Shift from Traditional 401k to Taxable Brokerage?

[REIJM]

Details are given below, but my question is given my situation, would it be better to put more money in a taxable brokerage account rather than maxing out my traditional 401k, or should I keep maxing out our 401k's?

My wife and I are both 35, make about $315k before bonuses, putting us solidly in the 24% MFJ tax bracket. We both currently max out our 401k's, and max out our IRA's which we do a backdoor Roth conversion on each year, and are also contributing to a taxable brokerage account. As it currently stands, I have $459k in my 401k and my wife has $265k in her 401k.

I've built out a spreadsheet to track and forecast our investing across our accounts, to see how much we would have saved at different retirement ages. Our goal is to retire before we are 50, with the earliest retirement age likely being 46. If we were to retire the year we turn 46, and we each max out our 401k each year from now until then, factoring in employer matches and using a conservative 4.25% real return, I would have $1.2M in my 401k and my wife would have 1.0M in her 401k (each of our Roth IRA's would have a balance of ~$180k at that point).

If we went that way, our taxable brokerage account would have $2.3M in it. My current plan is to live off of our brokerage account while we either do Roth conversions, or try to minimize MAGI to maximize healthcare subsidies. However, if I cut my 401k contributions to $11k a year, that $12k difference would be worth $8,640 post tax (assuming the 24% tax bracket reverts to 28% at the end of 2025), and doing that from now until we turn 46 would see our taxable brokerage account have a value of nearly $2.6M, while my 401k would still have a value just shy of $1.1M (I have the forecasted higher returns on the taxable brokerage account due to a higher exposure of equities compared to the 401k).


I know the typical investing advice is to max out tax-advantaged accounts before putting money in post-tax accounts, but that advice seems to be aimed more towards people looking to retire at an age where they'll be able to immediately start drawing funds from those tax-advantaged accounts. For those looking to retire early and live off of a brokerage account, does it make sense to divert more funds towards a brokerage account so that when we retire, we have a larger balance to float us until we can start accessing those tax-advantaged funds, or begin pulling on accessible Roth conversions?

Thanks in advance for your thoughts/input.

 

[thod]

You do not mention anything about the annual spending side of the equation.

However, given that you mention possibly trying to "minimize MAGI to maximize healthcare subsidies", that would imply you would need to keep your MAGI around $80000. If that is the case, then 2.3 million divided by 80000 = 28.75 years even ignoring any investment gains. Therefore, 2.6 million would be 32.5 years.

I assume that trying to maximize your ACA subsidies is probably not a goal you should have. Instead, you should probably concentrate on minimizing taxes in the long run.

 

[Mark1]

I see your point of having money outside retirement accounts for easy access prior to 59.5 years of age, but isn't $2.3 million with your current projection enough? Maybe I'm confused.

 

[pjigar]

1. Generally speaking, you want to balance all 3 buckets equally: Roth IRA/401(k), Pre-tax IRA/401(k) and Brokerage. The tax law can and will change over time so having money in each bucket will allow you to change your withdrawal strategy.
2. Don't forget, you do have access to SEPP or section 72(t) withdrawals if all else fail.

On your specific questions, if I were you:

1. Maximize Roth 401(k) for one spouse and maximize Traditional 401(k) for another spouse.
2. If Roth 401(k) is NOT an option for either spouses then I would check if either 401(k) plan allows "after-tax" contributions (which will eventually flow into Roth IRA bucket). If yes, then use "after-tax" 401(k) contribution in lieu of Roth 401(k) bucket in #1.
3. Rest goes to brokerage bucket. Your income will go up over time so you will be able to catch up on this bucket as time goes by but you can't turn back time for Pre-tax and Roth buckets.

 

[REIJM]

You do not mention anything about the annual spending side of the equation.

However, given that you mention possibly trying to "minimize MAGI to maximize healthcare subsidies", that would imply you would need to keep your MAGI around $80000. If that is the case, then 2.3 million divided by 80000 = 28.75 years even ignoring any investment gains. Therefore, 2.6 million would be 32.5 years.

I assume that trying to maximize your ACA subsidies is probably not a goal you should have. Instead, you should probably concentrate on minimizing taxes in the long run.

Good point on spending. I didn't mention anything about it in my post, but I do have it accounted for in my spreadsheet. And as we all know, retirement is not an age, but a number where your you can cover your expenses without needing to work. Also, I didn't mentioned anything about it but we do have one child , so that plays in to the MAGI limit as well.

