Is my understanding of "FIRE" correct ?

[finalpsychyear]

I have a ortho friend who keeps telling me he will be able to retire in 7 years and spend 100k yearly indefintely after that. He is currently 34 years old and claims to have a little over a million in "investments"which he adds 100k yearly every year. I have read into fire and it seems a large goal is to attain 2.5 million which apparently lasts for your lifetime if invested if you only spend 100k per year out of it?

Is my friend truly on track to retire in 7 years with his assets mentioned above?

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[The Physician Philosopher]

I have a ortho friend who keeps telling me he will be able to retire in 7 years and spend 100k yearly indefintely after that. He is currently 34 years old and claims to have a little over a million in "investments"which he adds 100k yearly every year. I have read into fire and it seems a large goal is to attain 2.5 million which apparently lasts for your lifetime if invested if you only spend 100k per year out of it?

Is my friend truly on track to retire in 7 years with his assets mentioned above?

Here is the primer on this.

The Trinity study established (with a few other repeat studies showing similar findings thereafter) that you can spend 4% of your "nest egg" (what you have saved for retirement) and rest reliably assured it will last for 30 years (96% chance).

From this, a reciprocal rule came about called the "25 X" rule meaning at whatever point you have 25 x your annual spending, you are financially independent. So, if you want to spend $100,000 per year, then $2.5 million is your financial independence number. If you wanted to spend $200,000 per year you would need $5 million. All of this is predicated on annual spending. So, if you can find contentment at a lower end of the spending spectrum and have a high income, financial independence will come quite quickly.

Remember, at this point there would also be no debt. No mortgage, college for kids, cars, or student loans. In that situation how much do you need to be happy? Studies suggest that number is somewhere between $75,000 and $105,000 depending on the area of the country you live in.

That said, if you want to be safe (and retire really early) you might multiple your annual spending by 30 and know for sure that it will last so long as you don't undergo the worst sequence of return risk in know history (i.e. market returns drop really low for your first decade in retirement).

Others prefer to build passive income and when their passive income (say from real estate) matches their annual spending, that person would also be financially independent.

I take a hybrid view of financial independence where I intend to get to my "25 X number" in addition to having some passive income streams that should float me if there is any trouble.

It is not unreasonable what your ortho friend says. I am anesthesiologist and plan on being financially independent in my mid 40s and finished training at age 32.

 

[finalpsychyear]

Here is the primer on this.

The Trinity study established (with a few other repeat studies showing similar findings thereafter) that you can spend 4% of your "nest egg" (what you have saved for retirement) and rest reliably assured it will last for 30 years (96% chance).

From this, a reciprocal rule came about called the "25 X" rule meaning at whatever point you have 25 x your annual spending, you are financially independent. So, if you want to spend $100,000 per year, then $2.5 million is your financial independence number. If you wanted to spend $200,000 per year you would need $5 million. All of this is predicated on annual spending. So, if you can find contentment at a lower end of the spending spectrum and have a high income, financial independence will come quite quickly.

Remember, at this point there would also be no debt. No mortgage, college for kids, cars, or student loans. In that situation how much do you need to be happy? Studies suggest that number is somewhere between $75,000 and $105,000 depending on the area of the country you live in.

That said, if you want to be safe (and retire really early) you might multiple your annual spending by 30 and know for sure that it will last so long as you don't undergo the worst sequence of return risk in know history (i.e. market returns drop really low for your first decade in retirement).

Others prefer to build passive income and when their passive income (say from real estate) matches their annual spending, that person would also be financially independent.

I take a hybrid view of financial independence where I intend to get to my "25 X number" in addition to having some passive income streams that should float me if there is any trouble.

It is not unreasonable what your ortho friend says. I am anesthesiologist and plan on being financially independent in my mid 40s and finished training at age 32.

Thanks for the response. Yes, I have looked briefly into that study. It sounds actually not that difficult to attain and the number i was using was 100k spending which i agree could easily be 70k given what you pointed out. I would rather shoot for the higher number knowing that 70k would be then be 35-36 x that. Reaching that point, I would feel comfortable knowing if had some passive side incomes like real estate or something of that sort which would eventually also provide 70k.

