When to prioritize taxable over retirement accounts

[2029FIREaway]

Merry Christmas friends!
Been a long time since I’ve posted.

I’d like to hear from folks when it makes sense to prioritize taxable accounts for early retirement.

I am 6X in taxable and roughly 20X in retirement accounts (mostly 401k, some Roth)

I will need 10 years before tapping retirement accounts around age 60.

I have 4 years to go before ER. Should I switch from MBDR to taxable, while keeping pre tax 401k going the next 4 years?

Cheers

 

[RetiredHappy]

I maximized contributions into my 401K account when I was working. I wasn't eligible for Roth contribution. Since I was "highly" compensated, I also managed to save earnings into taxable account. By the time I retired, I had more in my taxable than my tax deferred account.

On the other hand, if I had to choose between taxable vs. tax deferred, it would boil down to tax rate while working vs. retired. Deferring taxes when taxed at a higher rate would usually mean that you are better off contributing to tax deferred account.

If you can make it to 55 yo before running out of money in your taxable account, you can always use 72t/SEPP to pull money out of your deferred contribution account.

 

[jazz4cash]

I’m having brain fog so I don’t lnow what you mean by 6X 20X or MBDR but I think it is vital to be balanced between taxable, tax deferred and Roth. Roth was not am option for most of my accumulation phase. In my case I prioritized taxable to ensure I had funds available to get me to 59.5 (along with age 55 exception).

 

[SevenUp]

Might be some exceptions, but "never" would be the most common answer.

Investment Order and How to withdraw funds from your IRA and 401k without penalty before age 59.5 go into more details.

 

[surprising]

Merry Christmas friends!
Been a long time since I’ve posted.

I’d like to hear from folks when it makes sense to prioritize taxable accounts for early retirement.

I am 6X in taxable and roughly 20X in retirement accounts (mostly 401k, some Roth)

I will need 10 years before tapping retirement accounts around age 60.

I have 4 years to go before ER. Should I switch from MBDR to taxable, while keeping pre tax 401k going the next 4 years?

Cheers

Merry Christmas! I am nearly in the same boat as you, but retired officially about 3 months ago at 51 and am using my taxable investments for about 9 more years before I can tap 401k. I've structured my taxable investments such that I can cover my average expenses with dividend funds plus rental income. And I also have some money in the market and individual stocks for gains. Allocation is probably around 70% dividend producing, 30% stock, and my rents cover about 50% of my expenses. If I have a month where my dividends and rents don't cover my expenses, I will sell something to balance the books.

Once I got to the point where my dividends plus rental income covered average expenses, I was confident that I could retire. Took about 5 years of work for me to get to that point. I lot of people here don't agree with my strategy and prefer to just own and sell stocks, especially given the meteoric rise in the market lately, but I like the stability of dividends that will pay in good times and bad.

 

[SnowballCamper]

It makes sense to use a regular taxable brokerage when you want withdrawal flexibility before age 59.5. It makes sense when your retirement tax bracket for ordinary income will be greater than your dividend tax bracket, and also greater than your capital gains tax bracket.

This happens to be the case for me, but I didn't know when I was saving for retirement. Luckily I used all three categories (Roth, deductible IRA, and taxable brokerage).

 

[Diogenes]

With respect, such situations confound me. Tax-advantaged vehicles have low annual contribution limits. For a long time, for IRAs it was $2000/year, and for 401Ks, I believe 10% of salary. Around 20 years ago - is that about right? - limits started to rise, more or less indexed for inflation.

I am confounded, because if John Doe is saving $80K/year, in today's dollars, what percentage of that, can go under a 401K or an IRA (Roth or otherwise?). Now roll back the clock, to the 1990s. Younger John is earning less and saving less, but the limits are lower too.

The result for affluent(ish) people ought to be, that the majority of their portfolio is in straight-up taxable accounts... unless they do something fiendishly clever, like Peter Thiel, who ended up with billions in his Roth IRA. I still don't understand how he did that! So, with all due apologies, because I have no advice to the OP... I can't help asking: how did he or she manage to reach 6X in taxable and 20X in tax-advantaged, at what is presumably late-40s age... and not vice versa?

