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Take loan to avoid tax hit? And meaning of FIRECALC Ending Portfolio
Old 02-21-2020, 03:35 PM   #1
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Take loan to avoid tax hit? And meaning of FIRECALC Ending Portfolio

Two One questions for the great minds of this forum:


We are considering taking a $45,000 loan for a five year term to avoid getting a tax hit on a withdrawal from a 403b this year. Does this make sense?


(edit: I found a thread with some answers to this second question, so this second question may end up duplicating earlier)

Second, how much “stock” do people put in to the lowest and highest portfolio balances at the end of a plan that Firecalc provides along with success rates? For instance, I put two different scenarios through the calculator. Both gave 100% success, but different portfolio values: for not taking the loan: $2,992 to $6,656,77, for taking the loan: $155,584 - $7,023,483. Is this a significant difference? (should I post this in the Firecalc forum instead?)



I would love for folks to chime in.


Background:
DW and I are about to retire. She is 58 and will be done this July after teaching for more than 20 years. I am 62 and working half time this year and next but am retirement eligible. I will retire fully in June 2021.

We have about $1million in a 403b, (55% stock index and 45% bond index) almost all of it tax deferred. So basically any withdrawals will be taxed. We owe about 70K on our main home which will be paid off in 2022. The house has a ridiculous amount of equity—we are in the overpriced Bay Area. Only other debt is car loan for 20k.

We have a rental property in another part of the state that we want to sell. We expect a capital gain of about 50,000.

DW has a CALSTRS California Teachers pension that she will defer for two years until she is 60. That will increase the amount of her pension $4500/year. But it reduces our income for the next 2 years.

I don’t have a pension but will get a decent SS of $37k/year if I delay till 70. I am pretty healthy so it makes sense. But it requires spending down the 403b a lot for the next 7.5 years. Also when I decided to go ½ time, we figured we would make up the difference in income by withdrawing from the 403b. That means we are facing some big tax hits, which leads me to my question/strategy.

My strategy:

We need about 45,000 to cover our expenses this year beyond our earnings. So we have two options: Option 1 is take $45,000 from the 403b. Option 2 is to use our HELOC to cover the extra costs.

Option 1 means we are in a higher tax bracket—I ran it through turbo tax and we would likely pay about 11% tax rate on all our income, state and fed. Option 2 be would be about 6%. That means we would pay about $14,200 extra in tax if we do the withdrawals rather taking the loans.

I figured that a 45k loan at 5% interest paid back over 5 years would cost about $8400 in interest. So we are about $5800 ahead by taking the loan. Does that seem right?

I also ran everything through Firecalc to see what it did to our success probability and estate—accounting for the increased annual expense of $6500/year in payments for 5 years and delaying taking anything from the 403b for a year (I guess that reduces sequence of returns risk and increases the chance we will have more money saved).

With both options Firecalc gives a 100% success rate over 40 years—that’s good. But it gives different ending portfolio values. For Option 1: $2,992 to $6,656,77 for option 2, $155,584 - $7,023,483.

Is this a significant difference?


Thanks for you wisdom.
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Old 02-21-2020, 04:00 PM   #2
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Hey, experts out there... in the back of my pea-sized brain, I recall a section in the internal revenue code that provides for early withdrawal without penalty from a retirement account such as the 403b upon loss of a job. I know you can withdraw to pay for health insurance without penalty. OP, ask your 403b administrator.

Do you have an old (aka at least 5 years old) Roth IRA? If yes you can roll money from the 403b into that account, paying income tax on that withdrawal, then withdraw from the Roth tax and penalty-free. You should be able to set up automatic conversions from your 403b to your Roth. The account age, not the money, is what is determinative.

HELOC? Talk to your credit union and First Tech Federal CU (I have been a member for over 20 years, Tektronix employees founded it). First Tech is now headquartered in Palo Alto.
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Old 02-21-2020, 04:07 PM   #3
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That sounds like a good idea for future years when our income drops and our tax bracket will be low. But for this year, because of her income and mine and the capital gains, it wouldn't help, I think.


Yes we have a Heloc from Provident credit union--which is what we would use for the loan this year.
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Old 02-21-2020, 04:10 PM   #4
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If you don't have a Roth start one as soon as possible. You don't need to contribute much.
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Old 02-21-2020, 04:13 PM   #5
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I think debt can be a good strategy.... if you take the withdrawal, it also takes away flexibility as it is irreversible. The loan is reversible and in the 5 years you anticipate repaying it, you may be able to pay it off early saving interest.


I plan to FIRE myself this year and in 2021 will likely borrow from my HELOC for living expenses and wait till late in the year to see how much earned income I get in "ER" and only then realize income from my investments to minimize my taxes and pay off the HELOC. If the market turns nasty early in my FIRE adventure, I also may use my HELOC to fund my living expenses for more than part of a year (leveraging my investments until valuations improve).
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Old 02-21-2020, 04:28 PM   #6
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Oh, just found this thread which addresses my second question of how much stock to put in the ending portfolio range.


https://www.early-retirement.org/for...age-97499.html
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Old 02-21-2020, 09:22 PM   #7
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Ok, this is a bit embarrassing--I made a couple errors in getting all these numbers together. I put the wrong loan costs into my spread sheet-- It turns out the savings from paying the cost of the loan vs paying the taxes is smaller--just 4k. And I would have to pay for 8 years not 5 to pay off the loan at the annual payments I want.


