Saving too much (pretax)

[jetpack]

I was reading this:
Can You Save Too Much Money? Edelman Financial

The guy is really asking if he can save too much money in pretax accounts. The answer was a resounding NO... However, it stuck me that it could be a
wrong answer for early retirees. What do you do if all your money is in pretax accounts, and you're say retired at 45? Wouldn't you be penalized more if you have to withdraw early than if you hadn't put it all away?

 

[bw1990]

SEPP payments or Roth IRA conversions and ladders. There are multiple ways to access pretax savings if you research them.

 

[fritz]

I felt that we saved too much in pretax IRA accounts - looking back. It was a great way to shelter income for retirement while our incomes were running high, but we will have to deal with RMDs all too soon and have Roth conversion issues now due to the ACA subsidy (retired early 58/56). Fortunately, we have about 1/2 of our savings in taxable/Roth accounts, and this allows us to manipulate our income to maximize our ACA subsidy. It's going to be tricky at best to manage our reportable income/taxes as the years go along (it is a nice problem to have vs. running out of funds).

The problem I see with having the majority of your funds in pretax savings is that it leaves you vulnerable to tax issues when unforeseen expenses cause you to hit pretax funds and raise the concern of taxes (ie. new car, furnace, roof, etc.). Depending on where you live - nothing like coughing up an extra $20~$25K (net) for buying a new car and adding paying Federal/State income taxes along with state sales taxes, registration fees, plates. Of course you could take out a loan and pay interest over the years along with the extra annual income required. God forbid you should get hit with multiple expenses in the year (Murphy's law). Maybe Ric Edelman's typical clients aren't generally looking at early retirement or contemplating future tax issue scenarios associated with substantial retirement and taxable savings.

 

[2017ish]

I felt that we saved too much in pretax IRA accounts - looking back. It was a great way to shelter income for retirement while our incomes were running high, but we will have to deal with RMDs all too soon and have Roth conversion issues now due to the ACA subsidy (retired early 58/56). Fortunately, we have about 1/2 of our savings in taxable/Roth accounts, and this allows us to manipulate our income to maximize our ACA subsidy. It's going to be tricky at best to manage our reportable income/taxes as the years go along (it is a nice problem to have vs. running out of funds).

....

We have similar concerns going into retirement. When we pull trigger, we will have at least 75% of investment assets in Traditional IRAs/401k (to be reduced by whatever a developer may pay us for our house acreage). That will make it interesting when withdrawing during retirement.

OTOH, with the exception of 3 years of relatively low income when we maxed $ in Roth 401k, our marginal rates have been too high to not take full advantage of deferral. As you say, it is a nice problem to have--and will result in continuing calculator usage as to whether (and what extent) we should convert during the 13-15 years before RMDs begin.....

 

[flyingaway]

I was reading this:
Can You Save Too Much Money? Edelman Financial

The guy is really asking if he can save too much money in pretax accounts. The answer was a resounding NO... However, it stuck me that it could be a
wrong answer for early retirees. What do you do if all your money is in pretax accounts, and you're say retired at 45? Wouldn't you be penalized more if you have to withdraw early than if you hadn't put it all away?

Saving too much? That is a good problem to have.

 

[RetireAge50]

There should be no penalties if you spread the income out over your lifetime (SEPP and/or Roth conversion ladder). We are planning to have approximately the same taxable income from ages 50 to death so RMD will be no different than any other year. Also our pre-retirement marginal rate is higher so better to have as much deferred as possible.

 

[Amethyst]

I thought this was going to be one of those threads about denying yourself fun and pleasure while you're young, only to retire with a big stash and the inability to enjoy it.

Amethyst

 

[scrabbler1]

I was reading this:
Can You Save Too Much Money? Edelman Financial

The guy is really asking if he can save too much money in pretax accounts. The answer was a resounding NO... However, it stuck me that it could be a
wrong answer for early retirees. What do you do if all your money is in pretax accounts, and you're say retired at 45? Wouldn't you be penalized more if you have to withdraw early than if you hadn't put it all away?

This was an issue as I was putting together my ER plan in the last decade. I realized I needed to have a lot of money away from my pretax accounts such as my 401k. But my ace in the hole was being able to liquidate the large amount of company stock in the 401k using NUA (Net Unrealized Appreciation) and not get killed on the tax bite. Because nearly all of the stock's value was NUA, it was subject to a maximum federal income tax rate of 15%. Only a small part of it was subject to ordinary income tax rates and subject to the 10% early withdrawal penalty. I still had to pay state income taxes and the huge windfall put the rest of my small income into the AMT. But it sure beat having to pull from the 401k and really get killed on the taxes. I also used this liquidation to pull some after-tax contributions from the 401k without any penalty whatsoever.

