Home stretch — Where best to accumulate when close to early retirement?

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PaulF
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Joined: Wed Aug 06, 2008 10:07 pm
Location: Wisconsin

Home stretch — Where best to accumulate when close to early retirement?

Postby PaulF » Tue Jan 10, 2017 2:51 pm

I am a long-time reader (back to M* days), but post very infrequently.

It looks like I will be able to retire much earlier than originally anticipated, and am trying to get my ducks in a row. I am seeking a bit of guidance on the last few years of accumulation. My main question regards optimal placement of ongoing savings.

The short story: I am 53, my wife is 51, no kids. Current assets are ~$1.4M in a very Bogleheadish portfolio, breaking down as ~$1M in tax-deferred, $250K in Roth IRAs, and $100k in taxable. (Thank you, Bogleheads! :happy ) A key factor is that we both will have nice pensions to provide much of the income stream needed in retirement. Combined, we have been saving about $60k/annum in tax-free/tax-deferred vehicles, but a recent, significant raise will allow additional pre-tax savings of ~$20k/annum (or ~$15k post-tax). I am trying to figure out where best to put this.

We have plenty of room available in tax-deferred and Roth vehicles. In addition to low-cost 403(b)’s, we have access to very low-cost 457’s. Moreover, both plans recently introduced a Roth option. (So far, we have continued to contribute pre-tax.) We also max out our Roth IRAs. Our future savings could go to: (a) tax-deferred 403/457; (b) Roth 403/457; (c) taxable; or (d) voluntary contributions to our pension plan (essentially buying an annuity with an initial payout of about 6.5% of contributions). We are currently in the 25% tax bracket, and expect to remain in that bracket in retirement (barring tax code changes, obviously).

My hope is to retire in 3 years, or maybe 4. Due to our young ages, we have recently been directing our contributions to the 457, because that allows withdrawals starting at age 55. At earliest, we can start drawing our pensions at 55, but (similar to SS), we may want to delay starting the pension (for ~5-7 years?) to increase the payout amount. I have not yet fully assessed this. Obviously, in that case, we would then need to draw on existing funds early in the decumulation phase.

My conflicting instincts are that (a) it does not matter too much what vehicle we use for additional savings/contributions, because the time frame is so short, and (b) nonetheless, it would be better to start contributing to the Roth 457 to maximize any benefit of long-term tax-free growth.

I am starting to appreciate that decumulation is different animal than accumulation, and am trying hard to come up to speed on those issues. Can any Bogleheads shed some light on how to best position myself in the home stretch?

Thanks,
PaulF

bigred77
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Re: Home stretch — Where best to accumulate when close to early retirement?

Postby bigred77 » Tue Jan 10, 2017 3:11 pm

My vote would be to prioritize tax deffered until you use up all the available space or you get down into the 15% tax bracket (where Roth contributions may start to make sense).

You will likely have at least a couple of years where you can live on your taxable account while deffering your pensions to obtain a higher payout (at least that's my understanding from your post). You can start traditional IRA to Roth IRA conversions over this time period.

It might be beneficial to you to really sit down and see when the optimal time to take your pension and/or SS is. Does your pension increase at an amount similar to SS? Is it COLA'd? You're close enough to retirement to really get a fairly clear picture on what the situation will be and how to optimize it.

Mudpuppy
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Location: Sunny California

Re: Home stretch — Where best to accumulate when close to early retirement?

Postby Mudpuppy » Wed Jan 11, 2017 2:28 am

Does your employer's 457b plan provide the special catch-up provision for the three years before retirement? This can be a great way to squirrel away more money if you have not been maximizing contributions to the 457b plan and you are within three years of retirement. Here is the provision (from https://www.irs.gov/retirement-plans/pl ... ion-limits):

Special 457(b) catch-up contributions, if permitted by the plan, allow a participant for 3 years prior to the normal retirement age (as specified in the plan) to contribute the lesser of:

  • Twice the annual limit ($36,000 in 2015, 2016, and 2017), or
  • The basic annual limit plus the amount of the basic limit not used in prior years (only allowed if not using age 50 or over catch-up contributions)

For example, let's say you've worked for this employer for 10 years and you've contributed 50% of the limit for those 10 years to the 457b plan. That means you've used $84,000 of the possible contribution space and you have $84,000 "of the basic limit not used in prior years". Since $84k is more than 3x the annual limit, so you could use the "twice the annual limit" special catch-up provision. If you had less than 3x the annual limit, you'd have to cap your catch-up contributions at whatever unused contribution space you had.