Since high school, it took me 12-13 years to finally start making an attending salary. Regardless, if i hit FI earlier I cannot fathom actually stopping less than the number i invested. Being overly conservative, I would probably base my numbers on the 3% withdrawal and closer to 35x total. I feel i would still do some part time work after hitting these numbers but wow its exciting none the less.

 

[LookForZebras]

if i hit FI earlier I cannot fathom actually stopping less than the number i invested

I think the neat thing about financial independence is that you can do whatever you want once you reach it - retire, keep working, cut back your hours, start a business. You're independent, and you no longer depend on your paycheck from your job coming in. FI is often lumped with RE, but they're really two separate things.

 

[mvenus929]

Since high school, it took me 12-13 years to finally start making an attending salary.

That's it? I'm 14 years from high school graduation and am still not making an attending salary. And won't for another 2.5 years.

You'll do fine.

 

[The Physician Philosopher]

I think the neat thing about financial independence is that you can do whatever you want once you reach it - retire, keep working, cut back your hours, start a business. You're independent, and you no longer depend on your paycheck from your job coming in. FI is often lumped with RE, but they're really two separate things.

I completely agree. I'll continue to work part-time in medicine while I explore other opportunities (mission work, hobbies, traveling/vacations, side hustles, etc), even after I reach FI.

In fact, that's one of the main messages that I preach. Financial Independence provides the freedom to be able to "practice medicine because
you want to and not because you have to". In a field with ever increasing burnout, the freedom FI provides is paramount to preventing and treating the things that are working hard to limit our career satisfaction.

 

[finalpsychyear]

I completely agree. I'll continue to work part-time in medicine while I explore other opportunities (mission work, hobbies, traveling/vacations, side hustles, etc), even after I reach FI.

In fact, that's one of the main messages that I preach. Financial Independence provides the freedom to be able to "practice medicine because
you want to and not because you have to". In a field with ever increasing burnout, the freedom FI provides is paramount to preventing and treating the things that are working hard to limit our career satisfaction.

So for someone who is 35 years old and and wants 70k in retirement may use the 30x number with a more conservative 3.33 withdrawal. Now, if that person hits the number in 5 years in this example are we counting only a taxable investment account as any tax deferred retirement accounts (roth, 401k,sep, cash balance) would not be accessible till 59.5. So basically you need to get to that 30x number just in your taxable account if your on the much younger side in this case 40 yo? If true, a bit more challenging for the younger group then.

 

[TMP-SMX]

So for someone who is 35 years old and and wants 70k in retirement may use the 30x number with a more conservative 3.33 withdrawal. Now, if that person hits the number in 5 years in this example are we counting only a taxable investment account as any tax deferred retirement accounts (roth, 401k,sep, cash balance) would not be accessible till 59.5. So basically you need to get to that 30x number just in your taxable account if your on the much younger side in this case 40 yo? If true, a bit more challenging for the younger group then.

Taxable should going to be the vast majority of your retirement savings

 

[finalpsychyear]

Taxable should going to be the vast majority of your retirement savings

Thanks for the clarification. So 2.5 mill to accumulate in my taxable is the goal for the 100k yearly withdrawals. Not sure what role my 401k/roth etc will really play then once i hit that in a taxable in if i'm lucky 10 years.

 

[Prepharm1214]

Thanks for the clarification. So 2.5 mill to accumulate in my taxable is the goal for the 100k yearly withdrawals. Not sure what role my 401k/roth etc will really play then once i hit that in a taxable in if i'm lucky 10 years.

You need 2.5M total, this blog post explains things with good detail. Basically as long as your taxable accounts can tide you over until your 59.5 and your total investments check out with regards to the yearly amount your SWR dictates you can spend you're fine.

How to Retire Forever on a Fixed Chunk of Money

 

[Stroganoff]

I've read of some obscure "advanced" but legal methods of tapping into 401k before 59.5, but I'm not at all well-versed on the subject matter. Probably read about it in the Bogleheads forums or the Mr. Money Mustache forums. (Recommend the former, honestly, although the latter's blog first introduced me to the concept of F.I.)

 

[Raryn]

Taxable should going to be the vast majority of your retirement savings

Maybe, maybe not.

