Roth IRA Idea: Burst my bubble

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Marche24
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Roth IRA Idea: Burst my bubble

Post by Marche24 » Thu Jul 23, 2020 1:12 am

Hi all!!

Newbie here seeking some advice...

Background: My wife didn't had a retirement account so I started reading to see what option she had and when reading about Roth IRA being able to withdraw any contributions (not the gains) at any moment w/o paying penalties or fees a light bulb turned on. But before making any moves I wanted to take other people input and here I am.

Present: Investing 15% to a 401K; have a emergency and money market account; paid off my car and have extra cash

Idea: Unlike other retirement accounts (e.g. 401K), money inside a Roth IRA is not locked away until retirement and you’re allowed to withdraw up to the amount you’ve contributed to your Roth IRA at any time, and for any reason, without tax or penalty. Instead of keep trowing money into my money market account at 1% interest rate, my idea is to start maxing out my Roth IRA (wife will have her own) and investing that money in a fund that tracks the SP500 and hopefully get bigger returns. Why? To retire early. With the Roth IRA I have access to my contributions at any time, so if X years from now I contributed $150K and those $150K can cover my expenses for 2-5 years I could withdraw (sell shares) my contribution ($150K) and retire 2-5 years sooner because my money is not "locked" until I'm 59.5 years old like a 401K. Once I'm 59.5 years old I can tap into my 401K and the gains from the Roth IRA. Why do it this way? Will have bigger gains investing than in a money market account

Thoughts?

retired@50
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Re: Roth IRA Idea: Burst my bubble

Post by retired@50 » Thu Jul 23, 2020 6:14 am

Welcome to the forum.

I don't think there is a bubble to burst. It appears your understanding of the situation is solid.

See link just in case you haven't already read it: https://www.bogleheads.org/wiki/Roth_IRA

Regards,
This is one person's opinion. Nothing more.

HomeStretch
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Re: Roth IRA Idea: Burst my bubble

Post by HomeStretch » Thu Jul 23, 2020 6:22 am

Welcome to the forum!

Prioritize contributing to a Roth IRA over a Taxable account for retirement savings. Roth accounts grow tax free. Invest the Roth IRAs in 100% equity (like the S&P500 fund) for highest expected growth.

It’s a good idea to open your and spouse’s first Roth IRAs to start the 5-year clock.
https://www.kitces.com/blog/understandi ... nversions/

If you/spouse exceed the IRS income limits for making direct Roth IRA contributions, another method is the backdoor Roth.
https://www.bogleheads.org/wiki/Backdoor_Roth

Roth IRA contributions are accessible prior to age 59-1/2. But consider tapping a Roth IRA prior to retirement only as a last resort. Roth space is limited and valuable.

rkhusky
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Re: Roth IRA Idea: Burst my bubble

Post by rkhusky » Thu Jul 23, 2020 6:29 am

If you use the Roth IRA for an emergency fund, which is a common idea, and invest it in stocks, make sure that you put in 2x the cushion. You don't want the market to drop in half and also have an emergency.

Note that a Roth IRA is always better than a taxable account - you pay taxes on contributions to both, but with the Roth there is no yearly taxes on dividends/interest/cap gains and there is no tax on earnings that you withdraw.

If you can afford to, the best plan is to max your 401k and max your Roth IRA's and contribute to a taxable account.

Note also that you can withdraw from your 401k before 59.5 (with taxes, but without penalty), if you retire or otherwise leave your employer in the year that you turn 55 or later (Rule of 55).
Last edited by rkhusky on Thu Jul 23, 2020 6:36 am, edited 2 times in total.

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Tamarind
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Re: Roth IRA Idea: Burst my bubble

Post by Tamarind » Thu Jul 23, 2020 6:29 am

For retiring early I'd recommend you both max out the Roths AND invest in a taxable account. Your choice is not S&P500 fund in Roth OR money market. It's S&P500 fund in Roth AND/OR S&P500 fund in taxable.

While you can get at the Roth money early, it's also most valuable to leave it longer if you can because of tax free growth.

If you only have enough extra income to max Roth IRAs, do that. But if you have more leftover, add a taxable account.

lakpr
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Re: Roth IRA Idea: Burst my bubble

Post by lakpr » Thu Jul 23, 2020 6:34 am

What state are you in? I may be about to burst your bubble.

New Jersey, my home state, does not recognize withdrawals from Roth IRA accounts like Federal does. Any non-qualified withdrawals from Roth IRA are treated as proportional withdrawals of contributions and gains. Not as withdrawals of contributions first.

So from years 1 through 10 you dutifully plow in $6000 per year, and in year 11 the value of the IRA is $100k with growth; year 11 you withdraw $10k for an emergency. Federal tax treatment says you owe 0 tax, as you certainly passed the 5-year rule and you certainly contributed more than $10k to the account, so it is a withdrawal of your earliest contributions.

