Pre-tax heavy, should we shift strategies?

[Pleeplus]

I can’t believe it’s been 12 years since my first post! I can honestly say that I owe a ton to this forum and thank all that contribute! Thanks to market tailwinds, salary increases, discipline and a little luck we (DW and I) have built our savings to $2.1m, even though we started late. We just ticked off one more major milestone, which is paying off our house.

The “problem” we currently have is that we are very pre-tax heavy. Of the $2.1m, ~$1.7 is in traditional 401k’s. The current plan is to continue to max out (including catch up contributions) our 401ks, continue to max out HSA’s and put the rest ($50k year) directly into our brokerage account (FXAIX), which sits at $160k. I can’t help but question if we should change that strategy, should we put less in 401k’s and more into the brokerage, other, or stay the course? I do worry about tax implications of changing course on the pre-tax funding.

We are 54 and 53, in good health and will make $380k this year. We also have a fully funded emergency fund.

Thanks for any input..

 

[Koolau]

Well, at least you'll be ready to begin Roth conversions of your tIRAs as soon as you retire. In addition to your emergency fund, I would try to build a fund to pay the taxes on your Roth conversions. Big advantage to paying the taxes with free cash instead of from you tIRAs or 401(k).

 

[audreyh1]

When do you project you might retire? If it’s after 59 1/2 for one of you, you could start pulling from one of your IRAs to meet spending needs, and once you both reach 65 figure out how to do Roth conversions aggressively. I mention 65 because before that you might want to take advantage of ACA healthcare subsidies.

Sounds like you don’t have much in taxable savings though. You might consider increasing that more aggressively.

 

[SnowballCamper]

You have to pay the tax man sometime...
How much do you think you'll want/need in spending in early retirement? Along with retirement age, this could have a big impact on the decision.

Retiring before 59.5 and you definitely want to have a bunch in a regular brokerage (unless an exception applies to you).

If you're waiting until after 59.5 then if you plan to live in a lower tax bracket it's probably best to keep putting it in the 401k and other tax deferred/advantaged accounts. (because you're avoiding your currently higher marginal tax rate)

 

[pb4uski]

Tax deferred savings are just a tax arbitrage play. Do you have an idea of what your marginal tax bracket in retirement? IF your marginal tax bracket in retirement will be lower than the tax savings of income deferral today then tax deferral is worth it. Given your current income is $380k the I suspect continued tax deferral savings is the way to go, but just prepare yourself that you'll eventually owe taxes on that money (unless you donate it to charity).

Once you retire, even if you're under 59-1/2 you will likely be able to do low tax cost Roth conversions.

 

[Out-to-Lunch]

Note that the OP should be able to withdraw from the 401(k)'s under the Rule of 55 (assuming he chooses to work another year). OP, need to check with your custodian to make sure that is an option.

 

[FlaGator]

Good "problem" to have

With your current income and balances at your ages, you are likely to be in a similar tax bracket as today come RMD time, and maybe all along the way, depending upon how much you draw down along the way. Not obvious to me there is a big benefit to deferring now only to have it come out later as ordinary income.

Suggest you consider pumping everything you can now into a regular brokerage account, even potentially including your normal 401K contributions necessary to get the match. Pay the taxes now and have more flexibility later with funds that have capital gain taxes instead of ordinary income. But you need to do some tax planning to make that determination.

The most important thing I learned in the past 10 years is that there is never enough money in regular taxable accounts. I would aggressively build them up over your remaining working years. Should be able to build a substantial amount with that income.

 

[SevenUp]

should we put less in 401k’s and more into the brokerage

No.

You might consider whether to put more into a Roth 401k vs. a traditional 401k, but the brokerage should come after that. See Investment Order for some reasons.

As others have mentioned, you should make a guess at what your marginal tax rate will be when you withdraw from traditional accounts, and compare that to the marginal tax rate you will save on traditional contributions now. What do you think your withdrawal marginal tax rate will be?

 

[jazz4cash]

Tax deferred savings are just a tax arbitrage play. Do you have an idea of what your marginal tax bracket in retirement? IF your marginal tax bracket in retirement will be lower than the tax savings of income deferral today then tax deferral is worth it. Given your current income is $380k the I suspect continued tax deferral savings is the way to go, but just prepare yourself that you'll eventually owe taxes on that money (unless you donate it to charity).

Once you retire, even if you're under 59-1/2 you will likely be able to do low tax cost Roth conversions.

This. But I would also say I like a healthy Roth balance for tax diversification e.g. income smoothing. Roth was not an option much for us so we also have a heavy tilt towards tax deferred. Ideally, I’d like to have 30% or more in Roth and taxable accounts. We are trying to catchup with small conversions and contributions, probably wont make it though.

