Questions answered on retiring overseas and foreign earned income exclusion eligibility, using your tax refund thanks to the foreign earned income exclusion for a back door Roth conversion, and working abroad and contributing to a health savings account (HSA). Plus, should you contribute to Roth accounts, pre-tax accounts, or a brokerage account when nearing early retirement? Are substantially equal periodic payments (SEPP) from your retirement savings a good idea to bridge the gap between retiring early and age 59 and a half? And finally, is it ever a good time to time the market?
- (01:03) Can I Do a Backdoor Roth Conversion With the Foreign Earned Income Exclusion Tax Refund Overpayment? (Nash, Overseas)
- (05:53) Taxation When Retiring Overseas and Foreign Earned Income Exclusion Eligibility (Kat)
- (10:33) Can I Use HSA as an Investment Vehicle as an American Abroad? (Jeff, Overseas)
- (14:33) Mega Backdoor Roth or Brokerage for Early Retirement Savings? (Susie, Brookfield, WI)
- (23:04) Where to Contribute Savings for Early Retirement? (Gilbert, Los Angeles)
- (32:41) Am I A Good SEPP Candidate for My Early Retirement? (JP, Northern VA)
- (39:57) Clarification: FIRE and Social Security Calculation (Barbara, NE)
- (42:10) Is There Ever a Good Time to Time the Market? (Gary, El Cajon, CA)
It seems a number of our new YMYW listeners are working abroad or planning to retire overseas. Welcome, we’re glad you found us! Today on Your Money, Your Wealth® podcast 345, Joe and Big Al answer questions on eligibility for the foreign earned income exclusion, the ability to use the tax refund thanks to the foreign earned income exclusion to do a back door Roth conversion, and using a health savings account or HSA when working abroad. Plus, the early retirement spitball analyses in episode 341 were so popular that today the fellas will spitball some more of them for you. Are substantially equal periodic payments (SEPP) from your retirement savings a good idea to bridge the gap between retiring early and age 59 and a half? And finally, is there ever a good time to time the market? Visit YourMoneyYourWealth.com and click Ask Joe and Al On Air to send in your money questions. I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.
Can I Do a Backdoor Roth Conversion With the Foreign Earned Income Exclusion Tax Refund Overpayment? (Nash, Overseas)
Joe: “To the YMYW crew, I have recently discovered your podcast and I’m disappointed I didn’t find it earlier.”
Oh, I thought it was going to be, ‘I recently discovered your podcast, and I’m very disappointed.’
Al: And that’s why I’m writing it, because I need you guys to get off the air.
Joe: Very disappointing.
“I’m 41, married with a newborn son. We currently live overseas as American expats and I work for an American company. I’m expecting to qualify for the foreign earned income exclusion again for the year 2021. I estimate that my gross income for 2021 will be about $245,000, putting me in the 24 % tax bracket. Last year, I received a tax refund of about $15,000, due mostly to the foreign income exclusion.
“I would like to do something productive with that overpayment, since we really don’t need the refund. I have about $190,000 in an IRA that I would like to start converting to Roth. In addition, I’m also planning on a backdoor Roth 401(k) via after-tax contributions, which should be converted of about $30K. It’s my first year doing a backdoor Roth conversion after hearing this talked about on your show many times.”
Al: It might be the first last year.
Joe: Well, thank you for bringing it up once again.
“Are there any pitfalls I need to know about regarding these plans while using the foreign earned income exclusion? My line of thinking is that I’m getting a lower average tax rate. I should do some conversions from tax deferred to a tax-free account. I’m definitely up for any ideas that you guys might have for someone in my situation. Not looking for advice, of course.
Just starting the conversation. Some more info on my situation, if you need it: no house or mortgage, wife is not working, approximate net worth of $1.7 million. We own two old, beat up vehicles and have no pets, unless you count the army of dumpster cats that patrol the neighborhood.” Wow. Dumpster cats. “Appreciate your time, Nash”
Al: Nash, ooh. That’s a good name.
Joe: That’s a bad ass name. Nash. I’m gonna change my name to Nash.
Al: Are you Graham Nash? No, I’m just Nash.
Joe: Nash. I’m going to move to Nashville. All right. What the hell is this foreign exclusion income? What is he talking about here?