NJ says not so fast; you contributed $60k, the gains are $40k, so the proportion of contributions to growth is 60:40. Therefore the $10k you withdrew is $6k return of contributions, $4k withdrawal of gains. Pay tax and penalty on $4k, since it is a non-qualified withdrawal.

TL DR: check your state laws

h82goslw
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Re: Roth IRA Idea: Burst my bubble

Post by h82goslw » Thu Jul 23, 2020 6:53 am

rkhusky wrote:
Thu Jul 23, 2020 6:29 am

Note also that you can withdraw from your 401k before 59.5 (with taxes, but without penalty), if you retire or otherwise leave your employer in the year that you turn 55 or later (Rule of 55).
While the law itself allows this to be the case, from what I've read, this is plan dependent...meaning some employer's plans allow this and some do not. Please correct me if I'm wrong.

treadingwater
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Re: Roth IRA Idea: Burst my bubble

Post by treadingwater » Thu Jul 23, 2020 7:06 am

https://www.madfientist.com/how-to-acce ... nds-early/ The roth conversion ladder is a way to access your 401k early without penalty. :happy
Never panic. Stop looking so much.

rkhusky
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Re: Roth IRA Idea: Burst my bubble

Post by rkhusky » Thu Jul 23, 2020 7:17 am

h82goslw wrote:
Thu Jul 23, 2020 6:53 am
rkhusky wrote:
Thu Jul 23, 2020 6:29 am

Note also that you can withdraw from your 401k before 59.5 (with taxes, but without penalty), if you retire or otherwise leave your employer in the year that you turn 55 or later (Rule of 55).
While the law itself allows this to be the case, from what I've read, this is plan dependent...meaning some employer's plans allow this and some do not. Please correct me if I'm wrong.
That's true. And employers that allow it might not allow multiple withdrawals. But it is worth looking into.

Topic Author
Marche24
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Re: Roth IRA Idea: Burst my bubble

Post by Marche24 » Thu Jul 23, 2020 6:31 pm

HomeStretch wrote:
Thu Jul 23, 2020 6:22 am
Prioritize contributing to a Roth IRA over a Taxable account for retirement savings. Roth accounts grow tax free. Invest the Roth IRAs in 100% equity (like the S&P500 fund) for highest expected growth.
That’s what I had in mind, especially since we still got 25-30 years to go and she doesn’t have employer matching
HomeStretch wrote:
Thu Jul 23, 2020 6:22 am
It’s a good idea to open your and spouse’s first Roth IRAs to start the 5-year clock.
She already made the first deposit 😊
HomeStretch wrote:
Thu Jul 23, 2020 6:22 am
If you/spouse exceed the IRS income limits for making direct Roth IRA contributions, another method is the backdoor Roth.
Still under the limits, but good to know. One thing I found curious, was that when I opened the account I wasn't asked for our income. What happens if you contribute to a IRA but do not qualify? I'm curious
rkhusky wrote:
Thu Jul 23, 2020 6:29 am
Note that a Roth IRA is always better than a taxable account - you pay taxes on contributions to both, but with the Roth there is no yearly taxes on dividends/interest/cap gains and there is no tax on earnings that you withdraw.
Some prefer a Traditional IRA estimating they will be in a lower bracket in retirement but I’m with you, I prefer Roth and keep Uncle Sam away from my gains
rkhusky wrote:
Thu Jul 23, 2020 6:29 am
Note also that you can withdraw from your 401k before 59.5 (with taxes, but without penalty), if you retire or otherwise leave your employer in the year that you turn 55 or later (Rule of 55).
I have a Roth 401K, well, started as Traditional but switched to Roth in the first 2-3 years, does this apply?
h82goslw wrote:
Thu Jul 23, 2020 6:53 am
rkhusky wrote:
Thu Jul 23, 2020 6:29 am

Note also that you can withdraw from your 401k before 59.5 (with taxes, but without penalty), if you retire or otherwise leave your employer in the year that you turn 55 or later (Rule of 55).
While the law itself allows this to be the case, from what I've read, this is plan dependent...meaning some employer's plans allow this and some do not. Please correct me if I'm wrong.
What is this plan you are referring to? Can you elaborate?
treadingwater wrote:
Thu Jul 23, 2020 7:06 am
https://www.madfientist.com/how-to-acce ... nds-early/ The roth conversion ladder is a way to access your 401k early without penalty. :happy
Thanks, will look into that

Topic Author
Marche24
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Re: Roth IRA Idea: Burst my bubble

Post by Marche24 » Thu Jul 23, 2020 6:41 pm

lakpr wrote:
Thu Jul 23, 2020 6:34 am
What state are you in? I may be about to burst your bubble.

New Jersey, my home state, does not recognize withdrawals from Roth IRA accounts like Federal does. Any non-qualified withdrawals from Roth IRA are treated as proportional withdrawals of contributions and gains. Not as withdrawals of contributions first.

