Anyone else dealing with this issue of "gap years" before retirement?

[Anonymous]

NP. I think the pp was referring to traditional IRAs and they certainly aren't a scam. They are actually really good if you are like most people and have a lower tax rate when you're retired. The pp is like a lot of feds, high tax bracket in retirement and large traditional IRA (TSP) balance. I'm in the same situation and have come to the conclusion that some Roth conversions make sense, but it's not exactly a slam dunk. I have a lot of cash currently, so that was definitely a factor in converting.

[Anonymous]

Anonymous wrote:NP. I think the pp was referring to traditional IRAs and they certainly aren't a scam. They are actually really good if you are like most people and have a lower tax rate when you're retired. The pp is like a lot of feds, high tax bracket in retirement and large traditional IRA (TSP) balance. I'm in the same situation and have come to the conclusion that some Roth conversions make sense, but it's not exactly a slam dunk. I have a lot of cash currently, so that was definitely a factor in converting.

We drew same conclusion about Roth conversions. For us, it makes sense to pay taxes in gap years (up to 22% bracket) so that we won’t pay in the very upper brackets that our RMDs are projected to be. You need to have cash outside of retirement accounts to do this though. For us, we’ll take each year as it comes and convert when we can. The key for us is to be flexible. If it makes sense, convert. If not, wait.

[Anonymous]

Anonymous wrote:

Anonymous wrote:Hey guys- there is simply no issue. You pay tax now or tax later. There is no "tax bomb" . Money in your 401K is just money you have never paid taxes on. The money inside your brokerage you paid taxes on it before you put it in your brokerage and you will also pay taxes on the gains.

Most people will be in a lower tax bracket when they retire (let's say you take out 200K a year when you retire but make $400K now). For the vast majority of high earners, it makes sense to shelter as much money from taxes now by putting it in your 401K so that the money can grow unencumbered. It doesn't actually make sense to save in a brokerage until you have maxed out your 401K.

This is definitely not true for people who will retire with pensions and relatively large social security benefits. My family, which is two government employees with relatively modest incomes (125K and 130K), will have enough income guaranteed between the two that we'll always at least land in the 22% tax bracket.

We have also already oversaved for retirement with 700K in retirement accounts at 40 (plus an additional 160K in brokerage and high yield savings accounts). Expected growth over the next 25 years, even with very conservative growth expectations, results in more money than we'd likely spend given our relatively modest spending and large amounts of guaranteed income.

All of this literally dawned on me in the last year so we're radically changing our plans to avoid OP's situation.
- We're doing in plan conversions in my old TSP account to get most of our money out of my Traditional TSP.* We want to minimize RMDs (and avoid paying taxes on money we're forced to withdraw but don't need), and it will be better for our kids to inherit Roth accounts. Plus having money in Roth accounts lets us retain control over the income we have in retirement and our level of taxation.**
- We'll leave some money in my Traditional TSP because we've always been charitably inclined and we can make contributions directly from our traditional accounts. We won't have to factor charitable contributions into our retirement budget, we'll likely be able to make more generous charitable contributions, and we'll skip paying taxes entirely.
- We are saving only in my new Roth 457(b) account. 457(b) funds can be withdrawn without penalty at any age so long as you've left your employer, so it's serving as our tax free brokerage account.
- We'll "retire" at 55 because there will be no point in working longer at the stressful and demanding jobs we currently have. We can do pro bono work, panel cases, or other work we truly enjoy if we want to keep working or if we need to earn a little bit of extra cash for extras above and beyond our normal everyday expenses. Otherwise we'll live off our cash, brokerage account, and my 457(b) account until 59½, likely fully depleting all of these accounts.
- At 59½, we'll start drawing from our retirement savings in decreasing amounts as we're able to access our pensions and social security benefits. Because we're only dependent on these funds for a short period of time, it will still be safe to withdraw more than 4%. We'll set aside the portion we need to use over the course of 10 or so years conservatively so that we don't have to worry about how the market is performing. We'll leave the rest of our retirement funds invested more aggressively for long term growth so we're not risking depleting everything.
- After we start receiving all of our guaranteed income, we'll drawn most likely less than 4% from our retirement accounts to cover any income gap, so this money will continue to grow without any risk of depletion. We will likely die with more money than we started retirement with.
- There are still many decisions we'll play be ear in this plan as we age. Maybe it will make sense to pay off our outstanding mortgage balance 4 years early at 55 to free up more spending in our budget. Maybe we won't want to wait until 72 to take Social Security because it will be better for us to claim early and reduce the demand on our investment accounts. Maybe we won't need to claim reduced pension benefits to allow for survivor benefits because there will be enough in retirement accounts to support the remaining spouse.