As far as the whole MAGI thing goes, at this point I'm of the mindset that I'd rather maximize Roth conversions to fill out the lower two tax brackets so that we don't get crushed by RMD's later in life (if we did no conversions from time of retirement until we turned 75, the 401k balance projection would be $7M, with an initial RMD of $285k and only going up from there), but in other posts I've had people mention it so I'm trying to keep my options open. I think it's one of those things where once we're closer to retirement, we'll have to run some more detailed tax analyses to see if we can stay under that MAGI limit to get subsidies, and do those subsidies outweigh the tax savings on Roth conversions down the road.

I see your point of having money outside retirement accounts for easy access prior to 59.5 years of age, but isn't $2.3 million with your current projection enough? Maybe I'm confused.

Is it enough? Probably. But having an extra $300k in the brokerage where it's more easily accessible for whatever needs arise is appealing (maybe our child gets in to a more expensive college than what we'd have saved for in their 529, maybe my wife and I want to buy a second home in a different area of the country, etc.).

 

[pjigar]

On a side note: Be sure to maximize HSA AND invest it if you have an option for HSA.

 

[REIJM]

1. Generally speaking, you want to balance all 3 buckets equally: Roth IRA/401(k), Pre-tax IRA/401(k) and Brokerage. The tax law can and will change over time so having money in each bucket will allow you to change your withdrawal strategy.
2. Don't forget, you do have access to SEPP or section 72(t) withdrawals if all else fail.

You your specific questions, if I were you:

1. Maximize Roth 401(k) for one spouse and maximize Traditional 401(k) for another spouse.
2. If Roth 401(k) is NOT an option for either spouses then I would check if either 401(k) plan allows "after-tax" contributions (which will eventually flow into Roth IRA bucket). If yes, then use "after-tax" 401(k) contribution in lieu of Roth 401(k) bucket in #1.
3. Rest goes to brokerage bucket. Your income will go up over time so you will be able to catch up on this bucket as time goes by but you can't turn back time for Pre-tax and Roth buckets.

Thanks for weighing in.

I'd like to avoid SEPP if at all possible, because we'd have to take withdrawals until we turned 59.5 based on our target retirement age.

As far as the Roth 401k goes, maybe I'm looking at it wrong, but the two issues I see with it are:

• We wouldn't be able to access it until we turned 59.5, no different than a traditional 401k
• 100% of the contributions made would be taxed at our top marginal tax bracket (currently 24%, likely to increase to 28% after next year).

But if we were to do Roth conversions out of a traditional 401k in to a Roth IRA upon retirement, we could convert $94k a year (nearly 4x what could be made as a personal contribution), and pay a much lower tax rate on those conversions, while living off of our brokerage account (which would only be taxed at 15% LTCG).

I do believe our plans allow for an after-tax contribution that can immediately be converted to a Roth IRA. My question there is, are those funds treated the same as other Roth conversions, where they're accessible 5 years after the conversion is made, regardless of your age? If so, that may be a more appropriate option to pursue.

 

[REIJM]

On a side note: Be sure to maximize HSA AND invest it if you have an option for HSA.

HSA isn't an option with our current healthcare plan unfortunately. I might look at switching to a HDHCP for next year, but with a young child I don't know that it would make sense compared to the plan we currently have (which has great coverage and very low premiums).

 

[karen1972]

I get that concern about wanting a chunk on the house.

However per plan you have a significantly bigger brokerage than 401k, RMDs you have 13.5 years form 59.5 to 73 to draw down the 401k so you wouldn't need massive RMDs.

I too would suggest looking at Roth 401k,

The big thing about deferred accounts is you don't have the "forced" income from dividends, and you don't have to think about tax consequences when you want to reallocate/switch out funds which makes managing your tax bracket a lot simpler.

I retired at 43, had about 50/50 and yes I wish I had more in my Brokerage but your numbers to me seem pretty good especially if you can get some of that into a Roth 401k.

 

[Surewhitey]

We are in a similar situation with the plan for the Roth conversion idea. You just need to have enough in post tax bucks for the first 5 years.

Also to consider is if your $94k conversion is enough for the annual expense of life or do you have some extra money for the difference.

Don't forget to add your ltcg (and any interest) into your MAGI number too for ACA purposes.

 

[REIJM]

I get that concern about wanting a chunk on the house.

However per plan you have a significantly bigger brokerage than 401k, RMDs you have 13.5 years form 59.5 to 73 to draw down the 401k so you wouldn't need massive RMDs.

