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Hey peeps, it’s Friday again and time for another reader case! This intrepid reader wrote to us after listening to our interview on ChooseFi. Let’s all say hi and welcome them to the Millennial Revolution.
And now take it away, Ann and David:
“Hello, we heard you on the Choose FI podcast. We had a personal plan made with someone from Vanguard back in May 2017. He suggested 60-40 stocks/bonds with the 60% broken down as 60% US large, mid, and small cap, and 40% in international. Once we put my wife’s 401K money into the overall picture we are more at 75-25, and we are fine with the additional risk.
What we are currently contributing:
18,000 traditional 401k
10% of pay in wife’s after-tax 401k to eventually roll over to roth IRA
5500 wife IRA
5500 husband IRA
Overview of finances:
|Bonus||7% of salary|
|RSUs (company stock options)||180-200 shares/year (at $49 currently). Vested so far = $19,093|
|Expenses||30,000/year (to be increased to 50,000/year in retirement)||Navy||Estimated $10,000/year college for 2 years||Estimated $10,000/year college costs for 2 years|
|Investible Assets||$71,500 (Cash) +$34,000 (HSA) + $533,029 (401K) + $28,700 (IRA) +$11,859 (Roth) + $216,816 (IA) + $19,093 (RSUs)= $914,997||$142,011 (IRA) + $11,859 (Roth) = $153,870||$9664 (529 account)||$8543 (529 account)|
|Other Assets||$3000 (car 1) + $3000 (car 2) + $315,000 (home) = $305,250 (after 5% real-estate agent's commission)|
|Pension||$28,000 (at age 43) | $40,000 (at age 47) | $51,000 (at age 50)|
We are looking for any advice on tax efficiency and a plan for withdrawal when we are both retired. Wife will stay employed anywhere from the next 1-8 years depending on kids in school and job outlook. We would like to plan to spend about $50,000 per year in retirement. We may sell the house and travel for several years. Also, considering becoming renters after that.
Thank you both for your time and consideration
Ann & David”
Well, A & D, just from first glance you’re can pretty much retire right the Hell now! On top of having a ridiculously healthy amount of assets, Ann also has a friggin PENSION! Say what? People have those these days?
And also for some reason this pension is considerably more flexible than most. If she were to retire at 43, she would get $28k a year. At 47, $40k a year, and at 50, $51k a year. Pensions like these also tend to be inflation indexed, which is great.
So let’s run some scenarios. Should we wait 1 year, 5 years, or 8 years? Let’s…MATH SHIT UP! God, I never get tired of saying that.
Retire in 1 year:
With a $28K/year pension, if Ann were to retire in just 1 year, the pension would be enough to cover your expenses at your current spending level. If you were to raise that spending amount to $50K in retirement like you’re planning to, you could cover the $50k – $28 = $22K/year shortfall with a portfolio size of $22k x 25 = $550,000.
And since you have 1 year of work to go, you should easily be able to save enough during that time to cover the rest of your kids college expenses. You have expected expenses of $40k for the both of them, and you currently have $18,207 saved in your 529s. That means you need to save an additional $18,203 over the year to cover this cost. Given your high earnings and low expenses of just $30k, you should be able to do this without breaking a sweat. Jam it into the 529s and forget about it.
As for the rest of it, you have more than enough in total to cover this $550k, but as you may have noticed most of that is in 401(k)’s, IRA’s, and Roth IRA’s, all of which have an age limit for withdrawals. Fortunately, we know how to get that money out. Once you leave your workplace, rollover all your 401(k)’s into your Traditional IRA, then create a 5-year Roth IRA conversion ladder.
However, in that article we advise withdrawing only the amount equal to your standard deduction of $24k. This will allow you to rollover your IRA tax free. You can’t do that because you’ll have a $28k pension eating up your standard deduction *sad tiny violin sound*.
You will have to therefore pay some tax on your portfolio as you do your rollover. Fortunately, your state (Florida) has no state income tax, so all you have to worry about is the federal tax brackets, which are here.
|Rate||Individuals||Married Filing Jointly|
|10%||Up to $9,525||Up to $19,050|
|12%||$9,526 to $38,700||$19,051 to $77,400|
|22%||$38,701 to $82,500||$77,401 to $165,000|
|24%||$82,501 to $157,500||$165,001 to $315,000|
|32%||$157,501 to $200,000||$315,001 to $400,000|
|35%||$200,001 to $500,000||$400,001 to $600,000|
|37%||over $500,000||over $600,000|
So by looking at that, you can see we want to target the 12% tax rate. You should be able to convert $77,400 – $28k (pension) = $49,400 a year as a married couple assuming no other income and pay 12% tax on that conversion. At that conversion rate, you’ll have a total tax liability of 12% on your 401(k) + IRA balance, which would be $703,740 x 12% = $84,448.80.
