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Retirement Planning and Converting to Roth IRA

Discussion in 'Investments and Savings' started by Ethan, Sep 19, 2017.

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  1. Ethan

    Ethan Level 2 Member

    So for the goal of early retirement, what is the best allocation for savings/investments. If I'm maxing out my IRAs, and also contributing as much as I am allowed to the 401(a) through my employer, is the next best pool to fill up my HSA? (It seems like it is for tax-reduction purposes). My question, however, is then what is drawn upon to use for expenses in an early retirement? I understand that you can draw from an HSA with qualified receipts (is there a time limit on those?), but I don't know that I would have enough qualified receipts built up to provide enough money to live off.

    Do people draw out of contributions to Roth IRAs? Once again, that wouldn't necessarily seem like enough to live on for very long. On that same note, is the idea of rolling over a Traditional into a Roth done in a year when you have no, or very low, income effectively reducing the tax
    burden on that money?

    Or, do early retirees need to build up money in a taxable brokerage account to live off until they can access their 'retirement' funds penalty free?
     
  2. El Ingeniero

    El Ingeniero Level 2 Member

    Not the expert Matt is, but I'll take a stab at answering:

    Roth rollovers: contributions of taxable income into your 401k which are then rolled over into a Roth IRA.

    Suppose you are making $120K/year, and your Federal/state tax burden is 30%. After maxing out your 401k, Traditional IRA and HSA, taxable income is now roughly $94K, and after taxes around $66K. If your company match on the 401K is 3%, you can roll over $59K - max 401K contribution - company match, about $37.4K per year. That leaves you $28.6K to live on. If you can live on $23.6K, you can roll another $5K/year over, via the traditional IRA, I guess.

    10 years of that, and your contributions should reach $374K or so. Combine that with a few hundred hours a year of self employment and you should be good to go.
     
  3. Matt

    Matt Administrator Staff Member

    I like the Roth rollovers, but they should occur IN retirement, rather than leading into it. The theory being that you start your annual income very close to $0 and roll in at the lowest possible levels.

    For the original question, you need to have zero expenses (no mortgage/debt/etc) and maxed out retirement accounts along with cash (taxable brokerage accounts) for early retirement.

    You can use some tricks to access funds early, but accessing your Roth or 401(k) money early isn't always a good thing if you want it to last.
     
  4. El Ingeniero

    El Ingeniero Level 2 Member

    OK, so maybe I am missing something here: you can only put earned income into an IRA or 401k, right? So where is the earned income from if you are doing your rollovers in retirement?

    One thing to understand, I am 55 and at least 10 years from retirement. Which changes things a lot: I have only 5 years of retirement before I need to make 401k withdrawals, and 7 years of retirement before I take Social Security.
     
  5. Matt

    Matt Administrator Staff Member

    You've got a couple of things off here, and if you can wrap your head around them, and plan accordingly, we're talking well over 6 figures to your bottom line.

    1. You should (pretty much always) never roll over a 401(k) to Roth in a high tax bracket. Broad rule of thumb for this is that 15% bracket is OK, above is not, with the caveat being that you have some major taxable events in the future, such as a very large taxable income in retirement. (IE don't roll over your 401k)
    2. The time to do Roth Conversions is when income is lowest, ide zero. While you do need income to 'Contribute' to an IRA or 401(k) you do not need income to Roll over. Therefore, if you retire, and your salary is removed, this is the time to roll over. I illustrate the income gap in this post: http://saverocity.com/finance/should-you-have-a-roth-401k-or-traditional-401k/
    3. The perfect financial solution will see you delaying 401(k) withdrawals as long as possible. For you, this is 15-16 years away, not 10. At this point, you will be faced with Required Minimum Distributions. Money that you've managed to roll over to Roth before that deadline is excluded from RMD.
    4. Social Security planning is it's own topic, but generally speaking, you would do best to take Social Security no sooner than Full Retirement Age (67, not 62) and if you can afford to wait longer, 70 is even better. This assumes that you do not die prematurely. The only reason to take at 62 is poverty, ill health, or an expectation that you will not live much longer, which for some, sadly is the case.
    The 'perfect' plan will be to get to a financial position where you can retire and have some sort of income gap, EG if you can retire at 62, but not take Social Security or 401(k) money, living on taxable savings instead. Using these years of income gap to roll over into Roths an amount of money from the 401(k). This ensures that the Roth funds go to the back of the line (an account of last resort) and grow tax free, potentially forever.

    This does depend on your own financial situation, IE if you have a modest amount in the 401(k) then you can do partial rollovers in a year or two, or maybe you don't even need to, because the RMD is so low that it doesn't make big impact.

    However, you should also be contributing at least $24,000 to your work based 401(k), along with another $X from your reselling 401(k) so in the next 5-7 years contributions alone should exceed $100K, probably closer to $150K. If you can't do that, look at debt management and expenses to see if anything can be done.

    You'd also benefit from doing back door Roths on top of this for another $6500 per year into the Roth.
     
