Too much retirement account vs taxable for early retirement?

[Dicast]

I've been running though a thought experiment on my current household savings pattern.  We have focused on maxing out our retirement accounts and paying down student loans.  We are blessed with up to $120k of tax deferred retirement accounts per year which has got my mind thinking about whether it could be a problem to have too much tax deferred, specifically for the early retirement minded.  Soon enough we'll no longer have any student loans and will start building our taxable account.  If the tax deferred is receiving $120k a year and taxable maybe another ~$80k, is it possible that we'll have enough total to retire but have it poorly placed for withdrawing?  The goal is to be able to retire in 10 years at age 45.  Current stats have our retirement accounts at $450k, no taxable and student loans will likely be paid off in the spring.

[The White Coat Investor]

I wouldn't worry about it for two reasons. First, those who retire early almost always end up with a taxable account of significant size even if you can't see it coming for you yet and second, it's easy to get money out of retirement accounts penalty free for early retirement.

 

https://www.whitecoatinvestor.com/how-to-get-to-your-money-before-age-59-12/

[q-school]

as a data point, my financial guy says we are way too heavy in retirement accounts.

by virtue of not being big spenders, we have also managed to accumulate a fair amount in taxable accounts.  well, maybe not compared to the rock stars on this board, but for most normal 1%ers we are doing well.

i think your question revolves around if you choose to retire early how to bridge the years until you reach traditional retirement age.  there are potential solutions to this problem.  remember if you truly are retiring at 45 you will have opportunities to lower your tax bracket for many years potentially.

i second the esteemed wci in that i think you are overthinking it until at least 5 and probably 7 more years.

i know i'm this lonely guy on an island worried about early retirement (have you really considered all the attendant issues) but 45 is really young to take into account all the risks.    unless you don't have kids.  if you don't have kids, the possibilities are endless.

congrats on nailing the student loans down!

[hightower]

q-school, is your financial guy a fiduciary?  If not, it sounds like he may just want you to have more in taxable accounts so that it can be managed (for a fee) by him.  I used to have an advisor too when I first got out of residency and he wasn't excited about me putting money in tax advantaged accounts either.  One of many reasons why one should not use a non-fiduciary advisor.

[The White Coat Investor]

I would be very skeptical of an advisor who recommended a doctor invest in taxable when he still had tax-protected space available to him. If for no other reason than a doctor who retires early can do Roth conversions at a very low tax rate in early retirement.

[Hatton]

It is possible to do it all.  After your loans are paid off then start building a taxable account.  You should always max out your tax deferred space first! Since tax deferred space is limited and if you are a thrifty saver then your taxable account will dwarf your tax deferred account at some future point.  Right now you think you want to retire at 45 but you might reassess this as time goes by too.  Have you thought about eliminating what is bothering you about your job and maybe working part time? Maybe you don't need a financial advisor since you have been on WCI for a while now.

[antheus]

I think it all depends on your goals and expenses. If you wanted to retire at 40 and all of your money was tied up in retirement accounts that may be an issue because that's a pretty long time before you could have full access to it. As it is though you're planning to contribute 80k a year to taxable and 120k to tax deferred so as others have said I would anticipate you having a large taxable account whenever you decide to retire regardless of what you do. There's no substitute for running the numbers if it gives you peace of mind.

[The White Coat Investor]

antheus wrote:

I think it all depends on your goals and expenses. If you wanted to retire at 40 and all of your money was tied up in retirement accounts that may be an issue because that’s a pretty long time before you could have full access to it. As it is though you’re planning to contribute 80k a year to taxable and 120k to tax deferred so as others have said I would anticipate you having a large taxable account whenever you decide to retire regardless of what you do. There’s no substitute for running the numbers if it gives you peace of mind.

Click to expand...

Again, bear in mind what full access means. You can SEPP it, you can withdraw Roth IRA contributions, and you can pay the 10% penalty as the worst possible outcome.