So that means your total investable net worth, after minusing off taxes owed, would be $1,068,867 – $84,448 = $984,419. Which is still WAY over your target of $550,000. So you win!
Now, and I can’t stress this enough, CONSULT A TAX PROFESSIONAL BEFORE YOU IMPLEMENT THIS. I’ve made a number of assumptions based on your email (you live in Florida, you plan to retire in Florida, you have no other income, etc.) which may not be actually true, so you’re gonna want to go to an accountant with all your tax returns in hand and have them draw up a detailed withdrawal plan.
That being said, considering how far ahead you are, I’d be extremely surprised if they concluded anything different than what I just did: You should be able to retire easily in 1 year.
Retire in 5 years:
Retiring in 5 years changes a few things: How much your pension would be, how much extra you’ve saved during that time, and the withdrawal tax bracket the higher pension may push you into.
In 5 years, your pension goes up to $40,000/year, so you only need to generate $10,000/year from the portfolio. Using the 4% rule, this would only require a $250,000 portfolio.
Already, I’m predicting a win but just for the Hell of it, let’s math shit up anyways.
In 5 years, based on your contribution numbers, your 401K will grow by $18,000 * 5 = $90,000, your HSA by $6750 * 5 = $33,750, your IRAs by $11,000 * 5 = $55,000 just from contributions. This increases their existing portfolio of $1,068,867 to $1,247,617. Yeah, I think you’ll be fine.
But now let’s see what the higher pension does to their conversion strategy. A $40k pension means they’ll have less room in that 12% bracket to do your IRA conversions, but that’s still $77400 – $40k = $37,400 a year, which is still pretty good. That means your new higher 401k/IRA balance of $848,740 will be subject to a tax rate of 12%, or $101,848. So their total after-tax net investable assets will be $1,247,617 – $101,848 = $1,145,769.
So that means that in addition to that $40k pension, as per the 4% rule they can safely withdraw $1,145,769 x 4% = $45,830, resulting in a spend rate of $85,830.
You can see at this point, they’ve saved WAY more than they need. I don’t know, put it towards the kid’s inheritance? Blow on booze and space cakes? And this is BEFORE selling the house and cars and running off to travel. If they were to actually sell the house and cars, that would be an additional $305,250 to play with, or an additional $305,250 x 4% = $12,210 per year.
Retire in 8 years:
And with $51,000/year from her pension, you wouldn’t even need a portfolio at all at this point because your pension covers your projected spend. In fact, you would be SAVING $1000/year.
After 8 years, you would end up with an extra $18,000 x 8 = $144,000 in your 401K, $6750 x 8 = $54,000 in HSA and $11,000 x 8 = $88,000 in IRAs. This increases their existing pre-tax portfolio of $1,068,867 to $1,354,867, and you wouldn’t need it at ALL.
The only wrinkle (and this is a REALLY minor one) is that at this pension rate you’re starting eat up most of the 12% tax bracket and you may end up pushing into the 22% one, so your tax liability on this portfolio is higher. But since you don’t need it at ALL, who cares? Just pay whatever amount of tax you’re comfortable with, and go live it up. You’re done.
Guys, you are winning SO hard at life right now. Technically, at your current spending of $30k you could retire today and be done. But since the pension kicks in next year and you want to increase your spending to $50k, it makes sense to at least wait until then. If you retire next year, you win. And if you retire in 5 or 8 years, you’ll barely even need to withdraw because you can just rely on the pension.
But again, CONSULT A TAX PROFESSIONAL before you actually do anything. Off the top of my head, something I haven’t done is take into account dividends and capital gains in your after-tax investment accounts since I don’t have that information. That would raise your gross income levels and reduce the amount you could withdraw each year inside the 12% bracket. So sit down with an accountant and have a proper tax plan written up.
What do you think readers? Should Ann & David retire in 1, 5, or 8 years?