I’ve long thought the optimal level of the pre-tax retirement account was about $250k for purposes of FIRE. This would mean that if the account generated at least a 5% nominal return each year, you would be able to do a Roth IRA conversion of the $10k annual standard deduction/personal exemption. This would be done in any year when you are not working, such as FIRE, and would otherwise forgo the non-refundable tax break.
If you FIRE in your 30s or 40s, then you’ll be able to convert a ton of money, tax-free into a Roth IRA. Where you never paid taxes on the money initially, since it was placed in a tax-deferred retirement account. And you never paid taxes on the conversion since you only did so up to the standard deduction. And you never pay taxes coming out, since it’s a Roth IRA.
That was the idea at least, before Orangeman. Orangeman scrapped the personal exemption for a larger standard deduction. However, it was my understanding the larger standard deduction was only going to last a few years, and then revert back to the original $6k or so, but the personal exemption was gone forever. Unless we re-elected Orangeman and he would extend the larger standard deduction. So it’s certainly possible the $10k of free conversions each year will drop. Although who knows.
On to my concern if the pre-tax retirement account value is too high. More money is generally better than less money, except when the government is involved. If you made over $75k last year, like me, then you got no $1200 stimulus check. However, Orangeman will let us take the $1200 as a refundable tax credit as long as you make no more than $75k in 2020. So if you make $75,001, then you get nothing. Thus, the extra $1 you earned cost you $1119. And we are likely to get a second $1200 stimulus check with the same criteria so if you’re at $77k AGI, it might be worthwhile to take unpaid leave from work for a week or so in December, to get a $2400 tax credit.
The problem with having too much money tends to be on the margins of government programs. I’d rather have $10M in my pre-tax retirement account than $250k, but I might actually be better off with $250k than $300k.
If the pre-tax retirement account value is too high, then RMDs will kill you in your 70s, if eating fast food hasn’t already. And Social Security starts getting taxed if you make more than $X per year, so you want to keep total income down.
The government has also made it clear that they want to do means testing for handouts, like the ACA subsidy. If your 401k is a few thousand dollars above an optimal level, then your RMDs may cause you to be a few dollars above the marginal threshold for various government cheese programs.
As a last ditch resort, you could put some portion of your 401k money into a triple inverse ETF that’s guaranteed to lose money over the long-term based on operating structure. But, rather than try to burn money from the account in my 70s, I want to avoid putting too much in there to begin with.
Thus, I’m considering the optimal account balance leading up to retirement. The $250k figure was something I thought about when I was in my late 20s. Now in my 30s, I wound up with $500k in there and I’m still not FIRE. Ooooops.
So now, I’m considering two strategies.
One, is I do Roth IRA conversions even past the “free” point, maybe into the first tax bracket marginal point. This sucks a bit, since it means I will have paid some tax on this money, which the original strategy was meant to get it out tax-free.
Two, is I take a 401k loan before the RMD point kicks in during my 70s, so that the total balance is lower and the RMD amount is lower. If you are self-employed, or have a pulse and a SSN and can apply for an EIN on the IRS website, you can qualify for a Solo 401k at a brokerage that allows loans. Even if you worked as a W2 employee your whole career, you can roll it over into a Solo 401k and take a loan from that. Bingo, bango, lower balance and less RMDs.
The problem is you can only do a loan of $50k so it doesn’t help much, but it’s something.
I post this to get some kicking at the tires. Am I crazy for thinking it’s a bad idea to have “too much” in a pre-tax retirement account? Any strategies I missed to strip money out?
All of this assumes the laws stay the same for the next 30 years but we can assume the future laws will be some kind of amalgam of current laws, meaning some form of RMD will exist. The age may get pushed later to a higher age. There also may be some kind of VAT to pay for universal healthcare which will reduce the value of Roths. It’s possible the VAT takes the place of some federal income tax, meaning tax rates go down, in exchange for this VAT, but that seems unlikely since it would be regressive in nature, and government tends to only increase tax, not trade a new tax for less of an existing tax.