Al: Well, I guess he wants to know if there’s any issues with doing Roth conversions or mega backdoor Roths, I think, with the foreign income exclusion. Not that I’m aware of, Nash. It works just the same way. The foreign income exclusion is just an extra deduction that you get when you’re working—when you’re when you’re an American citizen working in a foreign country—and it’s, I don’t know, it’s about $105,000, roughly in that range, that you don’t have to count as U.S. income. And the idea is that you’re already paying tax in the country that you’re working in, so you don’t have to pay it again in the U.S. Now, of course, we know that the rule is such that when you do have income, any kind of income, no matter where you’re living outside the U.S., it’s still fully taxed in the U.S. You pay tax in the US, you pay tax in the foreign country, you get a tax credit in the U.S., generally, for the taxes you pay in the foreign country. But the U.S. kind of said, you know what? That’s sort of a complicated rule for most people, so we’re going to put in this foreign income exclusion. So, anyone that makes less than $105,000, you don’t even have to worry about it. Just pay the tax in the other country. But it doesn’t really affect the U.S. taxes, other than you’ve got an extra deduction. You can still do backdoor Roths, you can still do Roth conversions. It’s the same tax law.
Joe: So does the exclusion outweigh that the foreign tax credit if he’s in a higher income bracket?
Al: Usually the exclusion’s better, but I can’t say I’ve done that.
Joe: I guess my question is if he does a Roth IRA conversion that puts his modified adjusted gross income, does he fall into, you know what I mean, is it now like he doesn’t get the exclusion, he’s now on the tax credit?
Al: No, because the exclusion is based upon salary, earned income only. Yeah. Not modified adjusted gross income or anything like that.
Joe: All right. There you go, Nash. Thanks for writing in.
Taxation When Retiring Overseas and Foreign Earned Income Exclusion Eligibility (Kat)
Joe: Let’s go to Kat. “I have a question on retiring to another country and doing the taxes. The country we are moving to has a program that charges a flat rate of 10% on worldwide income for pensioners with residency. Please look at my example below and let me know if I’m figuring this out correctly.”
Al: OK, we’re ready, Kat.
Joe: “Provisional income, Social Security $30,000, pension $2,000, investment income $20,000 equals $52,000. I am not retirement age yet, so Social Security and pension are for my husband only. Since we file joint married, and the provisional income is over the $44,000 limit, my husband’s Social Security will be taxed at 85%, correct?”
Well, yes and no.
Al: The provisional income, of how you calculated it, I don’t think it’s quite right. You actually take half of Social Security, plus other income, to get your provisional income. I’m assuming that your husband’s Social Security—full Social Security—is $30,000, so you’d only take $15,000 and add it to the $2,000 and add to the $20,000. So, you’d get what would that be, about $37,000 provisional income, if I did this right.
Joe: Yeah, but up to a certain limit, it’s 50% tax, and then after that, it’s 85% tax. You would want to take an effective rate.
Al: Yeah, and that’s another good point. It’s not a cliff. In other words, if you’re a dollar over, if you’re $44,001, it’s just that $1 taxed at 85%, not the whole thing.
Joe: “So total, we would be taxed in the country we are living in. A 10% flat rate would $47,500 times 10% equals $4,750. We would owe, correct?”
Al: Well, depends upon the country. Every country has different rules on how they calculate income, so if this is, how you mentioned, as how the country you’re moving to is how they calculate income, then I guess that sounds right. But every country is different. That’s what makes international taxation pretty tough.
Joe: So, they’re looking at a flat rate of 10%. So, the flat rate of 10% would be on taxable income.
Joe: And so, you would look at what your taxable income is on your tax return. And she’s trying to figure out her taxable income, but she’s coming up with provisional income. I don’t know why she’s coming up with a provisional income when provisional income just determines how much your Social Security is going to be.
Al: Yeah, unless that’s what the other country calls it.
Joe: Oh, you know, why is because maybe the 10% flat rate is just on income, you know, Social Security and pensions.
Joe: Everything else is taxed differently.
Al: Although she’s got investment income of $20K, so I don’t know.
Joe: But 10% on worldwide income for pensioners.
Al: Yeah, for people that are retired, I guess. Anyways. Well, let’s do the second part of the question, then we’ll tie it all together.
Joe: All right, then the second part of the question:
“After we pay taxes in country we reside, we would finally, in the U.S., could receive a foreign earned income exclusion. Thank you in advance. Please let me know if I’m figuring this out correctly.”