PaulF
Posts: 61
Joined: Wed Aug 06, 2008 10:07 pm
Location: Wisconsin

Re: Home stretch — Where best to accumulate when close to early retirement?

Postby PaulF » Wed Jan 11, 2017 11:49 am

bigred77 wrote:My vote would be to prioritize tax deffered until you use up all the available space or you get down into the 15% tax bracket (where Roth contributions may start to make sense).

You will likely have at least a couple of years where you can live on your taxable account while deffering your pensions to obtain a higher payout (at least that's my understanding from your post). You can start traditional IRA to Roth IRA conversions over this time period.


Thank you, bigred77. You put your finger on something that I believe I had not been thinking about correctly. Previously, I had only been mentally comparing my LONG-TERM needs, i.e., after my pension and SS kick in, without thinking about how to maximize efficiency in the years before that time.

I am still trying to digest this. I swear I tried to research this before posting, but am only now coming across relevant posts and articles. For example, as a result of your post, I have recently come across this thread Roth vs. Traditional 401K, and some blog posts by The Finance Buff based on this discussion:
The Case Against Roth 401K and
Most TSP Participants Should Switch To the Roth TSP (which is not so different from my situation).


bigred77 wrote:It might be beneficial to you to really sit down and see when the optimal time to take your pension and/or SS is. Does your pension increase at an amount similar to SS? Is it COLA'd? You're close enough to retirement to really get a fairly clear picture on what the situation will be and how to optimize it.


I am trying to work through the math and/or a spreadsheet on optimal timing, but I have some work to do yet! My pension is not exactly COLA'd, but it increases (or decreases, with a floor) based on market performance. It should keep up with inflation, but I am not banking on it keeping up 100%.

Thanks again for your thoughts and hitting on an important point.
PaulF

PaulF
Posts: 61
Joined: Wed Aug 06, 2008 10:07 pm
Location: Wisconsin

Re: Home stretch — Where best to accumulate when close to early retirement?

Postby PaulF » Wed Jan 11, 2017 11:52 am

Mudpuppy wrote:Does your employer's 457b plan provide the special catch-up provision for the three years before retirement? This can be a great way to squirrel away more money if you have not been maximizing contributions to the 457b plan and you are within three years of retirement. Here is the provision (from https://www.irs.gov/retirement-plans/pl ... ion-limits):

Special 457(b) catch-up contributions, if permitted by the plan, allow a participant for 3 years prior to the normal retirement age (as specified in the plan) to contribute the lesser of:

  • Twice the annual limit ($36,000 in 2015, 2016, and 2017), or
  • The basic annual limit plus the amount of the basic limit not used in prior years (only allowed if not using age 50 or over catch-up contributions)

For example, let's say you've worked for this employer for 10 years and you've contributed 50% of the limit for those 10 years to the 457b plan. That means you've used $84,000 of the possible contribution space and you have $84,000 "of the basic limit not used in prior years". Since $84k is more than 3x the annual limit, so you could use the "twice the annual limit" special catch-up provision. If you had less than 3x the annual limit, you'd have to cap your catch-up contributions at whatever unused contribution space you had.


My plan does allow the special catch-up, but I am not within 3 years of normal retirement age. However, I still have enough room between the 403b and 457, plus the >50 yrs old contribution allowance, (along with DW's), that I don't think I could afford to use all of it up anyway.

Thanks for the thought!
PaulF

Mudpuppy
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Location: Sunny California

Re: Home stretch — Where best to accumulate when close to early retirement?

Postby Mudpuppy » Wed Jan 11, 2017 1:50 pm

I believe it's "normal retirement age" as defined by your employer, not as defined by Social Security. Here's how the California Savings Plus Plan defines it (from https://www.savingsplusnow.com/iApp/tcm ... utions.jsp):

Normal Retirement Age is the age specified in your employer’s 457 plan and is typically the age you choose for the purpose of initiating your Traditional 457 Catch-Up election. You must:

  • Have the right to retire to receive full retirement benefits under your employer’s pension plan with no reduction for age or service
  • No later than age 70½

So check your plan documentation to see how your plan defines "normal retirement age".