Meanwhile, if you do max out tax-protected first, you get a tax arbitrage, tax-protected growth, asset protection, and the ability to do Roth conversions later. I just think that passing up on tax-advantaged space is often a mistake for someone who hasn't really thought it through and understands all the exceptions to the 59 1/2 rule.

But I agree that if you're putting $80K a year into taxable, you're likely going to have a taxable account large enough that you probably won't need to touch the retirement accounts before 59 1/2 even if you retire at 40-45. And that's the case for most early retiree physicians. They simply have to save more than they can fit into retirement accounts so the taxable account just magically appears and solves the issue (since you generally want to spend taxable money before tax protected money anyway.)

[jfoxcpacfp]

Our "loose" goal for clients is 1/3 taxable, 1/3 Roth, and 1/3 pre-tax at retirement. It's not set in stone, but it gives us something to plan ahead for and helps with making decisions. The earlier you decide on your target, the longer you will have to arrange your finances so as to meet it.

[PhysicianOnFIRE]

As WCI referenced, there are many ways to access that money early, some of which require nothing out the ordinary.

The value of all Roth contributions are available at any time without penalty. Conversions are available after 5 years.

457(b) money is available as soon as you leave your employer at any age.

401(k) money is available if you leave your employer in the year in which you turn 54.5 (or later).

If you're not interested in SEPP for an IRA, start a "Roth conversion ladder" and start collecting 5 years after starting it.

 

It helps to have some taxable money, but it's certainly not necessary.

[Donnie]

jfoxcpacfp wrote:

Our “loose” goal for clients is 1/3 taxable, 1/3 Roth, and 1/3 pre-tax at retirement. It’s not set in stone, but it gives us something to plan ahead for and helps with making decisions. The earlier you decide on your target, the longer you will have to arrange your finances so as to meet it.

Click to expand...

What is the rationale for that split?

[ajm184]

jfoxcpacfp wrote:

Our “loose” goal for clients is 1/3 taxable, 1/3 Roth, and 1/3 pre-tax at retirement. It’s not set in stone, but it gives us something to plan ahead for and helps with making decisions. The earlier you decide on your target, the longer you will have to arrange your finances so as to meet it.

Click to expand...

I have seen this goal stated previously, and I understand the approach is to provide options and reduce taxable income in retirement.  It seems to me there are several challenges (one of which you touched upon, time).  First perspective, during early career (say first seven to ten years), ideally you are saving in tax deferred and Roth IRA, paying off student loans, perhaps saving/purchasing a home.   Very difficult to balance these competing goals early on, given the income side is lower than mid and late career people usually.  Second perspective, from a tax perspective, tax deferred savings is very compelling with relatively high amounts that can be saved, tax-free retirement savings is less than 1/3 of tax deferred savings, and have some restrictions.  It seems to me that very high levels of income are required to achieve the goal, in that a person is using current income to a. convert a portion (usually fairly high amounts if they have saved consistently) of tax-deferred into tax-free and contributing to a taxable retirement account.

Can you add any color/example of planning/achieving this approach for your clients?

[jfoxcpacfp]

Donnie wrote:

What is the rationale for that split?

Click to expand...

I'm glad you asked. We have evolved into this split as we have progressed with physician planning, and it's more reasoning than science.  ajm184 mentioned s/he has seen that split, but I'm not sure where. We just started using it ourselves; perhaps I inadvertently copied someone else's idea  8O .

I'll do my best to summarize.

• We recommend clients have all 3 types of accounts at retirement. The emphasis depends upon the long-term goals.


• Many of our planning projections for physicians, particularly dual-physician couples, are showing RMDs of $500k+ at age 70.5. Assuming a 15% bracket followed by Roth conversions is probably not going to work for them. Our goal is to move away from pre-tax as feasible during the early years when the long trajectory makes it easier.


• We knew that we'd have to give clients a benchmark to plan for so we begin with a simple 3-way split, which we believe affords investors with a lot of flexibility during retirement and decumulation of their savings.


