So, you want to retire early. That’s great! It’s probably one of the best ideas you’ve ever had, so I commend you on that.
Saving up to retire early isn’t a goal shared by many people. So you might be surprised to learn that, for the few people looking to go whole hog in saving for retirement, there is a shocking variety of accounts to choose from! Once you decide to start keeping your money instead of spending it, where the hell are you supposed put it? Under a mattress?
Today we solve that dilemma!
But first, there are a few Golden Rules to follow when it comes to investing your nest egg responsibly that I assume you have to know:
- Buy hugely diversified mutual funds instead of individual stocks. (Something like VTSAX, Vanguard Total Stock Market Fund, and its international cousin VGTSX)
- Make sure those mutual funds charge very low fees.
Diversifying between stocks and bonds, international and domestic, and small and large companies is simple and pretty fun*. But one area I found myself lacking knowledge in lately was the difference between retirement account choices. IRAs, 401(k)s, Roths, 457s, SIMPLEs,.. There are enough acronyms to fill a letter factory!
So I made a little summary for myself of the common options:
||W/D Taxed As
||W/D Can Begin
||Penalty on Early W/D
||Immediate / 5 Yrs
||Age 59 1/2, with exceptions
||Age 59 1/2, with exceptions
||Ordinary, unless for Medical
||20% under Age 65, on non-Med
How many do you have access to? Well, I can tell you right now that you have access to a Roth IRA. Because everyone does. The 457 Plan and 401(k) Plan are only available through your employer. The 457 Plan is optimal for early retirement planners because it lets you withdraw before age 59.5 for any reason, without a penalty.
As for the Traditional IRA, you have access to that, too, because everyone does. But there’s a hook, and it always messes with my head: You can invest post-tax dollars and take a tax deduction for that amount, essentially making them pre-tax dollars, but only if you do not have an employer-sponsored retirement plan.
If you have access to a retirement plan at work, your available deduction for a Traditional IRA starts getting phased-out when your income reaches $52k for individuals and $83k for couples. Oh, and did I mention the $5,500 limit covers your Roth and Traditional IRAs together? The Traditional IRA seems to have the most annoying rules to deal with, but we’ll leave that aside for now.
We had been doing most of our retirement investing in Roth IRAs as a way to guard against tax risk. Our income was taxed at 15%, and by saving in a Roth IRA, we wouldn’t have to pay taxes on that money again. We don’t know the future, but I would be willing to guess that tax rates will go up at some point. And who knows what the income brackets will look like? By investing post-tax money, you eliminate your risk that future tax rates will be sky-high.
But I realized recently that sometime in the past few years, we had entered the 25% tax bracket! So by investing mostly in a Roth, we were essentially gambling that our tax rate in the future would be more than 25%. At this point, I kind of doubt that, and here’s why:
You see, since we manage to live well on only about half of our income, then in the future, if we are only withdrawing that money which we need from our retirement accounts to live on, say $50,000 a year, we will be in the lower (15%) tax bracket. Again, assuming all tax brackets and rates remain level.
So what was I supposed to do? Invest it all in my employer’s 457 plan, or Marge’s 401(k) plan? What about those fees! What’s the best option?? Where are the best returns??? I demand only the best retirement option!!! Continue reading