Al: So, the second question, the answer is no. The foreign income exclusion is only for salary, except for other income. So, here’s the basic rules when you move to another country: you pay taxes in that other country, would how would they calculate taxes, right? So, it depends. Everyone’s different, right? But you’re also, as a U.S. citizen, you pay, you pay taxes on the same income, and U.S. has a worldwide income. In other words, no matter where you make the income, it’s taxable. So does this other country, according to Kat. Anyway, you pay the taxes in the country you living in, you do the same income in the U.S., but you get a tax credit in the U.S. for taxes that you pay in the other country. So, if the other country’s taxes are $5,000, and U.S. taxes are $4,000, you get a credit in the U.S. for $4,000, so you end up paying no tax in the U.S., you pay $5,000 to the other country. On the other hand, same example, $5,000 is your foreign taxes, U.S., is $6,000. You will pay $5,000 in the other country, you will get a $5,000 credit in the U.S., and you will pay $1,000 in the U.S. That’s basically how it works. It’s a little more complicated, but that’s the idea.
Joe: All right. Very good. Thanks for the question, Kat.
Can I Use HSA as an Investment Vehicle as an American Abroad? (Jeff, Overseas)
Joe: “Al and Joe. HSA question—not a Roth. A few weeks back, you answered some of my questions regarding living overseas and investing. Super helpful. I’ve had one additional follow up. Is there anything in the tax code that would prohibit Americans who live abroad from contributing to an HSA account? Their medical plan meets HSA eligibility as a high deductible plan into their plan as worldwide coverage, Cigna, including in the United States. I could not see anything in tax publication 969 that indicates we can’t. As always, your thoughts are much appreciated. We plan on using the HSA as an investment vehicle. We will be paying all medical bills with our US-based credit card while working overseas to keep track of medical expenses in U.S. dollars for later use, once retired, when we decide to pull the funds from the HAS. Kind regards, Jeff.”
Well, Jeff, if you’re not going to use the HSA funds for health purposes, you’re using it as a retirement play to get more money pre-tax into the overall plan, I think you’re totally fine. If you have a high deductible, eligible plan that your employer has overseas, I don’t see any reason why you wouldn’t be able to contribute to the HSA.
Al: And I’m not sure I know the answer to that one.
Joe: I don’t know either. But here’s my knowledge: if you have an HSA eligible plan, which he does.
Al: Yeah, I think that’s the that’s the most important thing. I think, this is now just a guesstimate, if you had a health insurance plan in a foreign country, I sort of doubt that would qualify, but maybe it’s a US company with foreign operations and it’s still a U.S. health insurance plan, maybe that qualifies.
Joe: Well, it’s a worldwide plan, Cigna.
Al: Yeah, which is also in U.S. So I guess, maybe so. I mean, I have read that you cannot do that working in a foreign country, but I think that was referring to foreign insurance companies, foreign health insurance companies. So, that would be my guess, too, I would guess, yes, but I don’t know that for sure.
Joe: Yeah. Sorry, Jeff. So, let’s assume that it’s a gray area. Right? He puts the money in. It’s going to grow. I mean, if he ever gets audited, he could say, ‘here, I have an HSA eligible plan.
Al: And he can say Joe and Al said it was okay.
Joe: And that he’s going to play this recording back—
Al: Keep this for the next five years.
Joe: —to the IRS agent that comes to Joe.
Andi: So Joe, what do you have to say to the IRS, right now.
Joe: All right. We’re going to take a break.
Alright so here’s the thing. On YMYW, Joe and Big Al can help you rough out some strategies to stretch your dollars from here to overseas to retirement, but obviously, you don’t want to base important decisions, or your entire financial future, on a spitball analysis and best guesses! Schedule a free financial assessment with one of the CERTIFIED FINANCIAL PLANNER™ professionals on Joe and Big Al’s team at Pure Financial Advisors to begin building a clear financial plan for your retirement. Like the YMYW podcast, this assessment is free. But unlike the podcast, a financial assessment is a one-on-one, comprehensive, deep dive into your financial life to help you make most of what you’ve got, based on where you’re at now, what you want to accomplish, and how much risk you want to take to get there. Click the link in the description of today’s episode in your podcast app to go to the show notes, then click Get an Assessment to schedule yours.
Mega Backdoor Roth or Brokerage for Early Retirement Savings? (Susie, Brookfield, WI)
Joe: We got Susie, writes in from Brookfield. It’s a city in Waukesha, Wisconsin. Waukesha. It’s one of my favorites.