  6. El Ingeniero

    El Ingeniero Level 2 Member

    OK, I confess I have a perfect storm going on. Without going into numbers, the rough outlines are:
    1. Age difference with my wife, who will be working for at least 10 years after I retire.
    2. Need to pay $800 to $1700 a month for childcare starting next year.
    3. I've wound down the reselling business to make time for my son.
    4. Need to move to a better school district (more expensive house) for my son within a few years, who will be college age in 18 years.
    5. Expect a couple of sizable windfalls sometime in the next 15 years.
    I am probably not going to have any period post retirement in the 15% tax bracket to be making rollovers in. My wife might.

    I will probably not be debt free until those windfalls happen.

    I can't expect to be as conservative with my investments as the usual retiree, since the money has to last an extra 30 years. To guard against failure, the total fund will probably need to be 30% larger than otherwise.
     
  7. heavenlyjane

    heavenlyjane Level 2 Member

    My daughter started her career at a high salary and has oodles of discretionary money (no dependents, no debt). When she started her retirement savings she chose the Roth path because she isn't retiring for 40+ years. She's expecting a huge amount of growth over the intervening years, which will be tax free later on. I am assuming she chose correctly?
     
  8. Matt

    Matt Administrator Staff Member

    No. See here: http://saverocity.com/finance/should-you-have-a-roth-401k-or-traditional-401k/
     
  9. Ethan

    Ethan Level 2 Member

    With my IRA and 401 (a) maxed out, would it be recommended to fill up my HSA or put the money towards paying off my house first?
     
  10. BananaStash

    BananaStash Level 2 Member

    Is an HSA the right choice for your health insurance?
    There are endless forum discussions on the topic of paying off one's mortgage early. They generally seem to come down to two camps: 1. It's better to leverage low interest mortgage debt to invest (preferably tax-sheltered) because you come out ahead; and 2. It feels so good to be debt-free and own your home outright.
     
  11. Matt

    Matt Administrator Staff Member

    The first one is wrong though. You cannot (with any real upside) borrow at mortgage rates and receive a like for like risk return. You can borrow against your mortgage and invest in stock/bitcoin/etc but any coming out ahead comes with the chance of coming out behind too.

    People forget risk adjusted returns.

    You raise a good question on the HSA though, "is it the right choice for health insurance?" if so, I would suggest then you look at tax bracket, if it is the 25% bracket or higher, I would likely go HSA first, then take the savings that come from the HSA and apply that to the mortgage..

    EG 25% bracket $4000 HSA (for simplicity)
    = $1,000 in extra cash each year.. which you then apply to the mortgage.
     
  12. BananaStash

    BananaStash Level 2 Member

    Considering it in light of risk-adjusted returns makes it seem like investing in your home (paying additional mortgage principal) should be balanced with your portfolio of stocks/bonds/etc and overall risk tolerance.
     
  13. Matt

    Matt Administrator Staff Member

    If you are going to risk adjust it, you can't really include stocks in that. Mortgage is a debt instrument, IE it is a Bond.
     
  14. El Ingeniero

    El Ingeniero Level 2 Member

    Net Worth = Assets - Liabilities. You are not looking at the assets part of the equation.

    Overall, renting a 1 bedroom in some random suburban apartment complex would be maybe $350/month cheaper for me than living in my house. That's the real opportunity cost, since my mom's basement in Michigan is not an option for me.

    Balance that against building $3000 (and growing every year) in equity every year, and the value of the house growing $6000 (conservatively) every year. I think I'm about 2 or 3 years from owing less than 50% on the house than what I can sell it for.
     
  15. Matt

    Matt Administrator Staff Member

    Nope, you are conflating a mortgage with the property that it is attached to.

    Mortgage = Liability
    Bond Issuer = Liability
    Bond Holder = Asset
    Property = Asset
    Rent = Expense
    Mortgage Payment = Expense

    If you can disconnect the debt from the property (which is easy if you imagine you have equal amounts of Cash/Bond asset and Mortgage liability) then you can see the truth.

    In reality, anyone who has a mortgage and stock investments is borrowing to fund stocks. That could be a margin trading account, or a mortgage, either way, the house doesn't matter.
     
  16. El Ingeniero

    El Ingeniero Level 2 Member

    I still don't get it.

    The asset involved, the house, can't be invested in stocks. My down payment and increase expenses could otherwise have been invested in the market. I didn't take cash out of the house with a second mortgage. So where are the stocks I am funding?
     
  17. Ethan

    Ethan Level 2 Member

    Another HSA question: I receive $1500 in employer contributions to my HSA, paid in quarterly. If I want to max out my total contributions to my HSA, is it best to do that through payroll? It is my understanding that contributions made through payroll have the benefit of no social security and medicare taken out, whereas if I were to contribute after-tax money, I receive a tax deduction for that money, but do not receive the medicare/social security back.

    Am I understanding this correctly?
     
    Last edited: Oct 1, 2017
  18. Matt

    Matt Administrator Staff Member

    Yep.
     

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