If your employer plan allows a mega-backdoor Roth, you can save up to $56k in your 401k (all told - probably $19k pretax and the rest is your after-tax money). Add in your backdoor Roth for you and your spouse, and that's another $12k. Plus your familial HSA for another $7k. If you're not trying to retire particularly young, $75k/year is a very respectable savings rate that doesn't have a single dollar of taxable in it. Back of the envelope estimates with a reasonable growth rate, median physician salary, and reasonable annual spending tells me that that sort of savings rate would lead to FI after maybe 15-20 years of attendinghood - probably late 40s early 50s for the typical doctor (average med school graduate is 28, median residency is 4 years or so).

If they set it up right, they'd be able to pull from all those accounts at that age too - Roth principal 5 years after contribution, and they can do Roth conversions of the pre-tax money to access that young too. There's other ways to access the pre-tax money once they turn 55 as well.

Even if the mega-backdoor isn't an option, many people also have an option of a 457(b), which is another $19k. There's also things like deferred compensation plans, profit sharing, etc that are extra tax-advantaged options. If you have access to any of those, even without the mega-backdoor, maybe at most 1/4 of your money is in taxable (as opposed to pretax or posttax).

If you have access to *none of* the mega-backdoor, a 403b+457b, or some kind of deferred compensation plan then yes, probably the majority of your retirement savings are taxable.

(Before this seems actively pedantic - it's a real world scenario. My wife and I have access to so many tax-advantaged options between our two employers, we can squirrel away something like $90k/year in various random accounts. Between those and vehicle purchases that were entirely unavoidable, I've yet to put a single dollar in to a taxable account for us since I became an attending. I'll probably do that at some point, but I can't say it will be the "vast majority" of my retirement savings).

 

[finalpsychyear]

Maybe, maybe not.

If your employer plan allows a mega-backdoor Roth, you can save up to $56k in your 401k (all told - probably $19k pretax and the rest is your after-tax money). Add in your backdoor Roth for you and your spouse, and that's another $12k. Plus your familial HSA for another $7k. If you're not trying to retire particularly young, $75k/year is a very respectable savings rate that doesn't have a single dollar of taxable in it. Back of the envelope estimates with a reasonable growth rate, median physician salary, and reasonable annual spending tells me that that sort of savings rate would lead to FI after maybe 15-20 years of attendinghood - probably late 40s early 50s for the typical doctor (average med school graduate is 28, median residency is 4 years or so).

If they set it up right, they'd be able to pull from all those accounts at that age too - Roth principal 5 years after contribution, and they can do Roth conversions of the pre-tax money to access that young too. There's other ways to access the pre-tax money once they turn 55 as well.

Even if the mega-backdoor isn't an option, many people also have an option of a 457(b), which is another $19k. There's also things like deferred compensation plans, profit sharing, etc that are extra tax-advantaged options. If you have access to any of those, even without the mega-backdoor, maybe at most 1/4 of your money is in taxable (as opposed to pretax or posttax).

If you have access to *none of* the mega-backdoor, a 403b+457b, or some kind of deferred compensation plan then yes, probably the majority of your retirement savings are taxable.

(Before this seems actively pedantic - it's a real world scenario. My wife and I have access to so many tax-advantaged options between our two employers, we can squirrel away something like $90k/year in various random accounts. Between those and vehicle purchases that were entirely unavoidable, I've yet to put a single dollar in to a taxable account for us since I became an attending. I'll probably do that at some point, but I can't say it will be the "vast majority" of my retirement savings).

One small thing i keep hearing that while all these tax deferred accounts are great for now given you save taxes in the present, long term it is very likely that tax rates will increase by a lot. In an taxable account you have already paid the taxes (minus capital gains) and maybe at a lower level than in 20 plus years from now esp if someone in the future has similar ideas such as bernie sanders. I will have both just in case.

 

[Raryn]

One small thing i keep hearing that while all these tax deferred accounts are great for now given you save taxes in the present, long term it is very likely that tax rates will increase by a lot. In an taxable account you have already paid the taxes (minus capital gains) and maybe at a lower level than in 20 plus years from now esp if someone in the future has similar ideas such as bernie sanders. I will have both just in case.