Al: One of your favorites. Yeah, people love that name.
Joe: It is, yeah. Favorite beer: spotted cow. You know what? That is my favorite beer as well, Susie from Waukesha.
Andi: What happened to Coors?
Joe: Well, I mean.
Al: It’s hard to get that’s why.
Joe: It’s really hard to get spotted cow. My cousin kind of sneaks it in, he mails it to me.
“It’s brewed in Wisconsin, hope you’ve tried it, Joe?”
Absolutely. I love it. Thank you, Suz.
“Favorite drink is Tinos and Tonic. I have driven various Lexuses over the last 10 years, married, two kids in college, funded and had the best yellow lab. Love your podcast! Here’s the information: we are both 50 and we plan to retire from corporate America at the age of 55, when I qualify as retired for equity and retiree medical. Current balances are $500,000 after-tax, $3 million in pre-tax. That includes a $1 million estimate of a lump sum pension plan.
Annuity options that we are evaluating, but planning on taking the lump sum. Annual spending about $120,000 a year. We will have subsidized pre-65 health care at age 55, unless company takes it away in the next five years. So, fingers crossed that annual spend holds. No debt, but thinking about a second home in Florida in the next couple of years. We will have our highest taxable income this year: $465,000 dollars. As such, still shoveling money into pre-tax versus Roth, however, thanks to your podcast, I did my first $10,000 implant conversion last year to the top of the 24% tax bracket. Question: would you alter my plan to continue with pre-tax savings up to the limits and let the overflow go into a brokerage account? I have backdoor option, but limited to 16% of $200k. Husband is not sure, but if he has backdoor or not in his 403(b).”
Do you understand what she’s saying there?
Al: I think she’s talking about the mega backdoor.
Joe: “I have a backdoor option, but limited to 16% of $200,000.”
Al: I think replace the backdoor with… add the word mega. I have a mega backdoor Roth option limited to 16%. That’s what I think.
Al: I’m guessing. Which would be $32,000, if I’m understanding that right.
Joe: So, she talks in percentages, which is what you’re telling me. Instead of saying $32,000, she’s like 16% of $200,000.
Al: That’s what it says. I’m just doing a little math for people that don’t think that way.
Joe: “I will likely use my unvested equity income to live on the first few years, but will have 17 years of annual spending before RMDs are required before Social Security kicks in. So, I plan to take from pre-tax to bleed that down, to live on and still stay in that 22% tax bracket. Spitball away, please. T-Y.”
I’m guessing that’s—
Andi: Thank you.
Al: Yeah, it’s good guess.
Joe: All right. Okay, so, what do you think? What do they have in total? $3 million, right?
Al: Yeah, $3.5 million.
Joe: Most of it’s pre-tax.
Joe: So, they’re going to spend $120,000. Social Security is probably going to be $50,000. So, they still need probably 60-70 % coming from that. They’re in the highest tax bracket, $340,000 base, $75,000 bonus, $50,000 in options exercised. So, I like where she’s at, got a ton of assets, given where her living expenses are. I think retiring at age 55, they’ve got the health care kind of taken care of. If they separate from service at 55, you know, they have access to their retirement accounts, so that’s good. Would you do anything different, Big Al?
Al: Well, I mean, so if you think about the spending need of $120,000 and they get about $3.5 million, they’re retiring… when you’re going to retire at 55 and you got a 401(k), you want to work until you’re 55, and then, you retire and then you still keep the money in the 401(k), then you can actually pull money out and you pay tax on it, of course, but you won’t pay penalty.
So that’s one thing that, you know, they want to make sure they do because it looks like they’re probably going to have to withdraw from their pre-tax to make this work.
Joe: Well, yeah, it’s like a 3.5% distribution rate at 55. Until you’ve got to bridge the gap to Social Security, but given inflation, it’s still going to be, you know, plus tax, it’s still going to be around 3-4 %, right?
Al: Right. So, I think it works. I think you just want to make sure that you work till age 55 and then you retire and then you keep the money in the 401(k) so you can pull the money out if you need it out of 401(k) without penalty. I guess the question is, should you put the overflow into a brokerage account, I guess, versus doing the mega backdoor Roth? And I would say do the mega backdoor Roth as long as you can, because then you get the money into the Roth IRA, that seems like the better approach there.
