now to hedge against the 10% penalty before 59.5? Have you?

Alternatively, given the 2020 tax brackets gap of 10% is it better (if nothing in tax law changes ) to stay the current course? (Given we'll be in the 24% bracket with monies not saved pretax)

Tax rateMarried filing jointly or qualifying widow
10%$0 to $19,750
12%$19,751 to $80,250
22%$80,251 to $171,050
24%$171,051 to $326,600

Thanks for taking the time to read, I appreciate all that I've learned here.
In my case, since the passage of the Secure act and the elimination of the stretch IRA I have completely eliminated tax-deferred contributions. I am doing Roth contributions. I'm doing this even though I am in the 24% marginal (single) - because I believe the rates will be higher when I am forced to take RMDs.
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Old 01-29-2020, 02:43 PM   #4
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You are wise to plan what sources you can use from when you retire at 55 to when you qualify for penalty-free withdrawals at 59 1/2. If you can use the rule of 55 and take money out of your 401k penalty free after retiring at 55 then that is a great solution.

One other solution if you don't plan on moving is just before you retire take a cash out mortgage on your house for 5 years worth of withdrawals... use those proceeds to carry you from 55 to 59 1/2 (gross it up for mortgage payments)... and then use withdrawals after 59 1/2 to pay off the mortgage. Essentially, you are using your house as collateral for a bridge loan to carry you from when you retire at 55 to when you gain penalty-free access to your 401k and 403b.

The only other solution would be to dial down tax-deferred savings and dial up taxable savings in preparation for those years.

Once you and your wife are both retired and collecting pensions, SS and any withdrawals needed for spending, what would you expect your margnal tax rate to be? If the answer is 22% or more, then tax-deferred savings doesn't gain you much so taxable savings or a Roth is much more viable.
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Old 01-29-2020, 02:50 PM   #5
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I think you need to plan where your income is coming from for the different phases.

Retirement to 59.5
59.5 to 65 (Medicare)
59.5 to SS
SS to RMD

You don't mention Roth accounts or Roth 401k as an option. Roth conversions from retirement to SS should be looked into. That won't really help with living expense money.

You need Taxable funds to bridge the first gap unless you want to use Roth for this. Most like to let Roth grow and be used "later".

If your spouse will have healthcare for a couple years and some income, then figure out where the other income will come from. Then plan how to get health coverage after the couple years.

Spending is the key number. Understand it very well. Use 3.5% or 3.0% as your baseline income from your portfolio. If spending is higher than that, either you have to spend less or work longer/save more.

This is the hard work that will give you confidence your early retire plan will work.

I'd switch to Roth 401k, lower the contribution amount and start building a taxable account for the bridge years.

Lots of smart people here who can chime in.
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Old 01-29-2020, 06:45 PM   #6
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Originally Posted by NgineER View Post
Investigate to see if your 401(k) allows for rule of 55, penalty free withdrawal if you retire after turning 55.
Thank you, I will
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Originally Posted by copyright1997reloaded View Post
..because I believe the rates will be higher when I am forced to take RMDs.
I believe you're correct.
Quote:
Originally Posted by pb4uski View Post
Once you and your wife are both retired and collecting pensions, SS and any withdrawals needed for spending, what would you expect your margnal tax rate to be?
I'm budgeting our expenses to require about about $85,000 so not much over 22%
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Originally Posted by bloom2708 View Post
I think you need to plan where your income is coming from for the different phases.
Thank you, I agree and I'm going to spend some time planning each one of your points, thank you.
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You don't mention Roth accounts or Roth 401k as an option.
We have 74k in Roth accounts, I don't think we've contributed to in a while due to limits or funds.
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Old 01-29-2020, 08:43 PM   #7
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.... I'm budgeting our expenses to require about about $85,000 so not much over 22% ...
Good news!

It doesn't work that way. If you have $85k of income, but only $60,200 of taxable income after the $24,800 standard deduction, so you're in the 12% bracket, not the 22% bracket.

Good opportunity to do $20,250 of Roth conversions to the top of the 12% tax bracket for only $2,430 in tax.

But I am confused, where is the $85k to pay the $85k in expenses coming from? It could make a diffeence in the calculation above.
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Old 01-30-2020, 06:04 AM   #8
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+1 on Roth.
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Old 01-30-2020, 06:45 AM   #9
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But I am confused, where is the $85k to pay the $85k in expenses coming from?
If I don't change my after tax savings, it would come from my 401(k) through SEPP or withdraws that include a 10% penalty.

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+1 on Roth.
I will plan my after tax withdrawals up to the top of our tax bracket and put the remainder into a Roth.
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Old 01-30-2020, 09:48 AM   #10
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We were in a similar situation about 5-7 years before ER, i.e., all tax-deferred except for an emergency fund. I thought we'd have to do a 72-t. But the taxable account grew extremely fast in those last several years, while still maxing out both 401Ks. There were a variety of reasons, but it basically boiled down to the fact that earnings were peaking while expenses were flat or slightly declining.

Expenses were helped by the kids moving out and just keeping our lifestyle in check with ER so close. The income side was helped by stock options, RSUs, bonuses, and some expat benefits. I'd been getting those for some time, but in prior years, we always managed to spend some of it on vacations, home improvements, used cars for the kids, etc.

I think with ER so close, we just stayed focused on saving more than spending.
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