Roth accounts (which is close to half of my current savings) are the exact opposite. If income taxes go up, they only get better.

But here's the rub: We have no clue what will happen in the future. I would predict that *total* taxes go up from now (that's an easy prediction - they've been getting cut for some time now, and the trend will likely end eventually) but we don't know the form that will take. Pretend for example that income taxes stay the same or even drop but a national VAT (which is basically a sales tax) gets implemented - well, traditional accounts come out ahead, versus Roth money (which has already been taxed) likely loses out.

You can make up similar scenarios to come up with almost any order of Roth vs Traditional. Taxable will always be behind Roth due to tax drag and capital gains - but in some cases will be better than traditional and in others might be worse.

 

[VA Hopeful Dr]

Maybe, maybe not.

If your employer plan allows a mega-backdoor Roth, you can save up to $56k in your 401k (all told - probably $19k pretax and the rest is your after-tax money). Add in your backdoor Roth for you and your spouse, and that's another $12k. Plus your familial HSA for another $7k. If you're not trying to retire particularly young, $75k/year is a very respectable savings rate that doesn't have a single dollar of taxable in it. Back of the envelope estimates with a reasonable growth rate, median physician salary, and reasonable annual spending tells me that that sort of savings rate would lead to FI after maybe 15-20 years of attendinghood - probably late 40s early 50s for the typical doctor (average med school graduate is 28, median residency is 4 years or so).

If they set it up right, they'd be able to pull from all those accounts at that age too - Roth principal 5 years after contribution, and they can do Roth conversions of the pre-tax money to access that young too. There's other ways to access the pre-tax money once they turn 55 as well.

Even if the mega-backdoor isn't an option, many people also have an option of a 457(b), which is another $19k. There's also things like deferred compensation plans, profit sharing, etc that are extra tax-advantaged options. If you have access to any of those, even without the mega-backdoor, maybe at most 1/4 of your money is in taxable (as opposed to pretax or posttax).

If you have access to *none of* the mega-backdoor, a 403b+457b, or some kind of deferred compensation plan then yes, probably the majority of your retirement savings are taxable.

(Before this seems actively pedantic - it's a real world scenario. My wife and I have access to so many tax-advantaged options between our two employers, we can squirrel away something like $90k/year in various random accounts. Between those and vehicle purchases that were entirely unavoidable, I've yet to put a single dollar in to a taxable account for us since I became an attending. I'll probably do that at some point, but I can't say it will be the "vast majority" of my retirement savings).

Yeah most hospital systems do have a huge number of options for physicians. I know mine even beyond the pension plan has a 401k, a 457b, and a deferred compensation plan reserved for high earners - meaning us and upper few levels of admin.

 

[TMP-SMX]

Agree. It's good to be in academics with decent bonus structure and I hope more HR departments allow mega backdoor Roth in the future.

 

[Espadaleader]

If you invest $100,000 per year into a brokerage account (Betterment, Vanguard), you will have $3 million by 55 if you start with $0 at 35. (20 years of investing).

This is possible with a $350,000 taxable income. I take home $250,000 after taxes. Invest $100,000. $150,000 is our "real" money. Most of this money goes to an AMEX savings account with 2% interest. Right now in residency, we are saving over 1/2 of our income ($150,000) per year and investing it, so by the time I finish residency, we'll have no debt within two years of residency (I am $200,000 in the hole and she will have an MBA estimating $100,000 - $200,00 K).

We live frugally, small home under 200 K, drive Prius bought in cash, never plan to have a home more expensive than 200 K (in 2019 dollars). Plan to have 1 child. We eat simply, only eat out once per week on date night. Grocery bill for two is $50 per week. We travel a lot, spend 2-5 K on international travel annually. I've been to over 20 countries during medical school and she's born abroad.

If you want have 3+ million by 55 and 8 million by 65 you need to live like a resident for your entire life. 401 K and Roth is a waste of time too. Yes, we max them out, but those are not wealth generators.

Big thing for me is that my partner is an engineer making $100,000 and she can basically cross subsidize my expenses while Im in residency etc. If you are single or are not married to a six figure income earner, its impossible.