Joe: Right. If you have the ability to, look, they’re making it $465,000 a year. Call it, they got $100,000 in taxes, maybe a little bit more, so they got $300,000, call it. If they pay $165,000, they only spend $120,000, they have $200,000 that they could save. So, what do you do with the $200,000? If you can put money into your 401(k) plan and you can still use the after-tax component up to the $58,000 or $60,000 roughly, then absolutely do that and then convert the after-tax dollars and put that into the Roth.
Al: Yeah, I would still do that.
Joe: Yeah, that’s your first. And then the other $150,000 that you have, then you would invest that into the brokerage account.
Al: Yeah. So, here’s my concern, and I don’t we don’t know enough to. This is just a concern. This what I would check, Susie if I were you, which is if you’re making $465,000 and you’re saying $340,000 base, $75,000 bonus, $50,000 stock option. So, we’ll take out the $50,000 options because that’s not really that’s income, you’re not really receiving the cash. So in other words, you’re making about $400,000, and I know you’re putting a whole bunch into the 401(k) and the mega backdoor, but are you really only spending $120,000? That’s what I would want to be careful of, because a lot of times when people come to their office and they say, ‘I’m only spending X number dollars’ and we do the math, we figure out, OK, what’s the gross pay? Take out the stock options, take out the taxes, take out the 401(k). All right. So, what’s left is $225,000 and you say you’re spending $120,000. So in other words, you’re telling me you’re saving $100,000 a year, and the people go, mm, not really. So that’s the math you have to go through. Make sure that $120,000 is a good number.
Joe: Right. But she said, this is our biggest year ever, highest taxable income.
Al: Yeah, I understand.
Joe: So maybe it’s the bonus, the option, the $340,000 is the base, but yeah, because if you’re planning $120,000 and you’re spending $200,000, the numbers don’t make sense. Because you’re super close right now, Susie, so if you’re going to retire at 55, you’re at $3.5 million, not excluding tax. We would probably want to see that a little bit lower, but they still have five years to retire and they’re making a ton of money as long as they can… But the market can turn, too, I don’t know how it’s invested. You lose 20 %, and then you’re kind of like,
oh boy, here we go.’ So, you’re close. Great job. Spitballing is just making sure that you’re fine tuning it. That’s all I got for ya.
Where to Contribute Savings for Early Retirement? (Gilbert, Los Angeles)
We got Gilbert, who writes in from Los Angeles. He goes, “Hi, I love your show. It’s the first podcast I listen to when it shows up in my podcast queue.”
Bam! Thanks, Gilbert.
“I drive a 2011 Infiniti G37. It’s only the second car I’ve owned because the last car I drove for 20 years.”
Infiniti G37, that’s a pretty cool car.
Al: Yeah, it’s close to my car. I got an M37.
Joe: Oh gee, it’s faster.
Andi: Look at them all. They’re all gray, silver and black.
Joe: “My wife and I are 51 years old and planning on retiring when we turn 55.”
Oh, this is the second 55.
Al: Yeah, I like it.
Joe: “We have about $3 million in 401(k) plan, $1 million in traditional IRAs, $300,000 in Roths, $200,000 in brokerage accounts, $200,000 in savings accounts. All right, so that’s 3…4…
Al: $4.7 million.
Joe: “Our mortgage is nearly paid off and we have no debt. We will use about $150,000 of savings account in the next year or so to do a kitchen remodel, so that will suck up much of our cash.”
Al: We’re going to lower to 4.5 now.
Joe: “I believe we will have plenty to cover retirement expenses of approximately $120,000 a year, as we will collect a $50,000 a year pension at 55 and $90,000 in Social Security when we turn 70. That includes the fact that we will stop working at age 55. The shortfall: we will draw from our retirement accounts, which are currently allocated 75% equities, 25% bonds. Our current income is $360,000 a year, and we currently max out 401(k) contributions, $52,000, including the catch-up contribution in each HSA account, but I was wondering if we should only contribute enough to get the company match and put the rest of the money into a brokerage account, for tax diversification for the next four years? I hesitate to make Roth 401(k) contributions or conversions right now because my thought is that we should try to accumulate in our after-tax accounts right now. I’d love to know your thoughts, thanks.”