PaulF
Posts: 61
Joined: Wed Aug 06, 2008 10:07 pm
Location: Wisconsin

Re: Home stretch — Where best to accumulate when close to early retirement?

Postby PaulF » Wed Jan 11, 2017 2:28 pm

Mudpuppy wrote:I believe it's "normal retirement age" as defined by your employer, not as defined by Social Security.

...
So check your plan documentation to see how your plan defines "normal retirement age".


Thanks to your suggestion, I just checked. My plan & employer define NRA as 65 for my category of worker. So, at age 53, no joy there, but I still have plenty of tax-deferred room using the normal 50+ category ($96k/annum between the two of us).

Thanks,
PaulF

Fishing50
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Joined: Tue Sep 27, 2016 1:18 am

Re: Home stretch — Where best to accumulate when close to early retirement?

Postby Fishing50 » Thu Jan 12, 2017 2:53 am

I am starting to appreciate that decumulation is different animal than accumulation


What are your annual expenses? What percentage withdrawals is annual expenses from your investments? I’m thinking you may have won the game already…so why continue working? Do your pensions meet or exceed your needs? What tax bracket will you be in with your pensions? You may have a chance to retire earlier than expected and live off your taxable accounts (paying 0% capital gains) while you wait to collect your pensions.

I've found decumulation planning a fun hobby. Threads on Roth conversions are interesting as people discuss RMD tax mitigation strategies.
($96k/annum between the two of us)
is before the standard deduction, tax deferred contributions will defer mostly 15% taxes allowing TGH in your taxable account at 0% capital gains rate. https://www.kitces.com/blog/understanding-the-mechanics-of-the-0-long-term-capital-gains-tax-rate-how-to-harvest-capital-gains-for-a-free-step-up-in-basis/ If it’s after the standard deduction you are solidly in in the 25% tax bracket after deductions. In that case tax deferred contributions would defer 25% which is an obvious win if your pensions leave you in the 15% bracket, and you break even if you will be in the 25% bracket (making Roth a good option).

I’m 3 yrs from retirement at 50yrs old with a military pension that covers our needs. 4% investment withdrawals will fill our lives with dinners out, tee times, a boat, and vacations. In these final working yrs, we are contributing maximum to tax deferred investments because we’re in the 25% tax bracket. In 2016 my wife didn’t work, so I was able to TGH at 0%. In early retirement, I expect some 15% space to TGH or do Roth conversions before we get solidly into the 25% bracket when DW takes SS at 62yrs.

You are in a darn good position…it’s time to enjoy life! :sharebeer

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Watty
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Re: Home stretch — Where best to accumulate when close to early retirement?

Postby Watty » Thu Jan 12, 2017 11:08 am

There is a wiki on this choice.

https://www.bogleheads.org/wiki/Traditional_versus_Roth

You did not mention if you have a paid off house or not. If you still have a mortgage then getting it paid off by the time you retire would be worth looking at. I recently retired and having a paid off house made my numbers work a lot better.

With as well as you are doing and having the pensions in all likelihood are really investing the money for whoever will inherit it someday and need to consider if their tax rate will likely be higher or lower than your current 25% tax rate. If you are leaving the money to a charity then their effective tax rate is 0% so putting the money in a deductible retirement account would be an easy choice.

You will also have different income needs at different ages and by the time you are your mid 70s or so you may naturally slow down and spend a lot less while your health remains relatively well. I have seen relatives that slowed down like that and even though they could have afforded it they didn't want to travel much and even going out for the evening became a rare event. They lived in a medium to low cost of living area in a paid off house and there were many months that they didn't spend their entire social security checks. When people get older and their health starts to decline the income needs will go up but a lot of the health related costs are deductible so you may not pay a lot of taxes on it.

You already have some money in Roth and Taxable accounts that you could use in years when you have large expenses like buying a car.

Making Roth contributions in the 25% marginal tax bracket is really only a good choice if you would be in the 28% tax bracket in retirement. From what you have said that does not seem likely even if one of you survives the other and starts filing single tax returns.

I would look at using the deductible retirement account now and once you retire you can live on your taxable account money while doing Roth conversions up to the top of the 15% tax bracket each year.

PaulF wrote: We are currently in the 25% tax bracket, and expect to remain in that bracket in retirement (barring tax code changes, obviously).


A couple of things to watch out for.