 

[Raryn]

If you invest $100,000 per year into a brokerage account (Betterment, Vanguard), you will have $3 million by 55 if you start with $0 at 35. (20 years of investing).

Probably would have a lot more. $100k/year savings in a brokerage account over 20 years only gets you $3mm if you earn 4%. That's a pretty conservative estimate.

Also, with your reported expenses you have zero need for $8mm by 65.

 

[redfish955]

If you put your money in a few low cost mutual funds. Take the amount you want to save annually and multiply that amount by 15 to get ten years of savings. Multiply the annual contribution by 50 to find your value after twenty years of savings. Multiply that value by 135 to get the 30 year value. So, if you save 10k a year for ten years you should have 150k. If you save 10k a year for twenty years you should have 500k. If you save 10k a year for 30 years you should have 1.35 million. Most people want a net worth north of 2.5 million to retire at 59.5. Once you retire you will want to spend about 3-4% of your net worth and reinvest any other earnings. So, doing nothing but maxing your 401k and a roth ira for 30 years should set you up with close to 3 million. As you noticed saving for ten years doesn't do a lot for you so don't wait until the very end to save. Even if your saving $150,000 a year for ten years it will only be worth about 2.25 million.

 

[finalpsychyear]

Probably would have a lot more. $100k/year savings in a brokerage account over 20 years only gets you $3mm if you earn 4%. That's a pretty conservative estimate.

Also, with your reported expenses you have zero need for $8mm by 65.

I completely agree. I'll continue to work part-time in medicine while I explore other opportunities (mission work, hobbies, traveling/vacations, side hustles, etc), even after I reach FI.

In fact, that's one of the main messages that I preach. Financial Independence provides the freedom to be able to "practice medicine because
you want to and not because you have to". In a field with ever increasing burnout, the freedom FI provides is paramount to preventing and treating the things that are working hard to limit our career satisfaction.

Fictitious scenario : 35 year old ortho guy has 1m in taxable investments and 100k in IRA. If he was fire hungry and wants to retire in 10 years could he get away with a yearly 100k in brokerage account contribution plus yearly 55k in the solo 401k tax deferred and would be able to withdraw 100k inflation adjusted for life starting at age 45?

Is there any reason this 35 year old would consider a cash balance plan if he intends to do the 100k taxable and 55k tax deferred with the same starting amounts above just to be able to have another 110-115 tax deferred instead of just 55k or is this bordering on overkill with the given scenario?

 

[Raryn]

Fictitious scenario : 35 year old ortho guy has 1m in taxable investments and 100k in IRA. If he was fire hungry and wants to retire in 10 years could he get away with a yearly 100k in brokerage account contribution plus yearly 55k in the solo 401k tax deferred and would be able to withdraw 100k inflation adjusted for life starting at age 45?

Is there any reason this 35 year old would consider a cash balance plan if he intends to do the 100k taxable and 55k tax deferred with the same starting amounts above just to be able to have another 110-115 tax deferred instead of just 55k or is this bordering on overkill with the given scenario?

Back of the envelope calculations:

Goal is to have enough to pull $100k in todays dollars, inflation adjusted, for life, starting at age 45. From my standpoint, this would likely require just under $3mm at age 45 (a 3.33% SWR) just due to youth. Now, some might say $2.5mm is sufficient (a 4% SWR), but I'm conservative when we're talking about 45 year olds.

$1.1mm in assets today, saving $155k/year (inflation adjusted - that is, save ~158k next year, etc), for 10 years, growing at a conservative 4% real over that time gives you... ~$3.2mm in todays dollars (just under 4mm nominally assuming 2% inflation). So even at just 4% real, he'd be fine.

Is there any reason to do a cash balance plan? Well, with the above assumptions, probably not. I'm not super duper familiar with them (I don't have access to one) but as I understand it, they're reasonably limited in how much you can contribute if you're young. Cash Balance Plans: Another Retirement Plan for Professionals - Physician on FIRE has a summary of them. I personally have always considered them to be a tool for older savers trying to get back on track - but again, I haven't bothered to look into all the details.