So then when I reentered the corrected spending in Firecalc the situation becomes less clear. We are still at 100% success either way, but taking the 403b disbursement in year 1 gets us a better range of ending portfolios (we'd like to leave something to the grandkids) than if we take the loan in year 1. the low portfolio after taking the disbursement would likely be 87k, the low portfolio after taking the loan would be 53k. If I invested the 4k difference for the forty years of my plan, it would come to about 15-20k--making the two plans effectively identical



In fact, the difference seems like a wash-- I figure at age 102, I won't be able to read the difference between a 5 and 8 so it seems like they will be about the same.
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Old 02-21-2020, 11:00 PM   #8
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Your tax numbers don't make sense. You say:
Quote:
... Option 1 means we are in a higher tax bracket—I ran it through turbo tax and we would likely pay about 11% tax rate on all our income, state and fed. Option 2 be would be about 6%. That means we would pay about $14,200 extra in tax if we do the withdrawals rather taking the loans. ...
If $14,200 is extra tax and increases you from paying 11% vs 6%, then $14,200 divided by (11% - 6%) is $284k of income. Is that right?
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Old 02-21-2020, 11:22 PM   #9
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OP - What is your plan if the second house does not sell in 2020 ?

Will you be delaying implementing your grab for extra cash to near the end of the year in case the house does not sell ?
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Old 02-22-2020, 12:01 AM   #10
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On the tax: Pb4uski that is right according to the numbers I gave, but my percentage wasn't correct. Another error (this stuff is complicated!). the tax difference is correct but the tax rate is wrong. When figuring the rates I used the wrong income figures. Our gross income would be more like 225k (including the capital gains) if we withdraw from the 403b. I recalculated that after you brought up the income. the tax rate when taking the disbursement is 14%, with the loan it would be 9%.


Sunset, I am pretty confident in selling the property--we already have a buyer who is the current tenant. But if the deal falls through (possible since she's having a little trouble getting a mortgage -- she took out a lot of student loans to get an . . . art degree), and we can't sell it, we can keep renting it out. The rental market in the area is strong. We just don't like having to manage a property that far away from us.


And yes, we are delaying taking the extra cash as long as possible.
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Old 02-22-2020, 12:13 AM   #11
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Once you are fully retired and on SS, what do you think your marginal tax rate will be? Do you plan to stay in Ca?

If you plan to stay in Ca and your marginal tax rate in retirement will be 22% or more then I would go with the 403b withdrawals because at that point it is 22% now or 22% later so it really doesn't matter.

If you're going to move from Ca after you retire then I would look more seriously at the HELOC because if you withdraw after moving to a lower tax state you will save on state income taxes.
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Old 02-22-2020, 12:19 AM   #12
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That's good question about marginal tax rate. To be conservative, I have been assuming for the sake of firecalc and other forecasting that our marginal tax rate stays about the same--14%. But I think realistically 10% is more likely in a few years.


And we will never leave California for a low cost of living place--too much family here. And I love the never ending sense of crisis and looming disaster. oh and the weather is not bad when it is not on fire.
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Old 02-22-2020, 12:48 AM   #13
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Your margnal tax rate is the rate on the last $100 of income... it would most likely be either 12% or 22% or 24%
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Old 02-22-2020, 09:26 AM   #14
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Yes, I used the wrong term, my bad. I am still learning all this stuff. The percentages I gave were our effective tax rate which I find easy to get since I am using turbo tax and it makes for clearer (for me) comparison of what might happen with the different scenarios



Marginal tax rate currently is 31.3%--22% fed and 9.3% state. I think in the the loan scenario we drop into the 8% tax bracket for state but all else stays the same.
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Old 02-22-2020, 10:27 AM   #15
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Maybe I'm missing something here (so apologies in advance). You will eventually need to take the money out of the 403B, and it eventually will be taxed. Given that, why not take at least some now vs when you are 70 and also taking social security. It seems likely that your tax bracket will be higher at 70+?

Also do not forget that the existing individual tax rates are scheduled to end in 2025, at which time you will face higher rates. (Unless new legislation is done and approved.)
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Old 02-22-2020, 12:05 PM   #16
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If financially is it a push I agree with FLSUnFIRE. The HELOC would give you more flexibility.
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Old 02-22-2020, 02:26 PM   #17
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I don't understand why you would accelerate paying off your mortgage in two years and at the same time borrow money?


I can't sell my rentals for the tax rate would kill me.
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Old 02-22-2020, 05:49 PM   #18
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Old 02-22-2020, 07:02 PM   #19
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I haven't run any numbers, but I am about to do something similar and will go with the HELOC. Taxes are a big reason; but it also gives us extra cash, rather than depleting our cash reserves, and gives us a nice cushion for off-budget surprises.

At this point, I'd rather use someone else's low-interest money and pay it back later. I like having some leverage, and I prefer to hang onto my cash. With a HELOC, we only have to use what we need, and we can pay it off anytime we want.

You are selling a rental and didn't say what equity you have, just the capital gain. It sounds like you could use that revenue to cover your expenses for a year at least. If the timing of the sale doesn't work out, a 10-year HELOC could be a perfect bridge to get you over the hump.

You could always choose to pay the loan off with the sale proceeds and still keep the HELOC open for emergencies like health care or unforeseen repairs. It sucks to have to pull from tax deferred funds in an un-planned manner.

We also have some rentals and will be selling an underperforming property to buy a better one. In the process, we will finance some of the purchase of the new property and keep that cash for investing and covering some our excess monthly expenses. In our first five years of retirement, we have overspent our budget by a fair amount, but it is slowly coming under control and I eventually see it getting much easier as our lives settle down a bit.
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