Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

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jbk
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Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by jbk » Thu Nov 23, 2017 10:54 pm

Thanks for any assistance with this. The subject sums up my question, but here are the details:

Emergency fund: Don't keep a separate one.
Debt: 22 years remaining on 300K mortgage balance @ 3.75%
Tax Rate: 25% Federal, 6.45% State
State of Residence: NY
Age: Him 51, Her 45
General Asset allocation: 70% stocks / 15% TIAA Traditional/ 15 % TIAA Real Estate
Portfolio Size: Low seven-figure.

Taxable assets:
11% VLCAX Vanguard Large Cap Index Funds .06%
3%VSGAX Vanguard Small Cap Growth Index .07%


His 403b:
15% CREF Equity Index R1 .61%
14% TIAA Real Estate .85%
13% TIAA Traditional GSRA paying 3%
No company match.

His Roth IRA at Vanguard
9% VFWAX All-World ex U.S. Index .11

Her currrent 401k
10% Mutual of America Equity Index 1%
No match.

Her old 403b
12% CREF Equity Index R1 .11
1% TIAA Real Estate .85
2% TIAA Traditional GSRA paying 3%


Her Roth IRA at Vanguard
9% VFWAX All-World ex U.S. Index .11

Her Inherited IRA
2% VBTLX Vanguard Total Bond Index .05%


New annual Contributions:
Both are maxing all retirement accounts. He's using the catch-up provision.

Discussion:
We're a bit retirement-heavy with an 85-15 retirement/taxable split. We sell in taxable in order to be able to max all retirement accounts, but I estimate that taxable will be exhausted in roughly three years. That's too soon to tap retirement assets without penalty. At that time we could begin tapping Roth contributions and I estimate that would last roughly another three years. However, at age 57 I could be out of "penalty-free" funds. Should we:
A) Heavily reduce retirement savings now in order to ensure making it to 59.5 with taxable funds.
B) Take the 10% hit for non-qualified withdrawals for roughly two years at age 57.
C) Do something else not noted above.

(Assume I remain with my employer. I know about the options that become available should I leave my employer.)

I'm inclined to lean toward "B" perhaps because I'm so used to prioritizing retirement funding, but I'm eager to hear feedback and/or any other strategies. Thanks again!

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rob
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by rob » Thu Nov 23, 2017 11:37 pm

Read up about SEPP - Substantially Equal Periodic Payments
| Rob | Its a dangerous business going out your front door. - J.R.R.Tolkien

software
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by software » Thu Nov 23, 2017 11:40 pm

I don’t understand the question. Why are you withdrawing from your retirement funds at all? I understand why you might withdraw from taxable to fully fund retirement accounts if you can’t max with your current income, but why are you considering withdrawing retirement assets while you are working? Especially assets subject to tax and penalties?

Should the question be instead, do I continue withdrawing from taxable to fully fund retirement accounts, or should I leave retirement space on the table? In that question, I would continue to max retirement accounts using taxable, and once that is exhausted contribute as much as possible from income. Do not withdraw retirement funds until you can do so penalty free.

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Watty
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by Watty » Fri Nov 24, 2017 12:15 am

rob wrote:
Thu Nov 23, 2017 11:37 pm
Read up about SEPP - Substantially Equal Periodic Payments
+1

https://www.bogleheads.org/wiki/Substan ... c_payments

and I would check on the 403b to see if it is like a 401k where you can make penalty free withdrawals if you are 55 when you leave that job.

krow36
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by krow36 » Fri Nov 24, 2017 12:19 am

I agree with software. Using funds from the taxable account to fund your retirement accounts makes sense. Cashing a Roth IRA to fund a 403k or 401k does not make sense to me. Neither does taking an early distribution from a tax-deferred account in order to max out a tax-deferred account!?

If you can't max out the retirement accounts from your salaries and the taxable account, then contribute less than the max. Do you have a pension? Maybe keeping some part of the taxable account is a good idea--very handy to have in early retirement? Or any time? :happy

dharrythomas
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by dharrythomas » Fri Nov 24, 2017 7:36 am

rob wrote:
Thu Nov 23, 2017 11:37 pm
Read up about SEPP - Substantially Equal Periodic Payments
+2

jbk
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by jbk » Fri Nov 24, 2017 8:15 am

software wrote:
Thu Nov 23, 2017 11:40 pm
I don’t understand the question. Why are you withdrawing from your retirement funds at all? I understand why you might withdraw from taxable to fully fund retirement accounts if you can’t max with your current income, but why are you considering withdrawing retirement assets while you are working? Especially assets subject to tax and penalties?