 

[finalpsychyear]

Back of the envelope calculations:

Goal is to have enough to pull $100k in todays dollars, inflation adjusted, for life, starting at age 45. From my standpoint, this would likely require just under $3mm at age 45 (a 3.33% SWR) just due to youth. Now, some might say $2.5mm is sufficient (a 4% SWR), but I'm conservative when we're talking about 45 year olds.

$1.1mm in assets today, saving $155k/year (inflation adjusted - that is, save ~158k next year, etc), for 10 years, growing at a conservative 4% real over that time gives you... ~$3.2mm in todays dollars (just under 4mm nominally assuming 2% inflation). So even at just 4% real, he'd be fine.

Is there any reason to do a cash balance plan? Well, with the above assumptions, probably not. I'm not super duper familiar with them (I don't have access to one) but as I understand it, they're reasonably limited in how much you can contribute if you're young. Cash Balance Plans: Another Retirement Plan for Professionals - Physician on FIRE has a summary of them. I personally have always considered them to be a tool for older savers trying to get back on track - but again, I haven't bothered to look into all the details.

Amazing post and a ton of great info. Well basically for a 35 year old sole prop doc a cash balance+solo ira would equate to putting away at least about 2x what a normal max self employed retirement plan would allow. Instead of 55k roughly you could put closer to 110k tax deferred. Minimum 3-4 years you must contribute or longer if desired usually about 10 years for most folks unless they hit the cap which is 1.4 mill in this age range. At that point the plan is terminated and rolled over into your IRA. The fees are about 2k a year for every year you keep the plan open.

So the gist of what I am saying is it would amount to an extra 500k-750k in your IRA at the end of the 10 years vs if you just did a 55k contribution for a young 35 year old which I guess wouldn't really be needed based on the rough numbers above. But having 4 mill at 45 years old sounds damn amazing adjusted for inflation in today's dollars.

 

[Raryn]

Amazing post and a ton of great info. Well basically for a 35 year old sole prop doc a cash balance+solo ira would equate to putting away at least about 2x what a normal max self employed retirement plan would allow. Instead of 55k roughly you could put closer to 110k tax deferred. Minimum 3-4 years you must contribute or longer if desired usually about 10 years for most folks unless they hit the cap which is 1.4 mill in this age range. At that point the plan is terminated and rolled over into your IRA. The fees are about 2k a year for every year you keep the plan open.

So the gist of what I am saying is it would amount to an extra 500k-750k in your IRA at the end of the 10 years vs if you just did a 55k contribution for a young 35 year old which I guess wouldn't really be needed based on the rough numbers above. But having 4 mill at 45 years old sounds damn amazing adjusted for inflation in today's dollars.

If you truly can just roll it over into your IRA (again - I'm not an expert in these plans), it may be better to have the cash balance plan rather than taxable. This is a much more complicated back of the envelope calculation, but at the time of retirement at age 45, this person would theoretically have three buckets of money

1) Pre-tax

2) Post-tax

3) Taxable

The pre-tax money would be taxed if withdrawn (with potential penalties due to age - but we have a way around that). The post-tax money wouldn't be taxed at all. And the portion of the taxable money that is growth (as opposed to basis) would of course be taxed at capital gains rates.

Our theoretical person *today* has $1mm in taxable and $100k in pre-tax money. Assuming again 4% real growth rates, if using 401k, backdoor Roth IRA (only possible if he rolls the current IRA money into his solo 401k, which shouldn't be an issue), and taxable savings but not a cash balance plan, in 10 years he has:

1) $724k pretax

2) $72k post tax

3) $2.5mm taxable, of which at least $600k is capital gains

If he instead puts that $100k into his cash balance plan with no contributions into the taxable account, he would have

1) $1.7mm pretax

2) Still $72k post tax

3) $1.4mm taxable, of which at least $400k is capital gains

4) ~$300k cash savings from the fewer taxes he paid on the $1mm in contributions over the last decade (could throw these into taxable too - it wouldn't make as much of a difference).