As to the OPs situation, one possible concern is RMDs at age 72+. That presently feels very distant, and who knows how laws would change in the interim. But the concern is ending up with a huge tax bill, with those mandatory 401K distributions coming in as taxable ordinary income... whereas the after-tax accounts possibly being long term capital gains or qualified dividends.

 

[USGrant1962]

As long as I can remember the limit for employEE 401(k) contributions was 15%. My megacorp employER matched the first 5%, dollar for dollar (and later on bumped to 6%), and contributed a 2.5-3.0% profit share as well. So in the later, high earning years up to 24% of salary was going into my tax deferred 401(k) (and I'm pretty sure that included bonuses). Anyway, when I pulled the plug on megacorp I was ~75% tax deferred, including DWs IRA that had been invested aggressively since she left the workforce for the SAHM job. Looking at a big tax bomb with RMDs, but that is still a ways off.

I counsel my kids to be tax-diverse in their investments.

I agree that OP having 40x at age ~50 is a little odd (in a good way). Must be the denominator - perhaps OP is a very low spender compared to income. Or successful wild speculation in the numerator?

And yup, no idea what MBDR is.

To OP, I think tax diversification is the way to go. But it is a balancing act against a fuzzy far future tax regime so no hard and fast rules.

 

[GrayHare]

You proritize adding to taxable over retirement accounts when you project the RMDs from retirement accounts will put you in a higher future tax bracket than your current bracket.

 

[SevenUp]

You proritize adding to taxable over retirement accounts when you project the RMDs from retirement accounts will put you in a higher future tax bracket than your current bracket.

Or use Roth retirement accounts in that situation.

 

[2029FIREaway]

I maximized contributions into my 401K account when I was working. I wasn't eligible for Roth contribution. Since I was "highly" compensated, I also managed to save earnings into taxable account. By the time I retired, I had more in my taxable than my tax deferred account.

On the other hand, if I had to choose between taxable vs. tax deferred, it would boil down to tax rate while working vs. retired. Deferring taxes when taxed at a higher rate would usually mean that you are better off contributing to tax deferred account.

If you can make it to 55 yo before running out of money in your taxable account, you can always use 72t/SEPP to pull money out of your deferred contribution account.

Thanks. I’ve never given much thought on when to start/use a 72t/SEPP.

I guess I could use taxable for 5 years (50-55) and then use SEPP for 5 years? I think this is what you meant?

 

[2029FIREaway]

I’m having brain fog so I don’t lnow what you mean by 6X 20X or MBDR but I think it is vital to be balanced between taxable, tax deferred and Roth. Roth was not am option for most of my accumulation phase. In my case I prioritized taxable to ensure I had funds available to get me to 59.5 (along with age 55 exception).

Thanks. I meant I have 6 times expenses in taxable and 20 timed expenses in retirement accounts (mostly pre tax 401k)

MBDR is mega backdoor roth. An option some employers are offering.

 

[2029FIREaway]

Merry Christmas! I am nearly in the same boat as you, but retired officially about 3 months ago at 51 and am using my taxable investments for about 9 more years before I can tap 401k. I've structured my taxable investments such that I can cover my average expenses with dividend funds plus rental income. And I also have some money in the market and individual stocks for gains. Allocation is probably around 70% dividend producing, 30% stock, and my rents cover about 50% of my expenses. If I have a month where my dividends and rents don't cover my expenses, I will sell something to balance the books.

Once I got to the point where my dividends plus rental income covered average expenses, I was confident that I could retire. Took about 5 years of work for me to get to that point. I lot of people here don't agree with my strategy and prefer to just own and sell stocks, especially given the meteoric rise in the market lately, but I like the stability of dividends that will pay in good times and bad.