• We adjust depending upon the clients' goals and decumulation projections. For example, if passing along a tax-free inheritance is particularly important, we can plan accordingly, i.e.
  
  
  
  • convert larger chunks of available pre-tax funds during bear markets,
  
  
  • tilt more to Roth than pre-tax in 401k's, etc.,
  
  
  • focus on taxable to be inherited at a stepped-up basis.
  
  
  
  


• If the client's projections show low RMDs and a low tax bracket at retirement, we can tilt more to leaving pre-tax accounts intact.

We will use the 3-way split as a starting point as opposed to simply amassing assets to reach a certain number. This gives the clients a benchmark which we can follow and incorporate into the future plan.

Rather than zeroing in on a bond percentage, which we use only for specific purposes, we believe clients should first design their portfolios for maximum growth of wealth and second into sectors according to tax impact.

As I warned, not scientific, but financial planning is really more art than science.

[Donnie]

jfoxcpacfp wrote:

Donnie wrote:

What is the rationale for that split? 

Click to expand…

I’m glad you asked. We have evolved into this split as we have progressed with physician planning, and it’s more reasoning than science.  ajm184 mentioned s/he has seen that split, but I’m not sure where. We just started using it ourselves; perhaps I inadvertently copied someone else’s idea   .

I’ll do my best to summarize.

• We recommend clients have all 3 types of accounts at retirement. The emphasis depends upon the long-term goals.


• Many of our planning projections for physicians, particularly dual-physician couples, are showing RMDs of $500k+ at age 70.5. Assuming a 15% bracket followed by Roth conversions is probably not going to work for them. Our goal is to move away from pre-tax as feasible during the early years when the long trajectory makes it easier.


• We knew that we’d have to give clients a benchmark to plan for so we begin with a simple 3-way split, which we believe affords investors with a lot of flexibility during retirement and decumulation of their savings.


• We adjust depending upon the clients’ goals and decumulation projections. For example, if passing along a tax-free inheritance is particularly important, we can plan accordingly, i.e.
  
  
  
  • convert larger chunks of available pre-tax funds during bear markets,
  
  
  • tilt more to Roth than pre-tax in 401k’s, etc.,
  
  
  • focus on taxable to be inherited at a stepped-up basis.
  
  
  
  


• If the client’s projections show low RMDs and a low tax bracket at retirement, we can tilt more to leaving pre-tax accounts intact.

We will use the 3-way split as a starting point as opposed to simply amassing assets to reach a certain number. This gives the clients a benchmark which we can follow and incorporate into the future plan.

Rather than zeroing in on a bond percentage, which we use only for specific purposes, we believe clients should first design their portfolios for maximum growth of wealth and second into sectors according to tax impact.

As I warned, not scientific, but real financial planning is more art than science.

Click to expand...

Thanks, that's helpful.  I always thought the basic strategy was to max out tax advantaged retirement and HSA accounts, contribute to 529 in some amount (I personally under fund, but that's a debate for another day!), the rest to taxable, and let the chips fall where they may according to income and savings rates.

Does the 33% strategy alter this approach?

 

[jfoxcpacfp]

Argh - I just wrote a beautiful response and WCI went offline when I hit   :x

You're right, the "chips" strategy is what most of us use (me, too, until recently). But, in my experience, by the time our clients reach age 70.5, they don't usually need much, if anything, from their IRAs. They resent being forced to empty their accounts and pay taxes on their distributions. Having 3 savings sectors to draw from in the earlier retirement years gives them more flexibility and also lowers their taxable distributions when they reach RMD stage.

Another criticism of the chips strategy is it is based mostly on a very short-term focus with a goal of maximizing deductible contributions. With an allocation to target for the long term, clients can make strategic decisions today by assessing future needs and costs. 1/3 each is just a starting point - there is no "right" or "wrong" amount as long as you are planning accordingly and benchmarking your progress toward your goals.