OK. Here’s my quick thought. So Gilbert’s jamming a ton of money in. He’s got $4 million in pre-tax accounts, so that’s a ton of cash that is going to be subject to income tax down the road. And he’s realizing that even though he does have $4.5 million roughly, that 90% of it is pre-tax and he needs a little bit more diversification. So instead of maxing out the 401(k) plans, as he is doing right now, he’s saying, let’s just go to the match, and then from there, stop putting money in pre-tax and put money in after-tax. So, if you have money and after-tax dollars, Gilbert, when you sell those dollars, they’re going to be taxed at a capital gains rate. In most cases, it’s going to be lower than ordinary income. So, sure. I mean, I like capital gains versus ordinary income, but you’re not getting a tax deduction by putting the money into the brokerage account. So, with that same thought, would you rather have the money sitting in a Roth account that would grow 100% tax free? Again, you don’t get the tax deduction, just like you didn’t get the tax deduction by going into a brokerage account, but your Roth account will grow tax free, versus a brokerage account will be taxed at ordinary income rates. What would you rather have? I guess that’s the first question. And I’m sure he’s going to say tax free. But then he’s going to be like, well, Joe, I need access to the money.
Al: Yeah, I got four years where I don’t have enough money.
Joe: Right. So what’s the answer? FIFO tax treatment. So, it’s first in, first down in all Roth IRA, so if you make contributions, you get your contributions out at any age, tax free. So that could be an option. So even if he’s going to take the money out of the Roth prematurely, it’s still going to be… if he has room that he could put money into the Roth. I like that option a lot better.
Al: Yeah, you almost always do that, and you’re right. So when it’s a contribution, so a 401(k) Roth contribution, it simply means that those dollars you’ve already paid tax on, so you can withdraw them any age next day, whatever. There’s no tax to pay, but I think the smartest thing is, yeah, I agree with you, jam up your Roth as much as you can, but for the next four years, as long as you retire at age 55 and have a 401(k) plan, you can withdraw money out of the 401(k) to cover your expense needs right for the next four years without penalty. I think that’s what you’re worried about is the tax penalty, probably, til 59 and a half, you can withdraw that money out of the 401(k), you’re going to be in a low tax bracket anyway. You probably could also do Roth conversions along with withdrawing to pay for your living expenses because you’ll be in a low enough bracket, and then then that seems to be the best of all worlds to me.
Joe: So he’s like, “you know, I hesitate to make the Rod 401(k) contributions or conversions right now, because my thought is that we should try to accumulate in our after-tax accounts right now. Love to hear your thoughts.”
I guess I would want to know more. I would say, Gilbert, why? You know what I mean? Why do you want to grow that account versus a Roth account?
Al: Yeah, I think he’s thinking he’s only got$200,000 outside of retirement accounts, and that’s all he’s got to work with over the next four years before he hits 59 and a half.
Joe: Or maybe he understands the tax rules, but here’s another weird thing that people do with their money. Is that if it’s a retirement account, psychologically, they’re like, I don’t want to touch this money. That’s why they deplete cash, they deplete like their brokerage accounts first, and then because they’ve always been taught to defer, defer, defer, defer, right? Don’t touch that money until you absolutely have to. It’s always thinking, well, maybe I need to have a little bit more of a piggybank here, a little bit more of a nest egg that’s outside of my retirement accounts. I would say, Gilbert, don’t worry about that. Money is money. It’s just taxed a little bit differently. And depending on the type of account, you have certain restrictions, depending on your age. But if you’re retiring at 55, you qualify for any type of distribution as long as you follow the rules.
Al: Right. And I think, so just kind of thinking about this again, if you’ve got $400,000 outside of a retirement account, you’re spending $120,000 a year, but you’re getting $50,000, so you’re really only spending $70,000 of your own money, right? So, really, I mean, even if you keep $70,000 just for a year’s of expenses just to be safe, you still have $330,000 to work with. And if you need $70,000 for the next four years, there you go. You’ve got it. So now, you don’t take any money out of any retirement accounts, you do big Roth conversions for this next four years, and you’re in a much better shape.
Joe: Yep. I agree, because he’s going to is going to be in a higher tax bracket, potentially in the future.
Al: Yeah, see, that’s the problem. You got $4 million in retirement accounts.
Joe: Plus $90,000 in Social Security, plus $50,000 pension. No debt?
Al: Can you imagine that? Let’s just look at the RMDs. The retirement accounts are going to be worth $10 million bucks at 72?
Joe: Could be.
Al: I mean, even $6 million, let’s just say $6 million. So, 4% of that’s $240,000. That’s your required minimum distribution, plus another $140,000 of fixed income.
Joe: So, you’re 350, right?