I too would suggest looking at Roth 401k,

The big thing about deferred accounts is you don't have the "forced" income from dividends, and you don't have to think about tax consequences when you want to reallocate/switch out funds which makes managing your tax bracket a lot simpler.

I retired at 43, had about 50/50 and yes I wish I had more in my Brokerage but your numbers to me seem pretty good especially if you can get some of that into a Roth 401k.

I wouldn't say it's significantly bigger. We would have somewhere in the neighborhood of $2.3-2.6M in the brokerage account, and ~2.1M in the traditional 401k. Your comment about wishing you had more in the brokerage when you retired is my reason for making this post, because our aim is to retire in our mid-to-late 40's, and ideally not have to take money from the traditional accounts, but rather convert them in to a Roth IRA, and then pull from there as needed to supplement the brokerage account down the road.

When you mention Roth 401k, do you mean a straight up Roth 401k, or do you mean after-tax contributions to a traditional 401k that gets immediately converted to a Roth 401k?

The straight Roth 401k option would see me paying 24% (possibly 28% starting in 2026) tax on 100% of those contributions, and they wouldn't be accessible until 59.5. If we're talking about the after-tax & immediately converted option, I'd still pay the same tax rate, but the funds may be available 5 years after the conversion (I need to read through my plan description details, but that could be helpful in terms of accessing those funds prior to 59.5).

 

[QG67PK00]

Does your/spouse's 401k plan allow for after tax contributions? That would be a good way to fill up your Roth bucket via the Mega backdoor Roth.

 

[karen1972]

I wouldn't say it's significantly bigger. We would have somewhere in the neighborhood of $2.3-2.6M in the brokerage account, and ~2.1M in the traditional 401k. Your comment about wishing you had more in the brokerage when you retired is my reason for making this post, because our aim is to retire in our mid-to-late 40's, and ideally not have to take money from the traditional accounts, but rather convert them in to a Roth IRA, and then pull from there as needed to supplement the brokerage account down the road.

When you mention Roth 401k, do you mean a straight up Roth 401k, or do you mean after-tax contributions to a traditional 401k that gets immediately converted to a Roth 401k?

The straight Roth 401k option would see me paying 24% (possibly 28% starting in 2026) tax on 100% of those contributions, and they wouldn't be accessible until 59.5. If we're talking about the after-tax & immediately converted option, I'd still pay the same tax rate, but the funds may be available 5 years after the conversion (I need to read through my plan description details, but that could be helpful in terms of accessing those funds prior to 59.5).

I mean whether you are talking Roth 401k or after-tax contribution or you put it in a brokerage account, all 3 options are going to have you paying 24% or possibly more which is why I'm confused about your concern over those taxes. If you don't want to pay at the 24%+ rate then the only option is to keep maxing the Traditional 401k and wait to convert.

I've heard mixed things on the Roth 401k, as some allowed like for like rollovers, some allowed for partial rollovers (but were mixed so its more like a pro-rata conversion where 401k Roth % is non taxed, company match and traditional portion would be taxed at that point), some require 100% rollover which then is prohibitive if you had to pay the full tax bill at one time. It seems to be one of those evolving things so depends on your plan, the after tax may be a better option, its called a Mega Back Door Roth in most places so is handled much like a Back Door Roth except that your 401k is allowing a much bigger contribution.

My BF is currently contributing to a Roth 401k, his contract ends in October, so when he's done, we will move that all to his Roth IRA. In our case its simple as maybe $10k of it will be company match so thats the max we would be on the hook for paying taxes on if we can't do the like for like. We will get a tax form that says
- when we opened the account (for the 5 year rule)
- How much of it was contribution (so we can treat that portion as Roth contribution)
- How much was growth (which has to stay until 59.5)
- How much is taxable (ie the employers contribution)
Then normal Roth IRA rules should apply.

 

[GrayHare]

Avoiding the IRA/401k tax trap might indeed be the right approach in your situation. More funds in a regular brokerage account gives you more control over how the gains are taxed. For example, a portion invested in BRKB would incur no tax until you sell, and then capital gains tax would apply, which is typically less than the tax on ordinary income that applies to 401k withdrawals.

Even so, I'd not cut my 401k contribs below the company match amount. That match is like free money.

 

[pjigar]

As far as the Roth 401k goes, maybe I'm looking at it wrong, but the two issues I see with it are:

• We wouldn't be able to access it until we turned 59.5, no different than a traditional 401k
• 100% of the contributions made would be taxed at our top marginal tax bracket (currently 24%, likely to increase to 28% after next year).

