- In our eighth Households of FI touchpoint episodes, Kristi was successfully following the standard path with a six-figure job and keeping up with the Joneses but waiting to take a breath and enjoy life. After finding FI, she realized the money was no longer the goal but simply a tool.
- Kristi has been connected with Big ERN, from Early Retirement Now, and over several conversations, they discuss Employee Stock Purchase Plans, 401K contribution strategies, the phase of retirement, and more.
- While wealth accumulation is simple math, decumulation is more complicated so Big ERN created the ultimate safe withdrawal rate series.
- Some recent changes Kristi has made to her investments since starting her path to FI are moving from a Roth 401K to a traditional 401K and maxing her contributions out. She also moved her current balance and future contributions out of target retirement date fund and into an S&P 500 fund.
- While Kristi has the option to self-manage her 401K in a Schwab account which would give her access to a total stock market fund, Big ERN doesn't believe that the difference between it and an S&P 500 fund is minor. Expense ratios are a more important consideration. Moving from a 0.2% expense ratio to a 0.02% might be worthwhile, but leaving the money where it is fine when the difference is 0.01% unless it is an in-kind transfer or a quick process. Human Resources may know how long the process is likely to take.
- Kristi approached her HR department about making after-tax contributions so that she could do a mega-backdoor Roth conversion, but the HR department was not clear on how much she would be allowed to contribute. She found the ChooseFI community to be quite helpful for bouncing ideas off of.
- She's also interested in her company's Employee Stock Purchase Plan (ESPP). The advantage of it is that she can purchase stock at a 15% discount, but she will pay taxes on the discount and be required to hold the stock for two years.
- Such a purchase gives her investment a 5% per year boost, however, there's no diversification in purchasing company stock. Kristi's income, bonuses, and employment are all already tied to her company. That being said, Being ERN says he would probably still do the ESPP, although he would only keep two year's worth of money in the plan and then pull it out. After taking it out, it will be subject to long-term capital gains.
- The ESPP may have contribution limits, in which case she should make the additional contributions to her 401K and then do the backdoor Roth conversions.
- Big ERN likes to say don't let the tail wag the dog, meaning that asset allocation and expected returns should be the primary concern before tax considerations.
- Kristi has a difficult time determining exactly how much to contribute as her company does it by percentage and how bonuses are paid out. If she overshoots it, she could miss out on the company match in the last month of two of the year. Big ERN says some companies will do a true-up, or another HR term, where they will still contribute the match.
- Some who have access to a true-up prefer to contribute the maximum to their 401K at the beginning of the year so that their money is in the market longer.
- Those without a true-up need to be careful. Big ERN suggested Kristi could look at the minimum and maximum of her salary and bonuses to come up with a range. $19,500 divided by her maximum would give her a rough percentage to start the year with. Toward the end of the year, she will need to look at it again and make adjustments.
- Kristi also asked about Big ERN's thoughts on the stages of retirement, but she is most interested in the early retirement phase.
- Retirement is an uneven path. Health expenses may be higher before Medicare kicks in and there will be a boost of income once Social Security is received. How do you structure your withdrawals? What are the tax aspects? Which accounts do you tap into first? And what should the assist allocation be?
- Big ERN doesn't recommend 100% equities for people in retirement. 75% stocks and 25% bonds is a better allocation.
- Kristi will likely have to rely on more than just her taxable accounts during the early retirement phase. She could tap into her Roth IRA accounts as well which may get her to 59 1/2 when she could then begin withdrawals from her 401K tax and penalty-free.
- It's best to spread the tax liability as equally as you can due to our progressive tax system. Although trying to optimize taxes is important, safe withdrawal rate and asset allocation are significantly more so. Not all of the withdrawals in retirement are taxable. Some of the withdraw money is principal, which taxes were already paid on.
- Good tax planning versus alright tax planning in retirement probably doesn't make a significant difference.
- Kristi was also curious about when contributing to taxable accounts might be advantageous over continuing to fund retirement accounts for those who want to retire early. Big ERN thinks what there are cases when it might make sense, but for most people who can assume they will be in a lower tax bracket in retirement, it's better to fund retirement accounts.
- Previously, Big ERN had provided Kristi with a spreadsheet to use for determining cash flow issues before she turns 59 1/2 and model Roth 401K conversions.
- Kristi says that she has been participating in her company ESPP but hadn't sold any of the company stock until recently. She debated how much to sell and still has a lot remaining. Big ERN suggests that she could sell over a period of time to avoid any regret that might occur with a large price increase. However, there could be commissions associated with selling. As long as she's held it for more than two years, it's all subjective to long-term capital gains or will help with tax-loss harvesting. Low-cost shares with the highest capital gains should be deferred as long as possible.
- A little tax-arbitrage is the sell the investments with the highest cost-basis and lowest tax bill.
- Big ERN mentions that a lot of people have loss aversion but sometimes it's best to cut your losses, let it go, and take the tax benefit.
- Kristi has concerns about HSA rules changing after she's stashed all that money away and paying out-of-pocket for medical expenses. HSAs, however, have a triple tax benefit. there are no taxes paid on contributions, the money grows tax-free and comes out tax-free as long as it's used toward qualified medical expenses.
- HSA participants can save their receipts and allow the money to grow. Current or previous years' health expenses may be submitted for reimbursement.
- In the United States, rules tend to be backdated, so that if HSA rules do change in the future, the old rules will likely still apply to the contributions. Still, Big ERN suggests not letting the HSA grow to more than 15% of total net worth.
- It's important to note that not all target-date funds are the same. The closer the retirement date, the more conservative the fund is going to be. For most people, a total stock market or S&P 500 fund with a low expense ratio is good enough.
- Taxes shouldn't drive decision making. Make the best moves that impact you over the long-term. Buying a house for the mortgage interest deduction makes no sense for most people with the new higher standard deduction.
- When it comes to tax deductions, the point isn't o get a deduction just to get a deduction, it's to bring home more income
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