Early retirement is a dream for many Americans. In addition to saving aggressively and investing well, success depends on navigating pitfalls in the tax code.
If the IRA was a Roth rather than a Traditional IRA, then there would be no required minimum distribution and any distributions they elect to take should be tax free. Of course, this would be a much more favorable situation. The catch is that they would have had to use after-tax dollars to fund that Roth during their working years, or they would have had to convert their traditional IRA to Roth, paying taxes in the process.
Although it would depend on their tax rate during their working years, I suspect that it worked out fine to use a traditional IRA given the relatively low tax bracket they find themselves in during retirement. It wouldn't have made much sense to use after-tax dollars during their working years to fund a Roth given how they are not facing a high tax bracket in retirement.
The Roth vs. Traditional question could be a subject for an entirely separate article. Nick Maggiulli wrote an article giving his opinion on the issue that I remember reading a few years ago: https://ofdollarsanddata.com/roth-401k-vs-401k/
Thanks for that link to Nick’s article. My son recently asked me for advice on a Roth vs. a traditional 401k for his new employer, and I couldn’t decide which was better. I finally gave up and told him to just split his contributions 50/50 between the two. ¯\_(ツ)_/¯
When I quit my last job (early 2009), I rolled over my 401k into a traditional IRA. I didn’t have a Roth IRA at the time and there were no Roth 401Ks yet. I have slowly made Roth conversions over the past 14 years. The Roth is now 56% of my total in IRAs. For the most part, I have made conversions when I owed little income tax (offset by itemized deductions) or if they have been in the lower income tax brackets. One motivation is to reduce the size of RMDs in the future.
Ted Weschler was featured in a negative article a while back about how he converted his IRA to Roth and proceeded to compound it enormously.
So conversions and Roth contributions can make sense. But it really depends on individual circumstances. I think Nick’s advice makes sense overall.
I should have done Roth conversations like you the past 10 years since I was retired with little income and a low income tax rate, but my IRA was only like 10% of my total portfolio value so I kind of ignored it. Now I have to figure out how to spend the damn thing down without ballooning my tax bill. I’m currently loosely planning on just letting the IRA grow and not taking distributions until I hit the rmd phase, but also don’t want to leave it to the kids and create tax problems for them. These are trivial problems obviously and it’s silly for me to complain, but I do chafe under all the rules.
I’m so glad I put most of my work savings into a taxable investment account containing mostly Berkshire. Cap gain taxes on distributions are low (for now), and Berkshire is an efficient holding in a taxable account, as you know. I was always a bit leery of all the tax rules surrounding 401k and IRAs.
My daughter and son in law are a perfect match to your fictional couple right down to Austin residence. They are considering same from big tech names. Sent them your informative missive to aid decision. Her parents (us) are still working and her father under contract till he’s 71. Big difference between Boomers and GenX. They can’t wait to quit working while we enjoy contributing and adding value. It’s gotten much harder and weirder since Covid but we will finish out.
Nice article. This is pretty close to our situation, so it's good to see a "plan" that works out with a reasonable amount of spending and leaves a healthy cushion at the end.
Very informative! Thank you.
Would this game plan differ substantially if an IRA Roth is utilized instead of a traditional IRA? What taxes are we talking about at 75?
If the IRA was a Roth rather than a Traditional IRA, then there would be no required minimum distribution and any distributions they elect to take should be tax free. Of course, this would be a much more favorable situation. The catch is that they would have had to use after-tax dollars to fund that Roth during their working years, or they would have had to convert their traditional IRA to Roth, paying taxes in the process.
Although it would depend on their tax rate during their working years, I suspect that it worked out fine to use a traditional IRA given the relatively low tax bracket they find themselves in during retirement. It wouldn't have made much sense to use after-tax dollars during their working years to fund a Roth given how they are not facing a high tax bracket in retirement.
The Roth vs. Traditional question could be a subject for an entirely separate article. Nick Maggiulli wrote an article giving his opinion on the issue that I remember reading a few years ago: https://ofdollarsanddata.com/roth-401k-vs-401k/
Thanks for that link to Nick’s article. My son recently asked me for advice on a Roth vs. a traditional 401k for his new employer, and I couldn’t decide which was better. I finally gave up and told him to just split his contributions 50/50 between the two. ¯\_(ツ)_/¯
When I quit my last job (early 2009), I rolled over my 401k into a traditional IRA. I didn’t have a Roth IRA at the time and there were no Roth 401Ks yet. I have slowly made Roth conversions over the past 14 years. The Roth is now 56% of my total in IRAs. For the most part, I have made conversions when I owed little income tax (offset by itemized deductions) or if they have been in the lower income tax brackets. One motivation is to reduce the size of RMDs in the future.
Ted Weschler was featured in a negative article a while back about how he converted his IRA to Roth and proceeded to compound it enormously.
So conversions and Roth contributions can make sense. But it really depends on individual circumstances. I think Nick’s advice makes sense overall.
I should have done Roth conversations like you the past 10 years since I was retired with little income and a low income tax rate, but my IRA was only like 10% of my total portfolio value so I kind of ignored it. Now I have to figure out how to spend the damn thing down without ballooning my tax bill. I’m currently loosely planning on just letting the IRA grow and not taking distributions until I hit the rmd phase, but also don’t want to leave it to the kids and create tax problems for them. These are trivial problems obviously and it’s silly for me to complain, but I do chafe under all the rules.
I’m so glad I put most of my work savings into a taxable investment account containing mostly Berkshire. Cap gain taxes on distributions are low (for now), and Berkshire is an efficient holding in a taxable account, as you know. I was always a bit leery of all the tax rules surrounding 401k and IRAs.
Weschler’s response to the negative ProPulbica article
https://www.documentcloud.org/documents/20971124-ted-weschler-statement
My daughter and son in law are a perfect match to your fictional couple right down to Austin residence. They are considering same from big tech names. Sent them your informative missive to aid decision. Her parents (us) are still working and her father under contract till he’s 71. Big difference between Boomers and GenX. They can’t wait to quit working while we enjoy contributing and adding value. It’s gotten much harder and weirder since Covid but we will finish out.
Thank you for this great piece.
Well written and very informative (as usual). Thank you!
This is a fantastic piece. Thank you.
Enjoyed the timeline structure, is very unique from the generic retirement advice articles online with that level of detail
Nice article. This is pretty close to our situation, so it's good to see a "plan" that works out with a reasonable amount of spending and leaves a healthy cushion at the end.