Thanks for sharing! You are in a great position.
I don’t have rentals so it will be all interest/dividends/principle to get me thru at least er years

 

[2029FIREaway]

With respect, such situations confound me. Tax-advantaged vehicles have low annual contribution limits. For a long time, for IRAs it was $2000/year, and for 401Ks, I believe 10% of salary. Around 20 years ago - is that about right? - limits started to rise, more or less indexed for inflation.

I am confounded, because if John Doe is saving $80K/year, in today's dollars, what percentage of that, can go under a 401K or an IRA (Roth or otherwise?). Now roll back the clock, to the 1990s. Younger John is earning less and saving less, but the limits are lower too.

The result for affluent(ish) people ought to be, that the majority of their portfolio is in straight-up taxable accounts... unless they do something fiendishly clever, like Peter Thiel, who ended up with billions in his Roth IRA. I still don't understand how he did that! So, with all due apologies, because I have no advice to the OP... I can't help asking: how did he or she manage to reach 6X in taxable and 20X in tax-advantaged, at what is presumably late-40s age... and not vice versa?

As to the OPs situation, one possible concern is RMDs at age 72+. That presently feels very distant, and who knows how laws would change in the interim. But the concern is ending up with a huge tax bill, with those mandatory 401K distributions coming in as taxable ordinary income... whereas the after-tax accounts possibly being long term capital gains or qualified dividends.

We’re at a point we can/have saved $100k+ in retirement accounts for a couple. Likely 50/50 pre tax and Roth.

Question is should this continue!

 

[bada bing]

I max'ed my MBDR every year for the last 12 years I was full time. My thinking was that contributions into Roth, including MBDR, are available any time, penalty free. It is the gains in Roth accounts that have withdrawal restrictions. The annual limits for Roth contributions are "use it or lose it" every year. If it costs the same in taxes going in, which is the case for mega-backdoor contributions, then Roth is just about always better than taxable. Worst case is you'll have to withdraw some contributions made into your MBDR in a few years. My personal rule was to always max out both backdoor and MBDR.

I haven't had to withdraw from my Roth money or from my tax deferred yet, almost 5 years into retirement, but that wasn't the plan initially. Initially I thought my taxable account would be exhausted before I started SS and pension and I would have to withdraw from 401K. I've made more from retired side hustle and the markets have been better in my taxable account than planned, so it now looks like I'll make it to SS and pension before taxable runs out. . I'm happy that I prioritized the Roth money over taxable saving, but there was virtually no downside with respect to the MBDR if things hadn't gone as well as they have.

 

[bada bing]

I am confounded, because if John Doe is saving $80K/year, in today's dollars, what percentage of that, can go under a 401K or an IRA (Roth or otherwise?). Now roll back the clock, to the 1990s. Younger John is earning less and saving less, but the limits are lower too.

The "Mega-Backdoor Roth" uses the $69,000 401K all sources annual limit (for 2024). Then there is the additional $7500 for over 55 catch up available. That's $76,500. Then you can add in the regular backdoor Roth limit of $7,000 plus $1,000 catch up. The total you could theoretically put into 401K plus Roth in 2024 is $84,500. When I was full time, my employer's plan diverted their 401K match into the NQDC plan once the annual 401K limit was reached, so I frontloaded my 401K to max out by March to use as much of the total limit as possible for my Mega-backdoor contributions.

When I retired, my split was 40/40/20 Roth/tax deferred/taxable and most of the Roth balance was money that would have ended up in my taxable account had I not utilized the mega-backdoor.

 

[thod]

From what I understand, the MBDR (Mega-backdoor Roth) is a technique that uses additional contribution space (upto around 60-70 thousand dollars) to stuff more money into an IRA/ROTH. It is usually where the employer matched dollars go. But there is a catch that individuals can contribute into that space, but only with after-tax dollars. So, since they it was after tax, you should immediately go ahead and do a ROTH conversion on the monies just contributed.

I do not think all 401k plans allow for it, but some do and if you had a salary that left you with enough after-tax money to contribute large amounts over several years and you got favorable investment returns, it could accumulate to a large amount pretty quickly.