So from years 1 through 10 you dutifully plow in $6000 per year, and in year 11 the value of the IRA is $100k with growth; year 11 you withdraw $10k for an emergency. Federal tax treatment says you owe 0 tax, as you certainly passed the 5-year rule and you certainly contributed more than $10k to the account, so it is a withdrawal of your earliest contributions.

NJ says not so fast; you contributed $60k, the gains are $40k, so the proportion of contributions to growth is 60:40. Therefore the $10k you withdrew is $6k return of contributions, $4k withdrawal of gains. Pay tax and penalty on $4k, since it is a non-qualified withdrawal.

TL DR: check your state laws
Why? We where doing so well....

I'm not from Jersey but living there. How can this be? Is State law above Federal Law? Isn't a contribution withdraw in a Roth IRA a qualified withdraw? It's part of the benefits.

What if I move from NJ before making any contribution withdraws?
What do I type in google > how to prevent Roth IRA theft?... seriously, I don't know what to put on google.

HomeStretch
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Re: Roth IRA Idea: Burst my bubble

Post by HomeStretch » Thu Jul 23, 2020 6:45 pm

Marche24 wrote:
Thu Jul 23, 2020 6:31 pm
HomeStretch wrote:
Thu Jul 23, 2020 6:22 am
If you/spouse exceed the IRS income limits for making direct Roth IRA contributions, another method is the backdoor Roth.
Still under the limits, but good to know. One thing I found curious, was that when I opened the account I wasn't asked for our income. What happens if you contribute to a IRA but do not qualify? I'm curious
For a self-directed IRA, it is your responsibility (and not the provider’s) to determine if you are eligible to contribute and the amount you can contribute. Mainstream providers usually will prevent you from contributing over the IRS limit. If you are ineligible to make an IRA contribution you would need to contact the provider to correct the issue.

lakpr
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Re: Roth IRA Idea: Burst my bubble

Post by lakpr » Thu Jul 23, 2020 6:47 pm

Marche24 wrote:
Thu Jul 23, 2020 6:41 pm
lakpr wrote:
Thu Jul 23, 2020 6:34 am
What state are you in? I may be about to burst your bubble.
Why? We where doing so well....

I'm not from Jersey but living there. How can this be? Is State law above Federal Law? Isn't a contribution withdraw in a Roth IRA a qualified withdraw? It's part of the benefits.

What if I move from NJ before making any contribution withdraws?
What do I type in google > how to prevent Roth IRA theft?... seriously, I don't know what to put on google.
Hey man, laws do not have to make any sense :(

If you move away from NJ to another state before making any contribution withdrawal, as long as you establish residency in the new state prior to the withdrawal (NJ will argue that you owe them tax if you have any ties to the state such as using NJ drivers license, owning property in NJ etc.) -- you are good. I mean, you are subject to the new state's tax laws.

rkhusky
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Re: Roth IRA Idea: Burst my bubble

Post by rkhusky » Thu Jul 23, 2020 8:56 pm

Marche24 wrote:
Thu Jul 23, 2020 6:31 pm
What is this plan you are referring to? Can you elaborate?
Your employer's 401k plan - it includes the rules for contributing and withdrawing. Some plans don't provide a Roth option, for example. The Government's TSP plan, until last year, only allowed one partial withdrawal - after that one had to do a full withdrawal, although you could get monthly payments. Additionally, you had to withdraw proportionally from Roth and Traditional, not just withdraw from one. These types of rules would be listed in the employer's 401k plan.

BuckyBadger
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Re: Roth IRA Idea: Burst my bubble

Post by BuckyBadger » Thu Jul 23, 2020 9:45 pm

Order of operations are usually something like the following. Details may vary a little bit, but you will almost always hear the board suggest to max out a Roth IRA before taxable investing.

1) 401k to the match
2) HSA if you have one
3) Roth to the max
4) 401k to the max
5) taxable or 529 or mortgage prepayment

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celia
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Re: Roth IRA Idea: Burst my bubble

Post by celia » Thu Jul 23, 2020 9:58 pm

I am concerned that OP’s first post had 3!!! separate references to withdrawing the contributions early. ***THREE***!!!
That sounds like the primary motivation for opening the Roth IRAs. While the withdrawals can be made, they shouldn’t be considered as ready cash. They should be considered and treated as retirement money only.