But if we were to do Roth conversions out of a traditional 401k in to a Roth IRA upon retirement, we could convert $94k a year (nearly 4x what could be made as a personal contribution), and pay a much lower tax rate on those conversions, while living off of our brokerage account (which would only be taxed at 15% LTCG).

I do believe our plans allow for an after-tax contribution that can immediately be converted to a Roth IRA. My question there is, are those funds treated the same as other Roth conversions, where they're accessible 5 years after the conversion is made, regardless of your age? If so, that may be a more appropriate option to pursue.

Roth 401(k) or "after-tax 401(k)" are almost same (other than the gain part of later) from tax perspective. Yes, you will have to pay tax which you are already doing for the money going into your brokerage bucket. You are supposed to use the Roth buckets last or if and when the tax laws change that make it a better option. Your goal is to still spend first from brokerage bucket followed by pre-tax bucket followed by Roth bucket. Like I said, your brokerage bucket will have larger contributions over time so don't sweat about it being too small by the time you retire.

And if history of a lot of members on this forum (including me) is any proof, you likely will be retiring later than 50! Which means you will need a smaller brokerage bucket. I had a full plan to retire by 45, then 50 and now 55. I don't want to create a thread drift but you will have new variables as you get closer to FI which will extend your FIRE date.

 

[REIJM]

Avoiding the IRA/401k tax trap might indeed be the right approach in your situation. More funds in a regular brokerage account gives you more control over how the gains are taxed. For example, a portion invested in BRKB would incur no tax until you sell, and then capital gains tax would apply, which is typically less than the tax on ordinary income that applies to 401k withdrawals.

Even so, I'd not cut my 401k contribs below the company match amount. That match is like free money.

Definitely not cutting below the company match, as you said that would be foolish. Currently I just need to put in 7% to get a 5% match, and they just give us 5% as well on top.

And you're exactly right about the brokerage, and being able to control how it's taxed.

Want to Roth convert a lot of money one year? Take withdrawals from the brokerage with the highest cost basis to minimize LTCG. Don't want to convert one year? Take withdrawals to maximize tax gain harvesting while staying in the 0% bracket (if possible).

The brokerage account is really flexible, and a great asset when trying to retire early. I just wish we had started putting money in one sooner than we did. But, we can't change the past, so focus on the future.

Roth 401(k) or "after-tax 401(k)" are almost same (other than the gain part of later) from tax perspective. Yes, you will have to pay tax which you are already doing for the money going into your brokerage bucket. You are supposed to use the Roth buckets last or if and when the tax laws change that make it a better option. Your goal is to still spend first from brokerage bucket followed by pre-tax bucket followed by Roth bucket. Like I said, your brokerage bucket will have larger contributions over time so don't sweat about it being too small by the time you retire.

And if history of a lot of members on this forum (including me) is any proof, you likely will be retiring later than 50! Which means you will need a smaller brokerage bucket. I had a full plan to retire by 45, then 50 and now 55. I don't want to create a thread drift but you will have new variables as you get closer to FI which will extend your FIRE date.

True, the closer you retire to 59.5, (or 55 if you plan to use the rule of 55), the less a brokerage account matters.

I understand things come up in life that throw your plans off the ideal path, but the idea behind having a goal is that there's a focal point, and as things change you can adjust as needed to try to attain that goal.

My wife and I are of a similar mindset, where we don't want to be working late in life. We want to work and save now so that we can enjoy our money when we're still in good physical health, for as long as we can. Our child won't enter college until we're 52, so maybe we work till 48 or 50 instead of 46, because we can't go doing a bunch of traveling while they're in school anyways. But that's the beauty of becoming financially independent, is that you have the ability to pull the ripcord whenever you want, and you're not tied to your employment because you're financially reliant upon it.

 

[SevenUp]

I know the typical investing advice is to max out tax-advantaged accounts before putting money in post-tax accounts, but that advice seems to be aimed more towards people looking to retire at an age where they'll be able to immediately start drawing funds from those tax-advantaged accounts. For those looking to retire early and live off of a brokerage account, does it make sense to divert more funds towards a brokerage account so that when we retire, we have a larger balance to float us until we can start accessing those tax-advantaged funds, or begin pulling on accessible Roth conversions?

The advice in articles such as Investment Order and Prioritizing investments usually works very well for an early retiree. Your situation looks unexceptional.

Roth will be better than taxable (assuming you don't put your finger on the scale by predicting a higher return for taxable - if anything it should be lower due to tax drag). You could compare Traditional versus Roth and make that choice, but in your situation there is not a good case for taxable.