 

[Fermion]

Well, you can do some interesting things if you have a lot of money in after tax accounts and retire early. If you have a lot of cash, you can report years of little or no income while letting your pre-tax account grow. This can qualify you for Medicaid and other goodies.

 

[gauss]

There should be no penalties if you spread the income out over your lifetime (SEPP and/or Roth conversion ladder). We are planning to have approximately the same taxable income from ages 50 to death so RMD will be no different than any other year. Also our pre-retirement marginal rate is higher so better to have as much deferred as possible.

As a dual income couple this was the case for us also. In our case, I-ORP did a nice job of showing the spreading out of the taxes paid on 401ks/tIRAs over the entire retirement via Roth Conversions, RMDs etc.

 

[Major Tom]

I thought this was going to be one of those threads about denying yourself fun and pleasure while you're young, only to retire with a big stash and the inability to enjoy it.

Amethyst

Given the past threads here, I was thinking the same thing!

 

[Bestwifeever]

Virtually all of our money is in IRA funds at Vanguard, more than 95 percent of it. (It just sort of happened over the years, not really planned, as we paid ourselves first that way and DH's megacorp's retirement plan morphed into a 401(k) which he rolled over. There was an option to borrow against the 501(k) if we needed to.)

Personally I like the simplicity of it re taxes--whatever comes out gets taxed as ordinary income at our current low rate and we just have Vanguard send a percentage to the IRS whenever we withdraw any $$. RMDs in a few years will probably see us sending a higher percentage to Uncle Sam but that's okay--pay now or pay later.

 

[GrayHare]

I'm surprised that article made no mention of the IRA/401k tax trap. Since this is about saving too much, I'll use some large numbers to illustrate. $8m in non-retirement-account growth stocks is worth $6.4m after 20% CG tax (and probably worth more after subtracting cost basis) while a larger $9m in a tIRA/401k is worth less, $6.3m, since it will trigger large RMDs, putting the recipient in a high bracket, plus the Medicare surcharge, resulting in roughly 30% taxation or worse.

Furthermore, with portability, that $8m can be willed tax-free to an heir, plus receive a step up in cost basis, however the $9m in tIRA/401k will not be stepped up and will force the beneficiary to take at least RMDs and pay tax on the whole thing at *cringe* their ordinary rate.

 

[pb4uski]

I think too much tax-deferred savings (or really, insufficient post-tax savings) can be an issue for people who intend to retire early and don't have enough penalty free funds to carry them from ER to 59 1/2 and who don't have enough in tax deferred funds that 72t will provide enough to live on.

However, you can always accept the 10% penalty and simply consider that to be the price of freedom but I would not recommend it. Depending on your marginal tax rate while working and tax rate on withdrawals you may still come out ahead.

 

[fritz]

I'm surprised that article made no mention of the IRA/401k tax trap. Since this is about saving too much, I'll use some large numbers to illustrate. $8m in non-retirement-account growth stocks is worth $6.4m after 20% CG tax (and probably worth more after subtracting cost basis) while a larger $9m in a tIRA/401k is worth less, $6.3m, since it will trigger large RMDs, putting the recipient in a high bracket, plus the Medicare surcharge, resulting in roughly 30% taxation or worse.

Furthermore, with portability, that $8m can be willed tax-free to an heir, plus receive a step up in cost basis, however the $9m in tIRA/401k will not be stepped up and will force the beneficiary to take at least RMDs and pay tax on the whole thing at *cringe* their ordinary rate.

I've instructed our daughters to increase the funding of their 401Ks and/or their spouses 401Ks if they are not working at the time by at least the same amount (RMD) that they will have to withdraw annually from the inherited IRAs from us (and subject to Federal/State taxes). The goal is to max out their 401Ks/their spouses 401K contributions at work - replacing that pretax sheltered income with taxable funds from their inherited IRAs. This would empty the inherited IRA w/o current taxes being owed by them.

This will allow us to in effect assist or completely fund their retirement accounts (and they avoid current Federal/State taxes on the amount they withdraw from the inherited IRAs from us). I've advised that the funds are to be maintained as pretax (and not paid out) at Vanguard and the RMD, or as much as they need to max out their retirement accounts be taken to fund their retirement accounts.