Should the question be instead, do I continue withdrawing from taxable to fully fund retirement accounts, or should I leave retirement space on the table? In that question, I would continue to max retirement accounts using taxable, and once that is exhausted contribute as much as possible from income. Do not withdraw retirement funds until you can do so penalty free.
Thanks. To be clear, I'm not withdrawing from retirement funds now. At 54 or so, I may not have taxable/liquid assets left for living expenses other than my Roth contributions.
rob wrote:
Thu Nov 23, 2017 11:37 pm
Read up about SEPP - Substantially Equal Periodic Payments
Thanks. Yes, that (and age 55 withdrawals) are definitely on the table should I no longer have the job. For planning purposes I'm assuming I stay in the job as I think staying makes the money more challenging to access.

sophie1
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by sophie1 » Fri Nov 24, 2017 9:13 am

If I am understanding this correctly: OP is saying that current expenses plus retirement contributions add up to more than they earn. 85% of savings are tied up in retirement accounts, nearly all of it in active accounts (with current employer). They have no emergency fund.

This is a pretty uncomfortable situation, at least I would consider it so. Are the high expenses temporary, e.g. paying college expenses? Are the retirement savings enough to cover this level of spending, i.e. annual expenses x 25 at minimum?

If you are in good shape with retirement at current spending levels, then I'd suggest converting some taxable assets to cash in order to build an adequate emergency fund. Then you can use the rest to fund retirement contributions. Once that is gone, then you will have to reduce retirement contributions. Personally I think 85% of assets in tax-deferred accounts is way too much, but I understand wanting to minimize the tax bill.

The part I don't understand is when you start talking about withdrawing from retirement accounts in order to fund retirement account contributions. Can you explain this more? Unless I'm missing something, what you're proposing is equivalent to taking a couple thousand dollars a year out to the backyard and setting it on fire.

goingup
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by goingup » Fri Nov 24, 2017 9:37 am

jbk wrote:
Thu Nov 23, 2017 10:54 pm
We're a bit retirement-heavy with an 85-15 retirement/taxable split. We sell in taxable in order to be able to max all retirement accounts, but I estimate that taxable will be exhausted in roughly three years. That's too soon to tap retirement assets without penalty.
I have to admit that I'm really confused. I think you're saying that you're selling assets in your taxable account to fund retirement accounts, but you want more taxable assets so don't have to tap tax-advantaged early.

Why are you selling taxable assets? We plan to use taxable assets as the bridge between early retirement and tapping retirement accounts. Aren't you incurring a capital gains tax bill when your sell your funds now?

I'm missing the point of your current strategy. :confused

jbk
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by jbk » Fri Nov 24, 2017 9:48 am

sophie1 wrote:
Fri Nov 24, 2017 9:13 am

The part I don't understand is when you start talking about withdrawing from retirement accounts in order to fund retirement account contributions. Can you explain this more? Unless I'm missing something, what you're proposing is equivalent to taking a couple thousand dollars a year out to the backyard and setting it on fire.
Thanks. To clarify, we're not currently withdrawing from retirement accounts at all. In a few years, we may need to withdraw from retirement accounts in order to fund living expenses, not retirement expenses. Thanks again.

jbk
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by jbk » Fri Nov 24, 2017 9:53 am

goingup wrote:
Fri Nov 24, 2017 9:37 am

Why are you selling taxable assets? We plan to use taxable assets as the bridge between early retirement and tapping retirement accounts. Aren't you incurring a capital gains tax bill when your sell your funds now?

I'm missing the point of your current strategy. :confused
Thanks. I think the capital gains hit is more than offset by reducing taxable income. Ideally, the taxable assets would've lasted to retirement, but it looks like I'll miss by a few years. Interested in opinions on whether to cut retirement contributions now or possibly take the 10% early withdrawal penalty for a couple of years. Thanks again.

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teen persuasion
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by teen persuasion » Fri Nov 24, 2017 10:00 am

OP, if you cut back on retirement contributions, where would you cut: traditional or Roth?

IOW, are you shifting taxable to traditional, or to Roth today?

Without an EF, I'd be reluctant to drain taxable down completely. What is your plan? Are you getting close to ER, and just trying to eek out as much tax advantage as possible while in high tax brackets? Are you trying to fully fund retirement before a job loss? Do you intend to work as long as possible, and are just pushing the max to retirement while you can, and may coast later? How do you envision your withdrawal stage: Roth conversions early on, pensions + SS + RMDs later, or straight to SS + RMDs? What's your optimal mix of traditional + Roth + taxable buckets?