 

[Koolau]

Good "problem" to have

The most important thing I learned in the past 10 years is that there is never enough money in regular taxable accounts. I would aggressively build them up over your remaining working years. Should be able to build a substantial amount with that income.

I found this out the hard way after FIRE. If I could go back 10 years pre-FIRE, I would have emphasized taxable accounts even at the expense of tIRAs or 401(k). It wan't a fatal error on my part but it did stress me for a few years.

 

[Pleeplus]

Thanks for all the feedback. To answer some questions, we are currently in the 24% tax bracket and our “back of the napkin” spend during retirement is in the neighborhood of $100k (22% tax bracket). Transparently, we have not done a great job of tracking expenses and are in process of collecting that info, but that should be fairly close now that the house payment is done.

Regarding retirement age, my wife would like to retire yesterday! However, 2-3 more years is what we are targeting (age 55 or 56) for her (she earns $160yr). I enjoy my job right now and plan to continue to work for another 5 or 6 years (depending on our numbers).

Perhaps its time to sit down with a flat fee / hourly advisor to look over our numbers to bring taxes into the equation?

 

[Aerides]

If you were suddenly retired, what would you do to bridge to 59.5? That's the problem your math needs to answer. Right now it doesn't - "get another job" is the only way.

I can't tell you how many times we get folks here who find they can retire at 50 or so, but have about 2 years in after-tax savings.

So, yeah, shore that up. I would continue the HSA, and then find a sweet spot in your 401ks between company match and max that allows you to put more into that 50k after-tax bucket.

Also check now into whether your company allows for the rule of 55. Some don't and we've had people find that out the hard way... it's not universally available.

 

[Exchme]

Pleepus:
It sounds like you are near your peak earnings, so deferring is still a good idea.

Thanks for all the feedback. To answer some questions, we are currently in the 24% tax bracket and our “back of the napkin” spend during retirement is in the neighborhood of $100k (22% tax bracket). Transparently, we have not done a great job of tracking expenses and are in process of collecting that info, but that should be fairly close now that the house payment is done.

Regarding retirement age, my wife would like to retire yesterday! However, 2-3 more years is what we are targeting (age 55 or 56) for her (she earns $160yr). I enjoy my job right now and plan to continue to work for another 5 or 6 years (depending on our numbers).

Perhaps its time to sit down with a flat fee / hourly advisor to look over our numbers to bring taxes into the equation?

One point I'm puzzled about is your spending. Backing out tax deferral (60k), SS taxes (27k), federal taxes (53k), HSA (9k), an allowance for state taxes (guessed 11k) and your $50K savings target, I get $167K in spending. So I think that, even excluding taxes, you are either spending a lot more than your $100k retirement target now or you are saving a lot more than the $50K you mentioned in the OP.

If you are really only saving $50K plus the $69K tax preferenced monies, then you are spending way more than you think and then you won't be ready for retirement for quite a while.

The fact that you haven't tracked your spending is not a big problem since you can recover the key data by simply looking at your final paystub (or go to SSA.gov and get your earnings record), plus bank and brokerage statements each year. Try to recover, say, 3 years of that data. If the money came in and didn't get saved, it was spent. Some of that spending (like SS taxes and income taxes) may be less in retirement. In your retirement projection, start from your actual spend and then adjust upwards if you know you have bigger expenditures coming up than represented in your data (roof, car, college, remodel, etc.). Further adjust your future spending estimates upward for the bout of inflation the last four years.

 

[USGrant1962]

I was about 75% tax deferred when I pulled the plug at age 55. It was too much and I've been working to tax diversify ever since.

In retirement you are facing IRMAA surcharges, more likely to be impacted by NIIT (living off of portfolio income), and perhaps eligible for ACA subsidies, yet you have more direct control of where much of your spending money/income comes from (compared to W-2 income). Hence, flexibility in your tax basis is even more valuable than when you are working.

I did dial down my 401(k) contribution at the end (but too late) and I suggest you do the same. Roth is the best, if available. LTCGs receive VERY favorable tax treatment with 0% and 15% brackets plus the principal portion was already taxed. Very helpful to have a good slug of brokerage money when managing income for tax purposes in retirement.

 

[imjustawarrior]

Keep maxing your 401k and HSA. If you can do a backdoor Roth, then do so. Everything else in taxable.

You should have plenty of time to do Roth conversions in retirement.

 

[MdaPetralia]

To answer some questions, we are currently in the 24% tax bracket and our “back of the napkin” spend during retirement is in the neighborhood of $100k (22% tax bracket).