If you start withdrawing them for anything else, you likely didn’t do appropriate planning to have a ready-and-waiting emergency funds account. So also set up an account for emergency expenses to cover 6-12 months of living expenses. Once you withdraw from the Roth, you can never replace that money in the Roth but you can re-build an emergency fund account.
Marche24 wrote:
Thu Jul 23, 2020 6:31 pm
What happens if you contribute to a IRA but do not qualify? I'm curious
You will find out you were not eligible when you do your taxes the following March or April (if you answer all the IRA questions). At that point you will either have to remove the excess you weren’t eligible for (plus it’s growth) or have to re-charactuze the excess to a tIRA. Then it will be considered as if you had contributed to that account from the beginning. That “recharacterized” contribution can either be deductible or non-deductible. Note that there are eligibilty rules for deductible contributions. There can also be pro rata tax calculations on the non-deductible contributions when they are withdrawn or converted to Roth.

aristotelian
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Re: Roth IRA Idea: Burst my bubble

Post by aristotelian » Fri Jul 24, 2020 8:21 am

treadingwater wrote:
Thu Jul 23, 2020 7:06 am
https://www.madfientist.com/how-to-acce ... nds-early/ The roth conversion ladder is a way to access your 401k early without penalty. :happy
Just to re-emphasize this, the combination of 401k + Roth conversions in retirement is even more powerful than Roth because you have more to invest up front from saving pretax, and if you can keep taxes low in retirement you come out ahead vs Roth. Of course, best is to do both. Likely anyone pursuing early retirement will need to be saving more than 15% of their income, so just maxing Roth IRA will not be enough.

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Marche24
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Re: Roth IRA Idea: Burst my bubble

Post by Marche24 » Tue Jul 28, 2020 9:02 pm

BuckyBadger wrote:
Thu Jul 23, 2020 9:45 pm
Order of operations are usually something like the following. Details may vary a little bit, but you will almost always hear the board suggest to max out a Roth IRA before taxable investing.

1) 401k to the match
2) HSA if you have one
3) Roth to the max
4) 401k to the max
5) taxable or 529 or mortgage prepayment
I guess option 1 to the match only if its a traditional 401K... if is a Roth 401K then I suppose the order would be 1/3 > 2 > 4 > 5

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arcticpineapplecorp.
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Re: Roth IRA Idea: Burst my bubble

Post by arcticpineapplecorp. » Tue Jul 28, 2020 9:06 pm

lakpr wrote:
Thu Jul 23, 2020 6:34 am
What state are you in? I may be about to burst your bubble.

New Jersey, my home state, does not recognize withdrawals from Roth IRA accounts like Federal does. Any non-qualified withdrawals from Roth IRA are treated as proportional withdrawals of contributions and gains. Not as withdrawals of contributions first.

So from years 1 through 10 you dutifully plow in $6000 per year, and in year 11 the value of the IRA is $100k with growth; year 11 you withdraw $10k for an emergency. Federal tax treatment says you owe 0 tax, as you certainly passed the 5-year rule and you certainly contributed more than $10k to the account, so it is a withdrawal of your earliest contributions.

NJ says not so fast; you contributed $60k, the gains are $40k, so the proportion of contributions to growth is 60:40. Therefore the $10k you withdrew is $6k return of contributions, $4k withdrawal of gains. Pay tax and penalty on $4k, since it is a non-qualified withdrawal.

TL DR: check your state laws
very nice write up and explanation. thanks for sharing this.
"May you live as long as you want and never want as long as you live" -- Irish Blessing | "Invest we must" -- Jack Bogle

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Marche24
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Re: Roth IRA Idea: Burst my bubble

Post by Marche24 » Tue Jul 28, 2020 9:14 pm

celia wrote:
Thu Jul 23, 2020 9:58 pm
I am concerned that OP’s first post had 3!!! separate references to withdrawing the contributions early. ***THREE***!!!
That sounds like the primary motivation for opening the Roth IRAs. While the withdrawals can be made, they shouldn’t be considered as ready cash. They should be considered and treated as retirement money only.

If you start withdrawing them for anything else, you likely didn’t do appropriate planning to have a ready-and-waiting emergency funds account. So also set up an account for emergency expenses to cover 6-12 months of living expenses. Once you withdraw from the Roth, you can never replace that money in the Roth but you can re-build an emergency fund account.
This Roth IRA account will not serve as my retirement account, for that I have a Roth TSP account that I contribute 15% of each paycheck. My idea was to deposit spare cash to a Roth IRA and use it as a savings account in steroids (by investing the money), thus why I'm inquiring about taxes, penalties, early withdrawals, etc.
celia wrote:
Thu Jul 23, 2020 9:58 pm
You will find out you were not eligible when you do your taxes the following March or April (if you answer all the IRA questions). At that point you will either have to remove the excess you weren’t eligible for (plus it’s growth) or have to re-charactuze the excess to a tIRA. Then it will be considered as if you had contributed to that account from the beginning. That “recharacterized” contribution can either be deductible or non-deductible. Note that there are eligibilty rules for deductible contributions. There can also be pro rata tax calculations on the non-deductible contributions when they are withdrawn or converted to Roth.
Thanks for the info

e5116
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Re: Roth IRA Idea: Burst my bubble

Post by e5116 » Tue Jul 28, 2020 9:25 pm

Marche24 wrote:
Thu Jul 23, 2020 1:12 am
Hi all!!

