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Thoughts on financial independence

October 30, 2017

Despite the fact that early retirement isn’t our plan, I’ve been on a little bit of  an obsessive Financial Independence kick lately.  Early retirement and financial independence are two different goals, but the methods of getting there are both pretty similar.  I can tell you exactly why I’m getting fixated on this right now, but that is a post for another day.

First, I wondered what our life would look like without my salary. I knew we would be able to withstand it and live on one income, but didn’t know what that really would look like.  Would we be able to save?  Would we have to cut back on our extravagances?    After running through the math, things are looking surprisingly good.  We could still max out T’s 403b or 457b, as well as bank some cash and/or do some mortgage prepayments each year.  This includes a generous 1% per year home maintenance budget, mostly because I project we’re likely to want to spend that in our first 10 years of ownership.  We won’t have the speedy savings growth we have at with two incomes, but it is perfectly adequate.

Once I’d determined we could indeed afford to add to tax-deferred accounts, I worried that we actually are going to end up with more money in tax advantaged accounts (that we can’t access until we are 60) than we could possibly spend from age 60.5 until end-of-life. This is actually quite likely, even if we stop contributing entirely.  This concern sent me down a rabbit hole as I debated if we should be focusing more on taxable investments (even though we have tax-deferred room available).  The short answer is we absolutely should not leave tax advantaged space on the table.

Here are a few things I learned:

  • Getting money out of retirement accounts: There are ways to access money in normal retirement accounts (401k, etc.) before you are 59.5 through Roth conversions, SEPP/Rule 72t, or even just paying the penalty.   This is important to know if you worry if you are over-saving for retirement.
  • Tax impacts of required minimum distributions are something I have not yet considered.
  • 403b vs 457b #1: For those with access to both a 457b and a 403b, a 457b allows you to take out money at any age if you no longer work for a place providing a 457b. You have to pay taxes when you withdraw (of course), but there is no 10% penalty.
  • 403b vs 457b #2: Non-profit 457bs are generally owned by the employer and subject to creditors in case of bankruptcy.  Government 457bs are held in trust for the employee/participant. On the other hand, all 403bs are owned by the participant (not the employer). So, there is some risk in non-profit 457bs, and that is worth being aware of if you have this type of account.
  • 403b vs 457b #3: If you decide to work through your 60s/70s, you cannot access money in a 457b until you are 70.5.  This is only an issue if you don’t have other accounts that will be available around age 60. Plus, you are still working in this scenario, so you shouldn’t need the money yet!  The end result of this is that we should favor a 457b over a 403b, despite misleading brochure information from T’s employer deeming the 403b to be the more flexible option.  Only true while you are still working for the employer!
  • Roth IRA/401k vs other options:  I’m still wrapping my head around this one.  This post from Mad Fientist indicates you should always fill up your tax-advangated accounts before investing in taxable accounts, and even before investing in a Roth. Paying the 10% penalty does better than a taxable account!  There are assumptions about tax rates and timelines here that are important to understand the nuances of.  I’m still puzzling this out, since most PF bloggers prefer a Roth.  Maybe a Roth is still more advantageous if you are not trying to retire early.  Early retirees generally have higher tax rates while working compared to while retired.
  • FAFSA/CSS considerations for college:  If you have kids, private colleges use something called a CSS and consider home equity in financial aid calculations.  If we are successful at having kids, this could affect long term plans.
  • Social security: I also learned how social security benefits are calculated, in case that might be around and available to us at some point in the distant future.
And a few things I learned about our own situation:
  • If I understand it correctly (which I probably don’t since I have done very little research and the plan is not detailed yet) Trump’s tax plan could cost us ~$9k in 2018 in an extreme scenario. This could change our strategy next year.  I am patriotic so I don’t mind paying taxes, but I don’t like my taxes to be increased in order to give corporations and the wealthy a break.  I await the details of how the State and Local Taxes deduction will be changed, and might pay my February tax bill early if it changes unfavorably.  (I’d have to ensure we wouldn’t be subject to the AMT if we did that.)  By the way, California is already a donor state, so my high state taxes are not being subsidized by low tax states.
  • I can see an argument for a higher standard deduction and removing some deductions (which we call “loopholes” if someone else is taking them) to simplify the tax code.  I don’t understand the wisdom of collapsing the personal exemption into the standard deduction.  This will impact families with kids, and the only reason I see for doing this is so they can claim “we are raising the standard deduction from X to Y” and have the difference between X and Y be larger.
  • Living one income is totally doable without lifestyle sacrifices. This does assume our mortgage recast and tax laws roughly similar to current ones, but there are enough knobs to turn if any of these assumptions turn out to be false.
9 Comments leave one →
  1. October 30, 2017 2:50 pm

    I think most of PF/FI blogosphere likes Roth because the folks like front-loading work and delayed gratification. An “I won’t even have to worry about taxes in retirement” sort of thing.

