FIRE.081 401k/IRA part of your 4% payday?

DONE!  25xExpenses saved.  You’re ready!  Time to truly evaluate the FIRE lifestyle, or Fully Funded Lifestyle change many of us are talking about right?

[insert screeching sound]  BEFORE jumping headfirst into your new awesome lifestyle, please (re)consider two things:

  1. Are you calculating your 401k/IRA’s balance(s) in your 4% withdrawal rate?
  2. Are your expenses all-inclusive of all the money you will need each year?

Qualified Tax Deferred balances:

I keep reading articles with the amazing accomplishments of “maxing/maxed out our retirement accounts.”  That is an amazing accomplishment in today’s economic/consumption lifestyle.  My concern is $500k in a 401k does not necessarily equal $500k spendable/$20k per year in spending.

Instead of spending $20k, you are actually using the 4% rule to withdrawal $20k for the spending amount plus taxes.

Now, of course, $20k counted as ordinary income—if your only income—is not going to hit you hard on the tax side.  However, if you were a big-time tax-deferred saver and your qualified accounts have skyrocketed, you may plan to take a much larger withdrawal THANK $20k, thereby pushing you into high teens/low 20’s total tax brackets (Fed, State, Local, sales, etc) or even higher (good problem actually).

I believe it’s safer to be more cautious and I adjust my personal retirement account balance to a projected 70-75% spendable amount.  At least for the big picture planning.

Expense Inclusions:

So you say, “I/we spend $3000/mo (or $4000, or $5000, or more) for our lifestyle.”  I’m assuming that is your after income-tax spending.  I mean, who calculates how much they are required to allocate for funding the government each year, right?  I can tell you exactly who knows, people who send in quarterly tax payments because they are not receiving a paycheck/annuity-type payment that has automatic withholding.” 

I know without a sliver of doubt, when you decide to take money out of your qualified accounts (I love the word ‘qualified’ as in accts, dividends, etc) you will know quite clearly how much net withdrawal you get to keep/spend and how much is going to your non-related uncle.  Or for the wise planners here, how much the Roth IRA conversion amount will cost you in taxes.  How’s that for using a Roth to find a positive slant on paying taxes?

Quick example:

You’re older, and you are all set up with retirement accounts and social security.  Life’s good.  But you decide it’s time for a new car because at your age you don’t want to hassle with AAA and/or getting your car repaired across town.  If you don’t want to make payments on a basic $20k (or cheap $8k) car and decide to use your “savings” you have to pull say $25k (or $10k) from your nest egg. 

Your large purchase will require a withdrawal of the vehicle’s price + sales taxes +other registration taxes PLUS the income taxes at your highest marginal rate.  This withdrawal is at the top of your income…top end of your ordinary income.

If you wanted to purchase a vacation home for cash…can you feel your uncle wringing his hands at your upcoming payment to the IRS?  Not exactly a house warming celebration party.

Not all account balances are true balances.  Sometimes (often) there are implied obligations within those balances.

*** Nothing in this article is to be construed as financial advice.  I am not a financial planner, nor do I pretend to be.  You should always consult your own professional when seeking advice.

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