Newbie here seeking some advice...

Background: My wife didn't had a retirement account so I started reading to see what option she had and when reading about Roth IRA being able to withdraw any contributions (not the gains) at any moment w/o paying penalties or fees a light bulb turned on. But before making any moves I wanted to take other people input and here I am.

Present: Investing 15% to a 401K; have a emergency and money market account; paid off my car and have extra cash

Idea: Unlike other retirement accounts (e.g. 401K), money inside a Roth IRA is not locked away until retirement and you’re allowed to withdraw up to the amount you’ve contributed to your Roth IRA at any time, and for any reason, without tax or penalty. Instead of keep trowing money into my money market account at 1% interest rate, my idea is to start maxing out my Roth IRA (wife will have her own) and investing that money in a fund that tracks the SP500 and hopefully get bigger returns. Why? To retire early. With the Roth IRA I have access to my contributions at any time, so if X years from now I contributed $150K and those $150K can cover my expenses for 2-5 years I could withdraw (sell shares) my contribution ($150K) and retire 2-5 years sooner because my money is not "locked" until I'm 59.5 years old like a 401K. Once I'm 59.5 years old I can tap into my 401K and the gains from the Roth IRA. Why do it this way? Will have bigger gains investing than in a money market account

Thoughts?
Just to be clear, you can only contribute $6k into a Roth IRA annually based on current limits. So, in order to contribute $150k to a Roth IRA, you'd have to be contributing the max for ~25 years (of course, the limit can and will likely change slightly in the future). I think you're already aware of that, but just wanted to make sure...

02nz
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Re: Roth IRA Idea: Burst my bubble

Post by 02nz » Tue Jul 28, 2020 9:28 pm

Marche24 wrote:
Thu Jul 23, 2020 1:12 am
because my money is not "locked" until I'm 59.5 years old like a 401K.
Common misconception. A lot of people (like you) think "early retirement" means the 401k is no good. It's just the opposite. If you're thinking of retiring even early-ish, you should probably plow every dollar you can into traditional 401k, maybe even ahead of funding a Roth IRA (although that would be good as well).

Read this for ways of accessing retirement accounts before age 59.5: https://www.madfientist.com/how-to-acce ... nds-early/. Pay particular attention to the Roth conversion ladder. Also, you can withdraw funds without penalty from the employer plan (401k) if you retire in the year in which you turn 55 or later. Apparently not all plans make this possible, but the law does allow it.

Having a large traditional balance is especially powerful for retiring early, because instead of paying say 22% or more in income tax, you can withdraw (or do Roth conversions) in early retirement at much lower average rates, since every year you have a standard deduction and 10% and 12% brackets. With no other income, a married couple can currently withdraw a bit more than $100K and pay an average of less than 9% federal income tax.

jarjarM
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Re: Roth IRA Idea: Burst my bubble

Post by jarjarM » Tue Jul 28, 2020 9:30 pm

02nz wrote:
Tue Jul 28, 2020 9:28 pm
Marche24 wrote:
Thu Jul 23, 2020 1:12 am
because my money is not "locked" until I'm 59.5 years old like a 401K.
Common misconception. A lot of people (like you) think "early retirement" means the 401k is no good. It's just the opposite. If you're thinking of retiring even early-ish, you should probably plow every dollar you can into traditional 401k, maybe even ahead of funding a Roth IRA (although that would be good as well).

Read this for ways of accessing retirement accounts before age 59.5: https://www.madfientist.com/how-to-acce ... nds-early/. Pay particular attention to the Roth conversion ladder. Also, you can withdraw funds without penalty from the employer plan (401k) if you retire in the year in which you turn 55 or later. Apparently not all plans make this possible, but the law does allow it.

Having a large traditional balance is especially powerful for retiring early, because instead of paying say 22% or more in income tax, you can withdraw (or do Roth conversions) in early retirement at much lower average rates, since every year you have a standard deduction and 10% and 12% brackets. With no other income, a married couple can currently withdraw a bit more than $100K and pay an average of less than 9% federal income tax.
+1, that's our plan (Roth conversion ladder).

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Marche24
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Re: Roth IRA Idea: Burst my bubble

Post by Marche24 » Tue Jul 28, 2020 9:57 pm

lakpr wrote:
Thu Jul 23, 2020 6:34 am
What state are you in? I may be about to burst your bubble.

New Jersey, my home state, does not recognize withdrawals from Roth IRA accounts like Federal does. Any non-qualified withdrawals from Roth IRA are treated as proportional withdrawals of contributions and gains. Not as withdrawals of contributions first.