    • October 30, 2017 3:25 pm

      Makes sense! Sometimes I can override those compulsions with logic and math, but I totally get those types of decisions.

  2. October 31, 2017 6:01 am

    My thought on the Roth preference for pf bloggers is that the only way that very high income people can get any tax advantage from the IRA is by rolling over a non-tax advantaged traditional IRA into a Roth, BUT you get taxed on the entire amount that you have in the traditional account, so if you’re high income and want to max out tax-advantaged savings, it makes sense to have all your IRA accounts in Roth (including 401k that have been rolled over).

    Plus the income limit is higher for tax advantages for the Roth for people who still qualify for an IRA, so it’s likely that some of the bloggers can’t get a tax advantage from a traditional IRA but still can for the Roth.

    I have no explanation for why they might prefer one over the other in a 401k.

    We do 50/50 on the Roth/Traditional in our 403(b)– my thought is that tax rates will be higher in the future because we’ll need to pay down the national debt when I’m in retirement. Then I went to a talk that said that the US could renege on the Roth promises in a few decades (!) which was something I’d never thought of because I always trusted the government’s promises to older people. So we 1/n it and put half in each. When DC1 is a junior in high school we will revisit that to make sure we’re doing what is most beneficial for CSS calculations.

    • October 31, 2017 9:57 am

      That does make a lot of sense. And, since the contribution limits are the same, you can effectively put in more with a ROTH method because an already-paid-tax dollar is worth more than a pre-tax dollar.

  3. October 31, 2017 9:21 am

    The PF bloggers who prefer a Roth are generally speaking from an educational perspective. To take the full Traditional IRA deduction in 2017 if you also have a retirement account available through work, your MAGI needs to be below $62,000 single or $99,000 MFJ. The Roth IRA income full limits on the other hand are $118,000 single or $186,000 MFJ. Many personal finance blogs aren’t written for people making less than $62,000 single – they’re written for people with plenty of money to save who are using their money inefficiently.

    Roths are seen as exciting too because you never pay taxes on the money, so it can grow from say age 20 to 60 and you won’t pay taxes. If you’re in the lower tax brackets, then the tax deduction of the Traditional IRA isn’t nearly as useful as it is in higher tax brackets. Also, people count it as getting more money into a retirement account now if it’s in a Roth account versus a Traditional one.

    I feel like it is so complicated to know what is actually better that I’ll take the tax savings now and worry about what comes out later.

    Yay I’m glad you figured out you could live on one income! I feel like the main roadblocks for that in our case are psychological and less money or lifestyle sacrifices… I say that because that’s essentially what we are doing now. I feel like we should make more lifestyle sacrifices than we are, but my husband doesn’t think we should, probably related to the fact that he never saw my income before, so he doesn’t fully realize how much our income dropped this year.

    • October 31, 2017 10:01 am

      That’s true regarding the MAGI and limits.

      I agree it is complicated, but the good news is that as long as you save, you are doing something good. Optimal is harder to achieve, especially with that pesky future being unknowable.

      Re one income – It has been more of a question of “under what circumstances / for how long” than whether it was possible, but glad that the answer is roughly “indefinitely”. Although we would have to make more sacrifices if it were just my income, that is an invalid scenario because we’d most likely move entirely if T’s job doesn’t work out. Indefinitely is also an invalid scenario… but a good bounding one!

  4. November 1, 2017 4:58 pm

    I’ve always leaned towards the traditional IRA because it wasn’t until we were married that I could actually afford to contribute anything and by that time, we were phased out of the Roth. And now our income is high enough that paying the tax bill at our probable peak tax liability point makes no sense. When we’re taxed on our distributions, our income is likely going to be lower than it is when we’re both fully employed. At least that’s what makes sense for us.

    With our new mortgage, I’m really antsy about the fact that we couldn’t survive on just one income and that’s stressing me out a lot but I’m trying to make myself settle down. I’m doing the best I can with the knowledge I have and we’ll get out of this hole as soon as possible.

    • November 1, 2017 5:24 pm

      When we first bought our house, it would have been tight to survive on just T’s income and maintain any forward savings. With raises, prepayments, and savings, we are finally back at a place that I’m much more comfortable with.

      Making big moves is stressful, but you got out of a bad living situation, and you’ll get where you want to be soon enough!

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