Al: Yeah. So, think about that. You want to get more money into the Roth as much as possible?
Joe: Yeah. If you cancel this thing out, Gilbert, I think you’ll realize that Roth is going to be a better play if you need more cash, you know, as an emergency or something like that, it’s available. So, Roth is always better in most cases because it compounds tax free, right? And you still have access to the money if you need it versus, you know, in a brokerage account, which is great, I like that too, I like the diversification aspect, but if I were to pick one or the other, I would go Roth all day.
You know, inflation is another important factor to consider as you’re determining where to squirrel away those dollars for retirement. How might rising inflation impact market returns, your investment portfolio, and your retirement plans? Is higher inflation likely, or is weaker economic growth a bigger risk to your portfolio? Get answers to these questions in our brand new white paper on Inflation and the Markets, available for a limited time in the podcast show notes at YourMoneyYourWealth.com. Click the link in the description of today’s episode in your podcast app to go to the show notes and download this new inflation white paper for free. While you’re there, check out the latest from the Your Money Your Wealth television show- it’s a can’t miss two-parter called Financial Planning Must Do’s Before You Retire. And if you like the podcast and the TV show and the free financial resources, why not share them?
Am I A Good SEPP Candidate for My Early Retirement? (JP, Northern VA)
Joe: “Hello, miss Andi. I hope you get paid extra for putting up with the boys.”
Al: Are we that bad?
Andi: I will just say that I knew what I was getting into when I signed up. So, it’s all good.
Al: I suppose, right?
Joe: “They can be a handful at times. This is JP from northern Virginia. I’m a WMWY new listener. Not much of a drinker, likes the water.”
Al: Mmm, water’s the best drink.
Joe: “My wife and I are 46 with $3 million in retirement savings accounts.”
I bet if he drank, he’d be worth $300,000. (laugher)
Al: There’s something to that. It’s like because of that, you can retire early.
Joe: “I’m seriously considering my options at retirement at age 50. I’d probably be looking at a 40-year retirement for planning purposes. The investments in my retirement account are currently 80% stocks, 20% bonds, all index funds, and seem to be growing at an annual rate that exceeds my $120,000 gross salary. If I’m already 72, I think my total RMD for the year would be closer to my current salary, and I’ve got 26 years of potential growth to come before those distributions kicked in.”
So pre-tax assets $2 million, pre-tax for 401(a) is $700,000. Roth IRA of $400K and a Roth 403(b) of $14K that he just started this year. No pension, no real estate beyond the primary residence. He’s got $1,000 in a brokerage account that he also just opened. A little bit of savings, nothing significant beyond the Household Emergency Fund. The wife doesn’t believe she has enough money saved for retirement, just over $1 million, nearly all pre-tax. She may also have a pension as a federal employee. Therefore, she’s thinking she’ll retire or she’ll work until she’s 55. She currently earns $180,000 annually, having surpassed my annual income within the last few years.
So he’s talking about his funds and then his wife has got an additional $1 million? Is that what you’re getting out of this? So he’s got 2.7 million…
Al: Let me add it up.
Andi: He says, “with $3 million in my retirement savings account.”
So yeah, it sounds like they’re separate.
Al: Yeah. If you add up his numbers, it’s over $3 million.
Joe: All right. And so she’s got another $1 million, which is $4 million.
Al: Yep. So it’s $4 million.
Joe: “RMDs aside, I think we’ll be OK. Once were 59 and a half, I’m just wondering if I can do anything else to take advantage of my retirement funds in the 10 years prior without significant penalties, like the 10% penalty for early withdrawal? Our outstanding expenses are the mortgage on our residence, $400,000, on pace to be paid off while we’re 59 and 60, and hopefully sending two kids to college. 100k already in 529 accounts, adding another $10,000 per year per kid. No plans to relocate or spend too lavishly once retired. So, am I a good candidate for SEPPs?” So that’s separate equal periodic payment he’s referring to.
“On the 72(t) calculations for generating income close to my current salary, give or take $20,000. Would pursuing SEPPs for 10 year really screw up my retirement savings for life after 59 and a half? Are my early retirement income options limited to savings and investing as much as I can for the next five years and Roth 403(b)s and taxable accounts?”
Joe: So, 46 and he wants to retire at 50. And she is going to work until 55. And how much are they spending?