So from years 1 through 10 you dutifully plow in $6000 per year, and in year 11 the value of the IRA is $100k with growth; year 11 you withdraw $10k for an emergency. Federal tax treatment says you owe 0 tax, as you certainly passed the 5-year rule and you certainly contributed more than $10k to the account, so it is a withdrawal of your earliest contributions.

NJ says not so fast; you contributed $60k, the gains are $40k, so the proportion of contributions to growth is 60:40. Therefore the $10k you withdrew is $6k return of contributions, $4k withdrawal of gains. Pay tax and penalty on $4k, since it is a non-qualified withdrawal.

TL DR: check your state laws
I've been searching and stumble upon the NJ Tax Division retirement guide (https://www.state.nj.us/treasury/taxati ... -Guide.pdf) which directs you to IRA Withdrawals Bulletin (https://www.state.nj.us/treasury/taxati ... e/git2.pdf)

Tax Topic Bulletin GIT-2 (all quotes)
"Roth IRA - As with any other IRA, contributions to a Roth IRA are subject to New Jersey Income Tax in the year they are made. When you make a withdrawal from a Roth IRA, the portion of the withdrawal that represents your contributions is not taxable, since the contributions were taxed when they were made."

"Nonqualified Distributions. A payment or distribution becomes nonqualified if it is not made under one of the four circumstances above or if it is made within the five-year period that begins with the year the first contribution was made to the Roth IRA. A distribution that is considered nonqualified for federal income tax purposes is also considered nonqualified for New Jersey Income Tax purposes."

This is were I get confused, above says it can be withdrawn but the definition of nonqualified distribution doesn't make a distinction to contributions.

"If you receive a nonqualified distribution from a Roth IRA, part of the withdrawal is taxable, and part is excludable. You must report the
taxable portion of the withdrawal on Line 20a, Form NJ-1040 or Line 22, Column A, Form NJ-1040NR. Residents must also report the excludable portion on Line 20b, Form NJ-1040." "If you make withdrawals from a traditional IRA or nonqualified withdrawals from a Roth IRA over a period of
years, you must report the portion of the annual distribution that represents interest and accumulated gains (including amounts rolled over and not previously taxed) as taxable income each year a withdrawal is made. The amount subject to tax is based on the ratio that the taxable portion of the account bears to the total amount in the account. Residents must also report the excludable portion of the distribution on Line 20b,
Form NJ-1040. Use the following formula to determine the taxable amount of a distribution from a traditional IRA or a
nonqualified distribution from a Roth IRA: (Taxable Portion/Total Value) × Distribution = Taxable Amount
Total Value means the value of the IRA on December 31 of the tax year (including contributions made for the tax year from January 1 through April 15 of the following year), plus total IRA distributions during the tax year. Taxable Portion means the Total Value minus previously taxed contributions. In the first year a withdrawal is made, contributions means the total amount you contributed to the IRA from the time the account was opened through the end of the tax year in which the first withdrawal was made. (It does not include amounts rolled over and not previously taxed.) After the first year, the formula for calculating the portion of a distribution that is taxable remains the same, but the base for each item changes to take into account the fact that both taxable and excludable (nontaxable) amounts have been withdrawn from the account."

I guess this is what you are referring to as proportional withdrawal?

TravelforFun
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Re: Roth IRA Idea: Burst my bubble

Post by TravelforFun » Tue Jul 28, 2020 10:01 pm

Marche24 wrote:
Thu Jul 23, 2020 1:12 am
Idea: Unlike other retirement accounts (e.g. 401K), money inside a Roth IRA is not locked away until retirement and you’re allowed to withdraw up to the amount you’ve contributed to your Roth IRA at any time, and for any reason, without tax or penalty. Instead of keep trowing money into my money market account at 1% interest rate, my idea is to start maxing out my Roth IRA (wife will have her own) and investing that money in a fund that tracks the SP500 and hopefully get bigger returns. Why? To retire early. With the Roth IRA I have access to my contributions at any time, so if X years from now I contributed $150K and those $150K can cover my expenses for 2-5 years I could withdraw (sell shares) my contribution ($150K) and retire 2-5 years sooner because my money is not "locked" until I'm 59.5 years old like a 401K. Once I'm 59.5 years old I can tap into my 401K and the gains from the Roth IRA. Why do it this way? Will have bigger gains investing than in a money market account

Thoughts?
You can do it but that's not a good idea. People put after-tax money into a Roth with only one purpose: to allow it grow tax-free for as long as possible. If you put money in a Roth then withdraw the contributions, you essentially kill the goose that lays the golden eggs.