Double check your expected marginal tax bracket in retirement. e.g. If you only need $100k (after-tax) for spending in retirement, that would put you in the 12% marginal Federal tax bracket in 2025 MFJ even if 100% is treated as income (e.g. if you withdrew approx. $110K from your 401k).
You can check out here:

Understanding Tax Brackets: Interactive Income Tax Visualization and Calculator - Engaging Data

This interactive, visualization shows you how your income is split into the various tax brackets for both regular and capital gains taxes.

engaging-data.com

put the rest ($50k year) directly into our brokerage account (FXAIX)

Perhaps consider doing a backdoor Roth IRA with the $50k/year.

 

[Taco]

If you want/expect to both retire before you are 59.5, then having enough after-tax funds to comfortably get you to 59.5 seems like it should be a top priority.

i.e. If saving on taxes had meant working longer than I wanted, (waiting on 59.5 to have non-penalized access to my funds), I would have rather payed some extra tax in order to start the retired life sooner.

 

[Pleeplus]

One point I'm puzzled about is your spending. Backing out tax deferral (60k), SS taxes (27k), federal taxes (53k), HSA (9k), an allowance for state taxes (guessed 11k) and your $50K savings target, I get $167K in spending. So I think that, even excluding taxes, you are either spending a lot more than your $100k retirement target now or you are saving a lot more than the $50K you mentioned in the OP.

Fair question. Those estimates were based off of last year spend and would have included a house payment ($32k year) that we just paid off, 529 savings for our HS son ( we currently have enough saved for 4 years of college), pre-tax parking option for working in town, etc. in addition, the $380k a year also includes a $40k pay hike that I just received.
In short that $50k is probably going to be closer to $80k when all is said and done. When we understand our new cash flow from the impacts of eliminating the house payment and raise, the plan was to increase our automated brokerage account deposit / purchases.

 

[Pleeplus]

Double check your expected marginal tax bracket in retirement. e.g. If you only need $100k (after-tax) for spending in retirement, that would put you in the 12% marginal Federal tax bracket in 2025 MFJ even if 100% is treated as income (e.g. if you withdrew approx. $110K from your 401k).
You can check out here:

Thank you and will do. I will admit that I am less versed on the taxes and tax impact.

 

[Pleeplus]

I did dial down my 401(k) contribution at the end (but too late) and I suggest you do the same. Roth is the best, if available. LTCGs receive VERY favorable tax treatment with 0% and 15% brackets plus the principal portion was already taxed. Very helpful to have a good slug of brokerage money when managing income for tax purposes in retirement.

Appreciate this. We do have the option at work to change our 401ks to Roth 401ks. Would a feasible route be stay the course I outlined with the brokerage portion but change our 401ks to Roth 401ks?

 

[Chuckanut]

You may wish to seriously consider Roth conversions. I was able to convert a chunk of my ordinary IRA funds to Roth. While the writing the tax check was unpleasant, It has helped.

FWIW, Roth accounts were not available for a good part of my earning years. Had they been, I would have used them exclusively . Those of you who have had Roths available for most of your earning years should count your blessings.

 

[Closet_Gamer]

Another reason to think about going harder at the after tax accounts right now is if you think rates will be going higher in the coming years.

Given the country’s fiscal situation, I think that is quite likely. I think of paying taxes today as diversifying across tax policy regimens.

 

[NgineER]

It looks like you need to sharpen the pencil and take a good look at your numbers. How much do you expect to spend, what can your portfolio support at 3.5-4% withdrawal rate. This would tell you how much you need to retire.
With this knowledge, figure out whether you prefer to be in the office 40+ hours a week vs. choosing what you do for that time.

Investigate whether you have access to an after-tax 401k (aka mega backdoor Roth)
Find out if you can utilize the rule of 55 for withdrawing from your accounts.

If your expected spend is indeed about $100k, then you should contribute to a traditional 401k and then do Roth rollovers for the 10-15 years of retirement prior to RMDs. It is very likely that you could retire sooner than the 5-6 years you are estimating.

 

[pacergal]

Welcome back! You have done a great job saving.
Have you run firecalc?
There are also good questions to answer in the forum FAQs:
Some Important Questions to Answer Before Asking - Can I Retire?

 

[MichaelB]

Appreciate this. We do have the option at work to change our 401ks to Roth 401ks. Would a feasible route be stay the course I outlined with the brokerage portion but change our 401ks to Roth 401ks?

I can’t add much to the discussion, you already have lots of good feedback. One thing I can share is that on this forum one of the most common regrets members have expressed is too much tax deferred and not enough after tax savings. This has two consequences; one is the inability to better manage the tax bill in retirement, and the other is being forced to take unwanted RMDs.