*One other warning as an FYI - it can actually be hard to out-convert a Roth account. If we waited until retirement, the Traditional balance would be much higher and with compound growth, the traditional balance would like grow faster than we can pull money out and stay within the 22% marginal tax bracket and faster than we can build up money outside of our retirement account to pay the taxes for the conversions. For example, I did a conversion earlier this year when the market tanked with the Straight of Hormuz mess and I was cautious and only converted 25% (37K) of what we can afford to convert this year (around 147K). Literally the day after I did the conversion, the market rebounded and the balance grew and it's as if I had never made a conversion at all. The Traditional TSP balance was back to what it was pre-conversion.

**Being able to control your income in retirement is so important - there are actually lots of "tax bombs" lurking, especially if you have a high minimum guaranteed income through pensions and social security. If we did nothing to minimize taxes, we'd have RMDs we didn't need to take, which would force us into higher income brackets, which in turn makes more of our Social Security taxable so we pay more tax on that. Which in turn makes our IRMAA Medicare costs higher. And then when one of us dies, we lose our married filing jointly status, have to file with the lower single deduction and we wind up paying that much more in taxes. I've read so many books and learned so much over the last year that I'm 100% confident that Traditional Roth contributions are a scam, especially if you'll have a high minimum income from pensions, high social security payments, and other guaranteed income (RMDs, annuities, rental income, etc).

Anyways, I really like personal finance (in a different world I would have been a financial planner), and the one thing I learned from readings lots of books about all these things is that this is what a good financial planner (ie one who doesn't just handle investments) is doing for you. They are helping you to figure out what's really going on with your money, and figuring out how to help you life both plan and live a great life. If this weren't my interest/hobby, I would have kept working until 65, always worried that I wouldn't have enough because when the only thing I know is the 4% rule, I would never have enough money.

Thanks for taking the time to write this. Super informative and helpful. Any recs for fee-only financial planners who are familiar with federal pensions? I’m not looking for anyone to help with investment allocations — more like the Roth conversions and tax planning you laid out here. It’s really hard to find.

[Anonymous]

Again this fear of RMD "tax bomb" is misplaced. They don't start until 75 now. The average life expectancy in the US is 79. You are paying a bunch more tax now to avoid some taxes for the last few years of your life.

[Anonymous]

Anonymous wrote:Again this fear of RMD "tax bomb" is misplaced. They don't start until 75 now. The average life expectancy in the US is 79. You are paying a bunch more tax now to avoid some taxes for the last few years of your life.

I expect to live a lot longer than 79. Both my parents are currently 86, I have multiple grandparents and a great grandparent that lived into their mid 90s, same for DH (his parents are slightly younger than mine but arguably healthier).

This info is very helpful.

[Anonymous]

Anonymous wrote:Stop putting your money into those accounts. Invest your own money in regular investment account.

It depends on how much they make. I'm still maxing out a regular 401k plus saving about 4x that amount in a brokerage per year to cover the gap years. I'm in the highest tax bracket, and if I'm working, I'm going to use whatever I can get to reduce taxes now and save more. I know there are ways to access retirement money early but I'm not overthinking that - will do it only if it's needed. Shouldn't be.

[Anonymous]

Anonymous wrote:Again this fear of RMD "tax bomb" is misplaced. They don't start until 75 now. The average life expectancy in the US is 79. You are paying a bunch more tax now to avoid some taxes for the last few years of your life.

I disagree. It’s different for all. For us, if we do Roth conversions we can pay almost 1M less taxes over the life of our estate. Plus, the Roth will be much friendlier for our heirs to navigate.

[Anonymous]

Anonymous wrote:

Anonymous wrote:Again this fear of RMD "tax bomb" is misplaced. They don't start until 75 now. The average life expectancy in the US is 79. You are paying a bunch more tax now to avoid some taxes for the last few years of your life.

I disagree. It’s different for all. For us, if we do Roth conversions we can pay almost 1M less taxes over the life of our estate. Plus, the Roth will be much friendlier for our heirs to navigate.

This is very much an outlier type situation if you are saving 1 mil in taxes. You must have 100 mil! For most people, Roth conversions aren't going to make that much of a difference, but advisors love to sell conversions because clients want to believe that their advisor is adding value.

[Anonymous]

OP- your RMDs won't be huge since it sounds like you will be drawing on your 401k/IRAs once you hit 59 1/2.