TravelforFun

lakpr
Posts: 5744
Joined: Fri Mar 18, 2011 9:59 am

Re: Roth IRA Idea: Burst my bubble

Post by lakpr » Wed Jul 29, 2020 7:56 am

Marche24 wrote:
Tue Jul 28, 2020 9:57 pm

I've been searching and stumble upon the NJ Tax Division retirement guide (https://www.state.nj.us/treasury/taxati ... -Guide.pdf) which directs you to IRA Withdrawals Bulletin (https://www.state.nj.us/treasury/taxati ... e/git2.pdf)
<<snipped for brevity>>
I guess this is what you are referring to as proportional withdrawal?
Yes, that's what I mean. I believe the reason the NJ-1040 form worksheet has the "First year of withdrawal" and "subsequent years of withdrawal" fields is to track how much of the contributions remain in the Roth IRA.

Continuing with my previous example of $60k contributions + $40k growth, and a $10k withdrawal for emergency, if you make another $10k withdrawal in second year, but due to market growth the portfolio value is now $93k, say, the proportional withdrawal calculations go like this:

Contributions to Roth left = $60k - $6k withdrawn first year = $54k
Growth = $93k - $54k = $39k
Proportion of contributions to growth in the account = $54k : $39k = 58:42
Tax + penalty accrues on 42% of $10k = $4200.
NJ-1040-Instructions wrote:...but the base for each item changes to take into account the fact that both taxable and excludable (nontaxable) amounts have been withdrawn from the account."

Topic Author
Marche24
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Re: Roth IRA Idea: Burst my bubble

Post by Marche24 » Sat Aug 01, 2020 2:10 pm

So I guess I'm better off just investing thru a brokerage account and paying capital gains instead of tax+penalties from a IRA.

MathWizard
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Re: Roth IRA Idea: Burst my bubble

Post by MathWizard » Sat Aug 01, 2020 2:17 pm

No bubble to burst. You have a solid plan

If some years you cannot fully fund Roth, and you have a large Emerg. Fund, fund it with EF and replenish the EF.

You only can put a limited amount into Roth. It may seem like a huge amount now, but I have over $100K in taxable that I wish I could get into Roth. Towards the end of your career you will most likely be making the most so that you will be able to put more aside for retirement than allows in tax advantaged, and you will be the highest tax bracket you will ever be in.

Getting the money in Roth as soon as possible is a great opportunity.

lakpr
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Re: Roth IRA Idea: Burst my bubble

Post by lakpr » Sat Aug 01, 2020 2:27 pm

Marche24 wrote:
Sat Aug 01, 2020 2:10 pm
So I guess I'm better off just investing thru a brokerage account and paying capital gains instead of tax+penalties from a IRA.
You can always settle in any other state than NJ :) No one is saying you MUST do your early retirement in NJ.
You can still follow your Roth conversion ladder plan.

If you intend to settle and retire in NJ, then simply don't do any withdrawals from any Roth IRA or Roth 401k either, until age 59.5

Robert20
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Re: Roth IRA Idea: Burst my bubble

Post by Robert20 » Sat Aug 01, 2020 7:32 pm

lakpr wrote:
Thu Jul 23, 2020 6:34 am
What state are you in? I may be about to burst your bubble.

New Jersey, my home state, does not recognize withdrawals from Roth IRA accounts like Federal does. Any non-qualified withdrawals from Roth IRA are treated as proportional withdrawals of contributions and gains. Not as withdrawals of contributions first.

So from years 1 through 10 you dutifully plow in $6000 per year, and in year 11 the value of the IRA is $100k with growth; year 11 you withdraw $10k for an emergency. Federal tax treatment says you owe 0 tax, as you certainly passed the 5-year rule and you certainly contributed more than $10k to the account, so it is a withdrawal of your earliest contributions.

NJ says not so fast; you contributed $60k, the gains are $40k, so the proportion of contributions to growth is 60:40. Therefore the $10k you withdrew is $6k return of contributions, $4k withdrawal of gains. Pay tax and penalty on $4k, since it is a non-qualified withdrawal.

TL DR: check your state laws
OMG. is this really true?.. What other states will have this clause?..

I thought Roth IRA is always TAX FREE when withdrawn...(after 59.5) or after 5 years..

lakpr
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Joined: Fri Mar 18, 2011 9:59 am

Re: Roth IRA Idea: Burst my bubble

Post by lakpr » Sat Aug 01, 2020 7:35 pm

Robert20 wrote:
Sat Aug 01, 2020 7:32 pm
OMG. is this really true?.. What other states will have this clause?..

I thought Roth IRA is always TAX FREE when withdrawn...(after 59.5) or after 5 years..
Yes it is true. Marche24 posted links to NJ Department of Taxation above -- so you can read and determine for yourself ...

New Jersey may be the odd state in this respect, but you must research your own state's laws to be absolutely sure. I just happen to be familiar with NJ laws because I live here ... probably retire here and die here (extended family lives here).