I'm on the other side, I have no taxable, just traditional + Roth, and I can see the disadvantages of no taxable in ER. I'm struggling with continuing as we are funding retirement accounts, or taking tax hits to create a taxable account. There isn't enough to do both, for us. As long as the marginal rates are high for our situation, I lean to retirement contributions. If things change, I'll reevaluate.

jbk
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by jbk » Fri Nov 24, 2017 10:45 am

teen persuasion wrote: ↑
Fri Nov 24, 2017 11:00 am
OP, if you cut back on retirement contributions, where would you cut: traditional or Roth?

I would heavily reduce 401k/403b contributions. I'd probably continue contributing to Roths since the contributions can be accessed without penalty.

>>IOW, are you shifting taxable to traditional, or to Roth today?

Both. Selling taxable to fund 403/401 and Roths.

>>Without an EF, I'd be reluctant to drain taxable down completely.

That gets to the crux of it, though even after taxable is exhausted we have a few years of Roth contributions that can be accessed.

>>What is your plan? Are you getting close to ER, and just trying to eek out as much tax advantage as possible while in high tax brackets? Are you trying to fully fund retirement before a job loss? Do you intend to work as long as possible, and are just pushing the max to retirement while you can, and may coast later? How do you envision your withdrawal stage: Roth conversions early on, pensions + SS + RMDs later, or straight to SS + RMDs? What's your optimal mix of traditional + Roth + taxable buckets?

No desire for ER. Planning to work as long as necessary and probably part-time on an enjoyable sideline after retirement. Your other questions in that paragraph are what I'm sorting out now. Thanks!

goingup
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by goingup » Fri Nov 24, 2017 11:13 am

jbk wrote:
Fri Nov 24, 2017 9:53 am
goingup wrote:
Fri Nov 24, 2017 9:37 am

Why are you selling taxable assets? We plan to use taxable assets as the bridge between early retirement and tapping retirement accounts. Aren't you incurring a capital gains tax bill when your sell your funds now?

I'm missing the point of your current strategy. :confused
Thanks. I think the capital gains hit is more than offset by reducing taxable income. Ideally, the taxable assets would've lasted to retirement, but it looks like I'll miss by a few years. Interested in opinions on whether to cut retirement contributions now or possibly take the 10% early withdrawal penalty for a couple of years. Thanks again.
Thanks. I do understand now and it's definitely a strategy that folks here employ. I do think it makes since to reduce taxable income by contributing to workplace plan. I'm less sure selling taxable assets to fund a Roth if you need that money prior to age 59. My inclination would be to build an adequate taxable bridge. When you think about paying capital gains when you liquidate taxable assets and early withdrawal penalty from a Roth it doesn't seem like the best plan. No expert though as we are 70% taxable and for various reasons can't fund Roths.

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teen persuasion
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by teen persuasion » Fri Nov 24, 2017 1:11 pm

jbk wrote:
Fri Nov 24, 2017 8:15 am
To be clear, I'm not withdrawing from retirement funds now. At 54 or so, I may not have taxable/liquid assets left for living expenses other than my Roth contributions.
If you continue to work, why may you not have liquid assets left for living expenses?

Somethings been nagging me about the details, so I tried to put some hypothetical figures in for me to get a frame of reference. Based on details in OP:

Low seven figures = minimum $1mm
15% taxable = minimum $150k
Expect to be depleted in 3 years = minimum $50k withdrawn/year

Contributions to retirement accounts = $24k +$18k +$6.5k +$5.5k = $54k

It appears you are getting (nearly) all of the retirement contributions from taxable, and taxable is being depleted, and no other savings exist. This implies you are spending all of your after tax income, there is no new savings at the current time.

There is a tax advantage to shifting taxable to tax deferred accounts, but how great is it once you take into account the cost of selling taxable?

$42k * (.25 + .0645) = $13209 tax deferred
I have no way of knowing how much you might have in LTCG vs basis, but let's guess $20k LTCG on a $50k sale.
$20k * (.15 + .0645) = $4290
I'm not sure how NY taxes LTCG, I'm assuming as ordinary income here.

So under my wildly speculative scenario, you've saved roughly $9k in taxes by shifting taxable into retirement accounts. When you run out of taxable, you can no longer contribute to retirement accounts at all, and have an additional tax burden of $9k. Is this why you need liquid assets for living expenses in the future?

nolesrule
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by nolesrule » Fri Nov 24, 2017 1:47 pm

You are focusing on the savings side of the equation, but the problem is your expenses are too high. You are not living below your means.

flyingaway
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by flyingaway » Fri Nov 24, 2017 5:51 pm

I think it is not that much advantageous for the OP to maximize the retirement accounts. It seems that they are in lower tax bracket, why pay the 10% penalty?