[Anonymous]

Anonymous wrote:

Anonymous wrote:We’re in this bucket, unfortunately. We maxed our 401ks in our 20s and are projected to have $12m+ at 55 (15 years from now). 40 and 45 now. The kids will be out of college when we are 55 and 60. A few changes I recently made:

- Drop 401k to just get the match
- Switched our 401k contributions to Roth 401k contributions
- redirect what we were contributing to our 401ks to my brokerage account
- look into the Rule of 55 - it allows you to tap your 401k balance at 55 instead of 59 from the employer you retire from.
- I plan on drawing down 401k balances for college funds, or repayment of our kid’s loans, since we have undersaved there. In an effort to reduce RMD before 73.
- haven’t yet, but will do Roth conversions after 55
- generally started living a bit more of a rich life - more family vacations now while our four kids are young

Very interested in other strategies too!

How exactly does a 401k get that high? You generally can’t put more than $15k per year and investment options are usually index funds. How did you have such smashing returns?

Someone else described it too. But probably close to 70k in 2 people maxing plus employer contributions. Add another 15k in backdoor Roth’s for 2, and 7k in an HSA, invested.

Plus we started investing right after 2008 so saw huge upswings in equities, the bulk of our portfolio.

[Anonymous]

Anonymous wrote:DH and I, late 40s, were both raised very middle-class. We have been able to save well and have been diligent about it, but we did not have any ideas about tax minimizing etc. We have been doggedly maxing out retirement and only after adding to a brokerage account. Champagne problems, I know, but now I discover that our retirement accounts are likely overfunded. And our brokerage fund isn't that big. So, if you add up our assets, we could probably retire in 5 years, but we can't really because all that money isn't accessible until 59.5. And then by the time we reach the age of RMD, the 401k balances will be huge and we will have to take large RMDs. We weren't previously thinking about retiring so soon or this would probably have been on our radar, but now it's just irritating that our total will be sufficient to retire but not in the right buckets.

I would love to hear any thoughts and also hopefully warn others who may be in a similar boat.

Roth Conversion - https://www.fidelity.com/retirement-ira/roth-conversion-checklists

Take out all Taxable before hitting SS or IRA

Mimimze Interest and NQ Dividends - Maximize Dividends and Capital Gains. Capital Gains up to 96,000 or so are tax free , this was simply amazing to me when it first happened

so it means beef up your Taxable Accounts so that you can defer Non-Taxable Accounts withdrawals , and keep working

[Anonymous]

This is a non-issue, but I see this problem here every so often. The key is Rule 72(t). Just google/AI it. It’s a section of the tax code that allows you to withdraw retirement money prior to 59.5 without paying the 10% penalty. However, there are stipulations, which are that you must draw the same amount of money each year for at least five years or until you’re 59.5, whichever is longer. Basically, it needs to be an annuity-type withdrawal. We setup a short-term, fixed-period annuity that pays us a fixed amount monthly, earns 5% interest, and ends at 59.5.

Separately, there are lots of other ways to use retirement funds before 59.5 and not incur a penalty. For example, you can pay college costs. We did that instead of a 529 plan.

[Anonymous]

We both retired at 55 about 5 years ago. Even though my spouse can withdraw from her 401k we haven't. Our rental income and brokerage account dividends covered expenses and we have not touched our 401ks/IRAs since retiring, even we now can without tax penalty. We paid off all the houses/rentals and have a decent amount in our brokerage by 55.

[Anonymous]

Anonymous wrote:This is a non-issue, but I see this problem here every so often. The key is Rule 72(t). Just google/AI it. It’s a section of the tax code that allows you to withdraw retirement money prior to 59.5 without paying the 10% penalty. However, there are stipulations, which are that you must draw the same amount of money each year for at least five years or until you’re 59.5, whichever is longer. Basically, it needs to be an annuity-type withdrawal. We setup a short-term, fixed-period annuity that pays us a fixed amount monthly, earns 5% interest, and ends at 59.5.

Separately, there are lots of other ways to use retirement funds before 59.5 and not incur a penalty. For example, you can pay college costs. We did that instead of a 529 plan.

I thought there was a 10% penalty for using it this way. How did you do it without the penalty?

[Anonymous]

Anonymous wrote:

Anonymous wrote:

Anonymous wrote:

This is a complete non-issue.

You can withdraw from your 401k for a 10% tax to compensate the government for your tax deferral. Since you're account is so huge it's obviously cheaper than if you had paid taxes and uses a non retirement vehicle.

You’re missing the point.

Not to mention that it's a 10 percent penalty on TOP of taxes. It's a big hit.

No, it's 10% to compensate for the tax deferral you already got.