Topic Author
Marche24
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Re: Roth IRA Idea: Burst my bubble

Post by Marche24 » Sun Aug 02, 2020 11:15 am

lakpr wrote:
Sat Aug 01, 2020 2:27 pm
Marche24 wrote:
Sat Aug 01, 2020 2:10 pm
So I guess I'm better off just investing thru a brokerage account and paying capital gains instead of tax+penalties from a IRA.
You can always settle in any other state than NJ :) No one is saying you MUST do your early retirement in NJ.
You can still follow your Roth conversion ladder plan.

If you intend to settle and retire in NJ, then simply don't do any withdrawals from any Roth IRA or Roth 401k either, until age 59.5

I don't plan to retire in NJ but the idea of the Roth IRA was to have access to my contributions in case I need it (you never know) and with NJ law that ruins it., and having to pay tax+penalty in the event I want to withdraw money is a deal breaker specially when is with after-tax money. I already pay a lot in taxes, just to hand the government more.

Looks like investing in stocks directly thru a broker account and paying the 15% tax seem as a better option as I would have access to the money at any time. Anyone knows when do you pay capital gains? I suppose is when you withdraw them?

ralph124cf
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Joined: Tue Apr 01, 2014 11:41 am

Re: Roth IRA Idea: Burst my bubble

Post by ralph124cf » Sun Aug 02, 2020 1:13 pm

lakpr wrote:
Wed Jul 29, 2020 7:56 am
Marche24 wrote:
Tue Jul 28, 2020 9:57 pm

I've been searching and stumble upon the NJ Tax Division retirement guide (https://www.state.nj.us/treasury/taxati ... -Guide.pdf) which directs you to IRA Withdrawals Bulletin (https://www.state.nj.us/treasury/taxati ... e/git2.pdf)
<<snipped for brevity>>
I guess this is what you are referring to as proportional withdrawal?
Yes, that's what I mean. I believe the reason the NJ-1040 form worksheet has the "First year of withdrawal" and "subsequent years of withdrawal" fields is to track how much of the contributions remain in the Roth IRA.

Continuing with my previous example of $60k contributions + $40k growth, and a $10k withdrawal for emergency, if you make another $10k withdrawal in second year, but due to market growth the portfolio value is now $93k, say, the proportional withdrawal calculations go like this:

Contributions to Roth left = $60k - $6k withdrawn first year = $54k
Growth = $93k - $54k = $39k
Proportion of contributions to growth in the account = $54k : $39k = 58:42
Tax + penalty accrues on 42% of $10k = $4200.
NJ-1040-Instructions wrote:...but the base for each item changes to take into account the fact that both taxable and excludable (nontaxable) amounts have been withdrawn from the account."
This, among others, is why so many people vote with their feet after retirement. There are many other states that are more tax friendly to retirees.

Ralph

lionroar22
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Re: Roth IRA Idea: Burst my bubble

Post by lionroar22 » Sun Aug 02, 2020 1:31 pm

lakpr wrote:
Sat Aug 01, 2020 7:35 pm

New Jersey may be the odd state in this respect, but you must research your own state's laws to be absolutely sure. I just happen to be familiar with NJ laws because I live here ... probably retire here and die here (extended family lives here).
I concur with your "odd state" comment. I'm from NJ originally, and when I was living/working there my TSP contributions were not allowed to be state tax-deferred. To make matters worse, since I no longer live there, my eventual withdrawals will be taxed so I'll actually be taxed twice at the state level!

lakpr
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Re: Roth IRA Idea: Burst my bubble

Post by lakpr » Sun Aug 02, 2020 3:07 pm

Marche24 wrote:
Sun Aug 02, 2020 11:15 am
Looks like investing in stocks directly thru a broker account and paying the 15% tax seem as a better option as I would have access to the money at any time. Anyone knows when do you pay capital gains? I suppose is when you withdraw them?
In NJ, all capital gains, short-term or long-term, are taxed as ordinary income. Again, no equivalency to the Federal taxation schedule of 0% capital gains tax rate for 12% bracket filers.

Yes, you pay the capital gains taxes when you sell the holdings. Assuming you are talking strictly the case where the holdings have been held at least for one full year, the tax-rates are 0%, 15%, 18.8% or 23.8% depending on your income.

lakpr
Posts: 5744
Joined: Fri Mar 18, 2011 9:59 am

Re: Roth IRA Idea: Burst my bubble

Post by lakpr » Sun Aug 02, 2020 3:15 pm

ralph124cf wrote:
Sun Aug 02, 2020 1:13 pm
This, among others, is why so many people vote with their feet after retirement. There are many other states that are more tax friendly to retirees.
Just to set the record straight: NJ provides an exemption of $100k income free from state taxation for retirees (but you have to be 62 or older). Go even one dollar more than that, then your entire income becomes subject to ordinary income tax schedule.
Traditional 401k/IRA withdrawals count, if you meet the age limit of course.

https://www.state.nj.us/treasury/taxation/njit7.shtml
https://www.state.nj.us/treasury/taxati ... e/git1.pdf

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