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Earl Lemongrab
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by Earl Lemongrab » Sat Nov 25, 2017 2:24 pm

flyingaway wrote:
Fri Nov 24, 2017 5:51 pm
I think it is not that much advantageous for the OP to maximize the retirement accounts. It seems that they are in lower tax bracket, why pay the 10% penalty?
There is no option to roll over with or without a 10% penalty, at least for employee deferrals/Roth. Seriously. It's against the law.

The plan could allow distribution of employer contributions or employee after-tax, but then there would be no penalty on the rollover.
This week's fortune cookie: "Your financial life will be secure and beneficial." So I got that going for me, which is nice.

jbk
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by jbk » Sat Nov 25, 2017 4:36 pm

teen persuasion wrote:
Fri Nov 24, 2017 1:11 pm
jbk wrote:
Fri Nov 24, 2017 8:15 am
To be clear, I'm not withdrawing from retirement funds now. At 54 or so, I may not have taxable/liquid assets left for living expenses other than my Roth contributions.
If you continue to work, why may you not have liquid assets left for living expenses?

Somethings been nagging me about the details, so I tried to put some hypothetical figures in for me to get a frame of reference. Based on details in OP:

Low seven figures = minimum $1mm
15% taxable = minimum $150k
Expect to be depleted in 3 years = minimum $50k withdrawn/year

Contributions to retirement accounts = $24k +$18k +$6.5k +$5.5k = $54k

It appears you are getting (nearly) all of the retirement contributions from taxable, and taxable is being depleted, and no other savings exist. This implies you are spending all of your after tax income, there is no new savings at the current time.

There is a tax advantage to shifting taxable to tax deferred accounts, but how great is it once you take into account the cost of selling taxable?

$42k * (.25 + .0645) = $13209 tax deferred
I have no way of knowing how much you might have in LTCG vs basis, but let's guess $20k LTCG on a $50k sale.
$20k * (.15 + .0645) = $4290
I'm not sure how NY taxes LTCG, I'm assuming as ordinary income here.

So under my wildly speculative scenario, you've saved roughly $9k in taxes by shifting taxable into retirement accounts. When you run out of taxable, you can no longer contribute to retirement accounts at all, and have an additional tax burden of $9k. Is this why you need liquid assets for living expenses in the future?
Thanks for this analysis! Yes, the liquid/taxable assets (not including Roth contributions which can be accessed without penalty, of course) may be depleted in three years or so because I'm using them to max retirement accounts. Then, tapping Roth contributions will give me another three years or so of living expenses. At that point I may need to take the 10% hit for a year or two in order to rebuild some liquid assets. That, however, may be a slow way of rebuilding liquid assets so I'm considering hitting the brakes on retirement contributions now in order to restock liquid assets while I still have some as a safety net.

jbk
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by jbk » Sat Nov 25, 2017 4:39 pm

nolesrule wrote:
Fri Nov 24, 2017 1:47 pm
You are focusing on the savings side of the equation, but the problem is your expenses are too high. You are not living below your means.
Probably so, but I'm locked into a couple of expensive things now which I should be able to ease off of in the future (i.e. summer camp for two kids, and other childcare-related issues). The overall portfolio is growing every year, but it's the location of the assets that I'm sensitized to now as I see the taxable portion shrinking faster than originally anticipated. Thanks!

jbk
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by jbk » Sat Nov 25, 2017 4:41 pm

Earl Lemongrab wrote:
Sat Nov 25, 2017 2:24 pm
flyingaway wrote:
Fri Nov 24, 2017 5:51 pm
I think it is not that much advantageous for the OP to maximize the retirement accounts. It seems that they are in lower tax bracket, why pay the 10% penalty?
There is no option to roll over with or without a 10% penalty, at least for employee deferrals/Roth. Seriously. It's against the law.

The plan could allow distribution of employer contributions or employee after-tax, but then there would be no penalty on the rollover.
I took Flyingaway's reply as a vote for cutting current retirement contributions instead of incurring the 10% penalty in the future.

gostars
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Re: Light on Taxable- Cut Retirement Contributions Or Take 10% Penalty?

Post by gostars » Sat Nov 25, 2017 10:27 pm

Cut retirement contributions. You're missing the forest for the trees here. Taking an extra 10% hit on retirement funds to put more funds towards retirement is nonsensical unless there are extraordinary circumstances, like getting an employer match that exceeds the cost. Adjust things so you have enough to live off of until you reach retirement age, contribute whatever is left, and leave your retirement fund alone until you actually retire. Put some extra thought into your risk tolerance and AA, because that AA seems incredibly risky if you're planning to retire within 10 years. If/when the market crashes in the next few years, you may not have enough time left for things to recover before you start needing that money tied up in stocks.

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