You also need to be careful about when you are looking at what retirement tax rates you will be in. An over 65 couple can have almost $100K ($97K ??) in income and still be in the 15% federal marginal tax bracket. If they have a few thousand dollars more taxable income than that they will be "in the 25%" marginal tax bracket but their effective tax rate would still be below 15%. It would be good to do a dummy tax return as if you are retired, including state taxes, to see what your retirement taxes will look like. They could be lower than you are thinking.

You need to look at the tax rates three ways, as a couple and as if one of you survives the other. The survivor would be filing in the higher single tax brackets and the pension payout could change.

If you decide to move to a different state your state tax rates could change too.

You will likely be getting Social Security too and the way that it is taxed could put you in a higher effective tax bracket.

https://www.bogleheads.org/wiki/Taxatio ... y_benefits

https://www.bogleheads.org/wiki/Social_ ... calculator

PaulF
Posts: 61
Joined: Wed Aug 06, 2008 10:07 pm
Location: Wisconsin

Re: Home stretch — Where best to accumulate when close to early retirement?

Postby PaulF » Thu Jan 12, 2017 11:47 pm

Fishing50 wrote:
I am starting to appreciate that decumulation is different animal than accumulation


What are your annual expenses? What percentage withdrawals is annual expenses from your investments? I’m thinking you may have won the game already…so why continue working? Do your pensions meet or exceed your needs? What tax bracket will you be in with your pensions? You may have a chance to retire earlier than expected and live off your taxable accounts (paying 0% capital gains) while you wait to collect your pensions.

I've found decumulation planning a fun hobby. Threads on Roth conversions are interesting as people discuss RMD tax mitigation strategies.
($96k/annum between the two of us)
is before the standard deduction, tax deferred contributions will defer mostly 15% taxes allowing TGH in your taxable account at 0% capital gains rate. https://www.kitces.com/blog/understanding-the-mechanics-of-the-0-long-term-capital-gains-tax-rate-how-to-harvest-capital-gains-for-a-free-step-up-in-basis/ If it’s after the standard deduction you are solidly in in the 25% tax bracket after deductions. In that case tax deferred contributions would defer 25% which is an obvious win if your pensions leave you in the 15% bracket, and you break even if you will be in the 25% bracket (making Roth a good option).

I’m 3 yrs from retirement at 50yrs old with a military pension that covers our needs. 4% investment withdrawals will fill our lives with dinners out, tee times, a boat, and vacations. In these final working yrs, we are contributing maximum to tax deferred investments because we’re in the 25% tax bracket. In 2016 my wife didn’t work, so I was able to TGH at 0%. In early retirement, I expect some 15% space to TGH or do Roth conversions before we get solidly into the 25% bracket when DW takes SS at 62yrs.

You are in a darn good position…it’s time to enjoy life! :sharebeer


I am not sure I have understood everything in your helpful post, but I am working through it all. Thanks a ton! The info on TGH alone was golden. I am up to my ears in new reading material!

I did want to clarify that $96K figure. That is the amount of room we have available in tax-deferred (2 people * 2 accounts * $24k). We cannot afford to fully fund these, but may be able to get close to it if we sock away all of our raises, plus stop contributing to the Roth IRA in favor of tax-deferred.

Another clarification: Our pensions are based on the 3 highest earning years, and as noted above, we just got significant raises. Thus, I have a large incentive to stay for 3 more years. I think the numbers will work in 3 years, but not before then.

Thanks,
PaulF

PaulF
Posts: 61
Joined: Wed Aug 06, 2008 10:07 pm
Location: Wisconsin

Re: Home stretch — Where best to accumulate when close to early retirement?

Postby PaulF » Fri Jan 13, 2017 12:08 am

Watty wrote:There is a wiki on this choice.

https://www.bogleheads.org/wiki/Traditional_versus_Roth

You did not mention if you have a paid off house or not. If you still have a mortgage then getting it paid off by the time you retire would be worth looking at. I recently retired and having a paid off house made my numbers work a lot better.

With as well as you are doing and having the pensions in all likelihood are really investing the money for whoever will inherit it someday and need to consider if their tax rate will likely be higher or lower than your current 25% tax rate. If you are leaving the money to a charity then their effective tax rate is 0% so putting the money in a deductible retirement account would be an easy choice.