If he only lives on $100k a year, he could easily convert that huge pre-tax balance to Roth over the next 2 decades of retirement - just say max the conversion up to the top of the 24% tax bracket every year while living on selling off the taxable holdings and your excess cash (and using them to pay taxes on your conversions). Just by doing that, without any fancy tax planning, by the 15-20 year mark (age 60ish), you would potentially have $3mm in todays money in a Roth account - and never pay income taxes again. The tax arbitrage there is worth several hundred grand. If doing things like mixing in drawing from the Roth early (which you can do as long as you draw down contributions that are at least 5 years old - and conversions count), you can stretch out the conversions even more and pay even less in taxes.

Basically, situation #2, where you retire with more of your savings as tax deferred, actually makes more sense the younger you are (assuming you still have enough taxable savings to live at least 5 years).

 

[finalpsychyear]

If you truly can just roll it over into your IRA (again - I'm not an expert in these plans), it may be better to have the cash balance plan rather than taxable. This is a much more complicated back of the envelope calculation, but at the time of retirement at age 45, this person would theoretically have three buckets of money

1) Pre-tax

2) Post-tax

3) Taxable

The pre-tax money would be taxed if withdrawn (with potential penalties due to age - but we have a way around that). The post-tax money wouldn't be taxed at all. And the portion of the taxable money that is growth (as opposed to basis) would of course be taxed at capital gains rates.

Our theoretical person *today* has $1mm in taxable and $100k in pre-tax money. Assuming again 4% real growth rates, if using 401k, backdoor Roth IRA (only possible if he rolls the current IRA money into his solo 401k, which shouldn't be an issue), and taxable savings but not a cash balance plan, in 10 years he has:

1) $724k pretax

2) $72k post tax

3) $2.5mm taxable, of which at least $600k is capital gains

If he instead puts that $100k into his cash balance plan with no contributions into the taxable account, he would have

1) $1.7mm pretax

2) Still $72k post tax

3) $1.4mm taxable, of which at least $400k is capital gains

4) ~$300k cash savings from the fewer taxes he paid on the $1mm in contributions over the last decade (could throw these into taxable too - it wouldn't make as much of a difference).

If he only lives on $100k a year, he could easily convert that huge pre-tax balance to Roth over the next 2 decades of retirement - just say max the conversion up to the top of the 24% tax bracket every year while living on selling off the taxable holdings and your excess cash (and using them to pay taxes on your conversions). Just by doing that, without any fancy tax planning, by the 15-20 year mark (age 60ish), you would potentially have $3mm in todays money in a Roth account - and never pay income taxes again. The tax arbitrage there is worth several hundred grand. If doing things like mixing in drawing from the Roth early (which you can do as long as you draw down contributions that are at least 5 years old - and conversions count), you can stretch out the conversions even more and pay even less in taxes.

Basically, situation #2, where you retire with more of your savings as tax deferred, actually makes more sense the younger you are (assuming you still have enough taxable savings to live at least 5 years).

Again a wealth of information so a big thank you. In your scenerio 2 did you keep the 55k ira contrinbution plus the 100k cash balance yearly or just the 100k cash balance to get to that 1.7 number?

Also, I guess if you wanted to be even more secure you would do the 100k cash balance and maybe try and get close to 100k in your taxable as well along with keeping your roth. For a 35 year old i think it would be better to be extra extra safe.

If one can get to a 400k gross 1099 salary i think this plan isn't that out of reach provided you only spend 75k max for total expenses and currently i spend about half that as i am doing the live like a resident for 5 years.

This plan sounds so simple even the 100k cash balance plus 100k taxable isn't out of reach and honestly even if you can't quite get to the 100k in your taxable account after 10 years you would be amazingly rewarded at the end. However, if one did do the 100k in both accounts they would have nearly 4.2 or 4.3 million inflation adjusted as a 45 year old and we are assuming conservative returns as this could be very close to 5 million in today's dollars!!! i am very excited!! thank you

 

[Hercules]

Just to chime in on the cash balance plan as one who has one: Yes, you can roll your cash balance plan over. One of the downsides to the CBP is that it typically can’t be invested as aggressively and has a low target return (typically in the 3-5% range with a lot of fixed income holdings in general). Having said that, the big advantage is the tax arbitrage as stated above. As someone who is in a 42% tax bracket (37 fed and 5 state), getting to put an additional pretax 60k into retirement saves me a good bit of tax expenses right now.

