It started with a couple of posts on The Wealthy Accountant.
These are articles that are worth reading in their entirety, but caused me to reconsider what was previously an unyielding vote in favor of pre-tax contributions. Some of these are in the category of “stop complaining when you’ve already won,” but in combination, they were compelling enough to cause us to switch to Roth 401Ks in mid-2020.
We already save enough.
I will never feel like I am able to save “enough”, but in 2020 we were able to hit all of the items on my savings order of operations. Even with a return of childcare costs in 2021, we will likely manage to meet all of these goals again. With our mortgage refinance in 2020, the actual return on mortgage prepayments is minimal. The ~$10K extra we pay in taxes feels less painful than in previous years; it is no longer a choice between college savings or mortgage principle reduction.
It’s also worth noting here that we wouldn’t qualify for expanded child tax credits or COVID stimulus payments with the additional tax deduction. I am glad for our high incomes and don’t begrudge others these benefits.
We may not be able to keep income super low in early retirement.
2020 was eye-opening in terms of the limits of our frugality. Our food spending was 50% higher. We had house repairs, including replacing an air conditioner. We got a dog (worth. every. penny). And we had some non-COVID medical issues.
Better bloggers than I have discussed the myth of level spending in [early] retirement, perfectly illustrated in those spending spikes. Health coverage is another enormous question mark that will greatly affect retirement spending/income; it’s possible we could need 50% more income than my current estimate.
The more we spend, the more we need to pull out of retirement funds, and the more we are on the hook for taxes.
We don’t have a viable drawdown strategy for early retirement.
We’re close enough to FI that I started a spreadsheet to figure out how we would pull money out of accounts and the tax implications.
Turns out, optimizing our retirement income is trickier than I planned. Managing our Roth basis, cash accounts, and rollovers for a Roth conversion ladder showed me one glaring error in our strategy: we don’t have enough Roth basis or taxable investments/cash to cover the first five years of spending. Yes, I know about 72(t) withdrawals, but I have commitment issues and 15-20 years of required income is… terrifying. The easiest path is to increase the amount of money we save in more accessible accounts.
There’s a tradeoff between a lower percentage tax, but a higher dollar amount of taxes.
This was not exactly intuitive to me, but each variation of the spreadsheet I ran gave the same answer: we pay more total dollars in taxes over a lifetime by opting for the traditional 401K. There are exceptions, notably if we can keep taxable income very low or if we die before the age of 76. Given that my two greatest early retirement “fears” are a.) having to be very frugal, and b.) running out of money when we’re in our 80s, these exceptions are interesting but not a problem.
Also worth noting that my calculations didn’t consider that…
Required Minimum Distributions (RMDs) will get us.
Most of my FI-related calculations focus on laughably conservative assumptions – usually growth is only a percent or two above inflation, with worst-case spending assumptions. Adjust as needed until I’m skidding into Age 100 with $100,000 left to my name.
There is the other end of the spectrum, though, where the market returns 8% and we have tens of millions of dollars by the time we’re in our 70’s. This is totally a problem where we have won the game and should stop complaining, but it is a mathematical tradeoff that absolutely deserves a place on this list.
This was the right decision for us in late 2020 and for 2021. It may not be the right decision in future years, and it may not be the right decision for you. Have you considered switching from traditional to Roth accounts?