 

[Montecfo]

A couple of notes. First 15% of comp is not an IRS 401k limit. The IRS limit is 100% of comp until a hard dollar limit is reached, which varies by age and filing status.

As far as the OPs question: you should switch to taxable when you project that lack of access to funds will mean you can't retire when you wish to.

Otherwise it is probably best to stay in tax deferred or tax free, unless you project higher marginal taxes in retirement. In that case taxable or tax free.

 

[RetiredHappy]

Thanks. I’ve never given much thought on when to start/use a 72t/SEPP.

I guess I could use taxable for 5 years (50-55) and then use SEPP for 5 years? I think this is what you meant?

Yes.

 

[2029FIREaway]

Thanks all. Reading actual experiences helps.
I could be in bada bings situation and not deplete taxable before SS.

Would love to hear other experiences too. I’m on the fence with this, especially as I have nothing but taxable account + Roth contributions to fund retirement from age 50 go 60!

 

[RetiredHappy]

Thanks all. Reading actual experiences helps.
I could be in bada bings situation and not deplete taxable before SS.

Would love to hear other experiences too. I’m on the fence with this, especially as I have nothing but taxable account + Roth contributions to fund retirement from age 50 go 60!

We don't have either rentals or pension too. You can do it!

 

[2029FIREaway]

A couple of notes. First 15% of comp is not an IRS 401k limit. The IRS limit is 100% of comp until a hard dollar limit is reached, which varies by age and filing status.

As far as the OPs question: you should switch to taxable when you project that lack of access to funds will mean you can't retire when you wish to.

Otherwise it is probably best to stay in tax deferred or tax free, unless you project higher marginal taxes in retirement. In that case taxable or tax free.

Thanks. I’ll be doing some Roth conversations in ER. I’ll need taxable cash to pay taxes for those conversions too though I think!

 

[pb4uski]

I would prioritize tax-deferred savings where the tax savings are 22% or more on an incremental basis. In other words, do tax-deferred savings only to the extent that it reduces your income to the top of the 12% tax bracket and then no further. This assumes that in retirement that your withdrawals from tax-deferred savings will be 12%.

So if you do tax deferred savings and save 22% today and pay 12% in retirement that is great. OTOH if you save 12% today and pay 12% in retirement, what's the point... just save that same money but in taxable or in a Roth since taxable gives you flexibility and Roth contributions can be withdrawn tax-free without penalty at any time.

 

[2029FIREaway]

I would prioritize tax-deferred savings where the tax savings are 22% or more on an incremental basis. In other words, do tax-deferred savings only to the extent that it reduces your income to the top of the 12% tax bracket and then no further. This assumes that in retirement that your withdrawals from tax-deferred savings will be 12%.

So if you do tax deferred savings and save 22% today and pay 12% in retirement that is great. OTOH if you save 12% today and pay 12% in retirement, what's the point... just save that same money but in taxable or in a Roth since taxable gives you flexibility and Roth contributions can be withdrawn tax-free without penalty at any time.

Thanks. This makes 100% sense for pre tax 401k. My marginal rates are high right now.

It’s the Roth accounts that I continue to debate. One question/concern: how easy is it to withdraw contributions?

 

[TheWizard]

We’re at a point we can/have saved $100k+ in retirement accounts for a couple. Likely 50/50 pre tax and Roth.

Question is should this continue!

I don't understand how $100k can be 20x your annual expenses. There's a typo or miscompute somewhere.

Most people will be fine investing up to $1M in tax-deferred prior to retirement; I had almost double that in 2013.

Additionally, put $8000 per year per person into your Roth IRA. Then in retirement from age 59-1/2 to 70, and then to age 75, withdraw a certain amount every year from tax-deferred for both living expenses and Roth conversions.

Focus on tax-deferred funds as DEFERRED COMPENSATION and start withdrawing early. You'll be in fine shape once RMDs start...