Al: Well, he’s talking about the 72(t) election and take $20,000, and that generates income close to his current salary. So if that’s all you want…
Joe: He’s $120,000 salary. But here’s my point is that… OK, let’s first explain what a 72(t) tax election. It’s a separate, equal periodic payment. There’s three ways to calculate it. And basically, you can take money out of a retirement account in avoid the 10% penalty, but you have to take the same equal periodic payment out of the account for five years or till you turn 59 and a half, whichever is longer. So, if he turns 50, he’s going to have to run that calculation and take the same amount of money out of the account until he turns 59 and a half. So, he’s curious, do I do this? But I don’t think he has to. If his wife is still working… I guess are they running everything super separate? You know what I mean? I’m not a huge fan of those because you’re locked in until you’re 59 and a half.
Al: They’re inflexible.
Joe: Totally inflexible. The market kind of blows up. This happened back in 2000, when the dot com bust in all these dot com-ers kind of retired early, and they took a separate equal periodic payment. They’re in their late 40s, early 50s, and they have to take the same amount of money out each year, and it’s based on a formula, based on today’s value. And now you’re stuck pulling out $30K, $40K, $50K from the account and the market’s tanking. The last thing you want to do is sell securities. So, I’m not a huge fan of it, but it could work for you. I would just want to know what is your annual expenses? Does your wife cover it? You can stop saving as much money in the overall plans because you already know you have plenty of cash if you combine the two. She’s probably going to have a pension, then you have Social Security and everything else. I think you’re just mapping out the cash flows to figure out how much money does the household need to be saving? She doesn’t think she can retire. He wants to retire. They need to come together. I think it’s kind of back to: are you and your spouse talking about this as a collective?
Al: And so I’ll just quickly say, yeah, if you if your spouse makes enough income to live off of, then that will work ‘til her age 55, she would retire at age 55. She has, I don’t know what kind of retirement plan, but let’s assume it’s a 401(k) or something like that. So, if she retires at 55, then she could pull money out without a penalty. Maybe she pays the expenses for the first 10 years and then you pay the expenses for the second 10 years and you equal out. And, you might think about refinancing your mortgage to a 30-year, low payment, because you’re going to need low payments, for the next decade. And then maybe you could avoid the 72(t). Right? And then you just pay off the mortgage off later when you have the ability to pull the money out of the IRA.
Clarification: FIRE and Social Security Calculation (Barbara, NE)
Joe: “I heard on your August 31st podcast, those that FIRE before retirement age, you don’t begin taking Social Security until 67 or later, that their benefits are lower.”
I think Al said the caller $4,400 per month benefit would be more like $3,000. This person was currently wanting to FIRE at 55.
Al: Financial independence, retire early.
Joe: If this person has the 35 years, where did you read they would not receive their full benefit amounts? “Signed, Me, Future FIRE. Age 57. More than 35 years under her belt.”
Al: Barbara, you are correct. I mean, so in this example, if this person started working at age 20, right, and they retired at 55, they would have 35 years. But here’s the point, which maybe I didn’t make clear, what you make at age 20 is usually a lot less than what you make, what you would’ve made at age 56, 57, 58, 59 and so on. So, when you work till age 65, it assumes that you’re making that same higher salary that you’re making at age 55, all the way through to age 65. That’s why when you retire early, even if you have 35 years, then it tends to be a lower benefit.
Joe: Right. Because they’re also looking through inflation, too. So, they’re going to look at, you know, X amount of years, but they’re plugging in all of those years into their equation, all the way up to their full retirement age. So, if you retire at 50, you know, even though you might have 35 or 40 years of benefit, that collective benefit might be lower than if you were to work until age.
Al: Yeah, because they take your last year’s salary and they project that forward for the next, in this case, 10 years, and 11 years until full retirement age. So that’s why you tend to have lower benefits than what’s on the statement. Now, if you’re a child prodigy, so an actor, made a lot of money in your 20s then, sure.
Is There Ever a Good Time to Time the Market? (Gary, El Cajon, CA)
Joe: OK. Timing the market. Is there ever a time when it’s time to time the market? No. And that’s like a nursery rhyme. That’s quick. That was Gary from El Cajon.
Al: There’s never a time?
Joe: Never a time. Is there a time when the time is quite the time. All right. That’s it for us. Hopefully you enjoyed another episode. We’ll be back again next week. Show’s called Your Money, Your Wealth.
Percentages and beer – specifically, Spotted Cow and Sierra Nevada – in the Derails at the end of the episode, so keep listening.
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