You will also have different income needs at different ages and by the time you are your mid 70s or so you may naturally slow down and spend a lot less while your health remains relatively well. I have seen relatives that slowed down like that and even though they could have afforded it they didn't want to travel much and even going out for the evening became a rare event. They lived in a medium to low cost of living area in a paid off house and there were many months that they didn't spend their entire social security checks. When people get older and their health starts to decline the income needs will go up but a lot of the health related costs are deductible so you may not pay a lot of taxes on it.

You already have some money in Roth and Taxable accounts that you could use in years when you have large expenses like buying a car.

Making Roth contributions in the 25% marginal tax bracket is really only a good choice if you would be in the 28% tax bracket in retirement. From what you have said that does not seem likely even if one of you survives the other and starts filing single tax returns.

I would look at using the deductible retirement account now and once you retire you can live on your taxable account money while doing Roth conversions up to the top of the 15% tax bracket each year.

PaulF wrote: We are currently in the 25% tax bracket, and expect to remain in that bracket in retirement (barring tax code changes, obviously).


A couple of things to watch out for.

You also need to be careful about when you are looking at what retirement tax rates you will be in. An over 65 couple can have almost $100K ($97K ??) in income and still be in the 15% federal marginal tax bracket. If they have a few thousand dollars more taxable income than that they will be "in the 25%" marginal tax bracket but their effective tax rate would still be below 15%. It would be good to do a dummy tax return as if you are retired, including state taxes, to see what your retirement taxes will look like. They could be lower than you are thinking.

You need to look at the tax rates three ways, as a couple and as if one of you survives the other. The survivor would be filing in the higher single tax brackets and the pension payout could change.

If you decide to move to a different state your state tax rates could change too.

You will likely be getting Social Security too and the way that it is taxed could put you in a higher effective tax bracket.

https://www.bogleheads.org/wiki/Taxatio ... y_benefits

https://www.bogleheads.org/wiki/Social_ ... calculator


Thank you for all the excellent points/questions/information. The Wiki link was very helpful. I actually did look at the wiki before posting, but I was researching other aspects of my question, so I didn't see that section. :oops:

Good point on the house. If we don't accelerate payments, it will be paid off in 4.5 years. I had been planning for it to be paid off well before retirement, but that was when I thought retirement would be in 10 years or so. But it is close enough.

I like your optimism that we will have an estate to pass along. I hope you are right. FIRECalc thinks there will be most of the time. Just so hard to know 40 years out!

Survivorship issues: I had considered this for the pensions, but not for taxes. (We have a few survivorship options on the pensions; I am leaning towards 75% to surviving spouse, but will have to give that more thought.) I'll be sure to look at various scenarios, not just the favored one where we both die precisely at the expected time! :wink:

My state income tax rates are ~6%, and we will likely move to a state with lower income taxes, so that is another vote for the tax-deferred vehicle that I had not thought of!

I did not realize that SS taxation was so complicated. Working through this. I just fell asleep about 6 times on the page you referenced. Maybe I will have better luck over the weekend.

Thanks again,
PaulF

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Watty
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Joined: Wed Oct 10, 2007 3:55 pm

Re: Home stretch — Where best to accumulate when close to early retirement?

Postby Watty » Fri Jan 13, 2017 10:19 am

PaulF wrote:Good point on the house. If we don't accelerate payments, it will be paid off in 4.5 years. I had been planning for it to be paid off well before retirement, but that was when I thought retirement would be in 10 years or so. But it is close enough.


If you have enough money in your taxable account to pay the house off now then that would be like getting a risk free CD at 4%, or whatever your interest rate is.

If you then save your "mortgage payment" the money will be back in the taxable account in 4.5 years.

PaulF
Posts: 61
Joined: Wed Aug 06, 2008 10:07 pm
Location: Wisconsin

Re: Home stretch — Where best to accumulate when close to early retirement?

Postby PaulF » Fri Jan 13, 2017 12:05 pm

Watty wrote:If you have enough money in your taxable account to pay the house off now then that would be like getting a risk free CD at 4%, or whatever your interest rate is.

If you then save your "mortgage payment" the money will be back in the taxable account in 4.5 years.


Thank you, Watty. Not a bad approach! Due to aggressive TLH, however, I have significant capital gains to worry about, that I was planning to defer until in the 15% bracket.

I could direct any spare cash flow to the mortgage, but I suppose this becomes equivalent (except for the interest issue) to the question of whether to put new monies into taxable or tax-deferred. :confused

Thanks,
PaulF


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