 

[Hamlet]

Yeah, early on I was a little worried about having too much tax-deferred money in the event of a lay-off, and then I realized that since I was currently in the 28% bracket, I would still probably come out ahead, since if I was unemployed my taxes on the deferred money would be 15% plus the 10% penalty.

I think too much tax-deferred savings (or really, insufficient post-tax savings) can be an issue for people who intend to retire early and don't have enough penalty free funds to carry them from ER to 59 1/2 and who don't have enough in tax deferred funds that 72t will provide enough to live on.

However, you can always accept the 10% penalty and simply consider that to be the price of freedom but I would not recommend it. Depending on your marginal tax rate while working and tax rate on withdrawals you may still come out ahead.

 

[photoguy]

What do you do if all your money is in pretax accounts, and you're say retired at 45? Wouldn't you be penalized more if you have to withdraw early than if you hadn't put it all away?

Unless you're like Romney (with millions in IRA), I don't think one can retire at 45 or earlier without accumulating a huge chunk in taxable accounts.

Obviously there may be some exceptions but I think the majority of people who retire that early have substantial taxable assets.

 

[pb4uski]

I'm not sure what your point is other than perhaps some political jab.

Is it that if you have zillions in your IRA that you can just afford to pay the 10% penalty?

 

[gerntz]

More than half of what we have in pre-tax accounts are due to employer 401K matches & direct payments by employers into pre-tax accounts.


Thus I ask, if you subtract your employer contributions to pre-tax accounts, were your contributions excessive? I don't need me no Edelman to answer that question: NOT.

 

[photoguy]

I'm not sure what your point is other than perhaps some political jab.

Is it that if you have zillions in your IRA that you can just afford to pay the 10% penalty?

No political jab intended. By like Romney I meant having access to founder shares in an IRA.

This is a generalization but I think many folks who are retiring early (by 40s) are probably targeting a portfolio of at least 1-2M. At 3% WR this yields a comfortable lifestyle roughly equivalent to US median.

To get to 1-2M it's going to be hard to achieve by only maxing out 401k's with the typical investing options (i.e. index funds). 20 years at 17.5k is only 350k. Granted it may be higher due to investment gains (or not) but unlikely to be reach 1-2M.

So either they (1) have a substantial windfall in their retirement accounts, (2) have sizable taxable accounts, or (3) live well below median lifestyle. I think (but do not know for sure) that most early retiree's would fall into bucket 2.

 

[MooreBonds]

Unless you're like Romney (with millions in IRA), I don't think one can retire at 45 or earlier without accumulating a huge chunk in taxable accounts.

Obviously there may be some exceptions but I think the majority of people who retire that early have substantial taxable assets.

I'm not sure what your point is other than perhaps some political jab.

Is it that if you have zillions in your IRA that you can just afford to pay the 10% penalty?

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.

 

[Closet_Gamer]

Definitely an interesting topic.

I used a financial advisor for a short time. Before I kicked his over-priced butt to the curb, he did say one thing that rang in my ears: "A risk a lot of my clients under-estimate is being so dedicated to tax efficient vehicles that they become unable to access their wealth." At the time I had no real wealth so this seemed an absurdly high class problem. Now it rings true.

For all of my adult life, I've been in the mode of "slam away savings in every vehicle possible with a preference for tax advantaged accounts wherever possible." Suddenly, I'm starting to think seriously about ER and for the first time thinking about how I get access to the money.

This may be a "blind squirrel finds a nut" moment however. I'm contemplating a plan where I hang it up at 51 or 52, allow my deferred comp to mature funding my 50s and the access the retirement accts at 60+. I will need to finesse the maturation dates to manage taxes, but it's starting to seem like a viable plan.

 

[dallas27]

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.

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.




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[2017ish]

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.

.....

And, if you maxed out since 1990, rolled to an IRA with mid-career job switch, and invested aggressively/smartly, you can flirt with 3,000,000 at mid/late 50's retirement without Roths and without considering your spouse's accounts.

(That's DW, unless the excrement hits the fan)

 

[Lucantes]

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.

+1: that is what I have been doing.
When my wife and I retire in 2017, at age 50, we should be at about 46% of assets in taxable (cover us from 2017 through 2027) and the other 54% in tax deferred (free to grow until 2027 and then fund our living from there). Hopefully anyways.....