 

[finalpsychyear]

Just to chime in on the cash balance plan as one who has one: Yes, you can roll your cash balance plan over. One of the downsides to the CBP is that it typically can’t be invested as aggressively and has a low target return (typically in the 3-5% range with a lot of fixed income holdings in general). Having said that, the big advantage is the tax arbitrage as stated above. As someone who is in a 42% tax bracket (37 fed and 5 state), getting to put an additional pretax 60k into retirement saves me a good bit of tax expenses right now.

Thanks for chiming in.
Are you in a group that provides this are do you have one as a solo sole prop?
Ball park for fees you pay per year to have it?
Are you able to put more than 60k if you choose to or is that like minimum?
Any regrets in having one as I think you must contribute for 3-4 years minimum before you terminate?

Thanks in advance and greatly appreciate your input in this thread.

 

[Hercules]

Thanks for chiming in.
Are you in a group that provides this are do you have one as a solo sole prop?
Ball park for fees you pay per year to have it?
Are you able to put more than 60k if you choose to or is that like minimum?
Any regrets in having one as I think you must contribute for 3-4 years minimum before you terminate?

Thanks in advance and greatly appreciate your input in this thread.

I’m in a group that recently chose to add this to our retirement. I vaguely remember the fees to set it up and validate it being around $3k. We self direct it or it would be an additional 1% at most of the places we looked at. We are an 8 doc group with 6 employed midlevels, so that makes the calculation of how much to put in a little more complicated as you’re trying to maximize your tax benefit while minimizing the amount you’re legally required to add to your employees’ retirement. If I were in a group that had all owners and no employees, this would be such a slam dunk that you really wouldn’t have to weigh out the costs and benefits.

Yes in general you need to keep it open for 3-5 years before closing it down or it looks kind of sketchy to the IRS. No regrets here. Our group spent a good bit of time discussing and researching all the various scenarios before we pulled the trigger and added it.

 

[finalpsychyear]

I’m in a group that recently chose to add this to our retirement. I vaguely remember the fees to set it up and validate it being around $3k. We self direct it or it would be an additional 1% at most of the places we looked at. We are an 8 doc group with 6 employed midlevels, so that makes the calculation of how much to put in a little more complicated as you’re trying to maximize your tax benefit while minimizing the amount you’re legally required to add to your employees’ retirement. If I were in a group that had all owners and no employees, this would be such a slam dunk that you really wouldn’t have to weigh out the costs and benefits.

Yes in general you need to keep it open for 3-5 years before closing it down or it looks kind of sketchy to the IRS. No regrets here. Our group spent a good bit of time discussing and researching all the various scenarios before we pulled the trigger and added it.

Thank so much for your response. I am a solo doc with no employees. I was quoted 4k first year in fees then ongoing 2k in fees. I am allowed to contribute 70k in year 1 and you can increase contributions by 8-10k per year. I figured this was a no brainer and it even sounded too good to be true. For my scenerio, where no employees are involved, it seems foolish not to do this. Even though the investments aren't aggressive, in 5 years if i choose i could roll it over into the IRA and be super aggressive which seems like a huge advantage. I believe a spouse can also be added to these if they do some meaningful work so the contributions can be quite high.

My guess why this is not very common is because most are no longer solo docs with no employees these days, docs have never heard of it, or due to poor money management they can't fathom putting this sum of money away yearly for 3-5 yrs minimum time. Next to the roth ira or maybe even better than roth ira given what Raryn said with the potential for massive conversions to the Roth ira maxing out tax arbitrage, this could be the single greatest move for my retirement that i ever do.

Needed to make sure because it sounded almost too good to be true.

 

[ArdorAyurveda]

These last few posts are the things that make me want to be a solo doc...thanks for the insight!

 

[Hercules]

These last few posts are the things that make me want to be a solo doc...thanks for the insight!

You don’t have to be a solo doc to do these things. You will usually need to own your practice if you want to optimize and design these kinds of plans though. Being an employee doc for a large corporation or hospital limits you in many ways.

 

[Stroganoff]

55k ira contrinbution

I believe 56k max for 2019.