 

[REIJM]

The advice in articles such as Investment Order and Prioritizing investments usually works very well for an early retiree. Your situation looks unexceptional.

Roth will be better than taxable (assuming you don't put your finger on the scale by predicting a higher return for taxable - if anything it should be lower due to tax drag). You could compare Traditional versus Roth and make that choice, but in your situation there is not a good case for taxable.

Thanks for the links.

I have the forecasted returns being the same for our brokerage account and our IRA accounts, so one isn't more inflated relative to the other as far as performance goes.

Question for you on the value of after-tax 401k's: The contributions are made with after tax dollars, so you're paying whatever your top marginal rate is, just as you do with a brokerage account. And upon withdrawal, your contributions are tax-free, but any gains are taxed at ordinary income rates. This sounds less favorable than a brokerage account, where any contributions are tax free, and any gains are taxed at LTCG rates (assuming you've held the position for at least 12 months).

It sounds like the only benefit of having an after-tax 401k is if you can do an immediate in-plan conversion to a Roth, so that the gains are also tax-free. My question around that is, are those Roth conversions accessible 5 years after they were made (so if I started doing it now at 35, I could start accessing this year's conversions when I turned 40), or are they locked down until 59.5 unless you employ a strategy like SEPP or Rule of 55, etc.? Or does that vary by plan/plan administrator?

 

[SevenUp]

(I have the forecasted higher returns on the taxable brokerage account due to a higher exposure of equities compared to the 401k).

I have the forecasted returns being the same for our brokerage account and our IRA accounts, so one isn't more inflated relative to the other as far as performance goes.

The first quote was what I had in mind.

Question for you on the value of after-tax 401k's: The contributions are made with after tax dollars, so you're paying whatever your top marginal rate is, just as you do with a brokerage account. And upon withdrawal, your contributions are tax-free, but any gains are taxed at ordinary income rates. This sounds less favorable than a brokerage account, where any contributions are tax free, and any gains are taxed at LTCG rates (assuming you've held the position for at least 12 months).

It sounds like the only benefit of having an after-tax 401k is if you can do an immediate in-plan conversion to a Roth, so that the gains are also tax-free.

Yes, using the Mega-backdoor Roth is what makes After-tax 401(k) contributions particularly attractive.

My question around that is, are those Roth conversions accessible 5 years after they were made (so if I started doing it now at 35, I could start accessing this year's conversions when I turned 40), or are they locked down until 59.5 unless you employ a strategy like SEPP or Rule of 55, etc.? Or does that vary by plan/plan administrator?

See Trying to understand Roth five-year rule - Bogleheads.org, particularly the several posts by Alan S. Does that give you what you need?

 

[ncbill]

I wouldn't say it's significantly bigger. We would have somewhere in the neighborhood of $2.3-2.6M in the brokerage account, and ~2.1M in the traditional 401k. Your comment about wishing you had more in the brokerage when you retired is my reason for making this post, because our aim is to retire in our mid-to-late 40's, and ideally not have to take money from the traditional accounts, but rather convert them in to a Roth IRA, and then pull from there as needed to supplement the brokerage account down the road.

When you mention Roth 401k, do you mean a straight up Roth 401k, or do you mean after-tax contributions to a traditional 401k that gets immediately converted to a Roth 401k?

The straight Roth 401k option would see me paying 24% (possibly 28% starting in 2026) tax on 100% of those contributions, and they wouldn't be accessible until 59.5. If we're talking about the after-tax & immediately converted option, I'd still pay the same tax rate, but the funds may be available 5 years after the conversion (I need to read through my plan description details, but that could be helpful in terms of accessing those funds prior to 59.5).

Keep in mind you can also set up a line of credit against your taxable brokerage account.

I did this and it uses an outside bank so the rates are lower than for margin loans through the brokerage.

That bank was willing to setup a huge credit line...like 75%.

So (not my personal numbers) $4 million in taxable would get you a $3 million credit line.

I set mine up for a fraction of what they were wiling to do, and have drawn just a small amount of that.

So when you want to retire you don't actually have to sell anything in taxable, but can borrow against it instead.

Then do Roth conversions or access ACA subsidies while living off the credit line to keep MAGI low.

 

[tulak]

Yes, using the Mega-backdoor Roth is what makes After-tax 401(k) contributions particularly attractive.

I’m a big advocate of contributing to an after-tax 401k and converting to a Roth. I’m doing this and it’s helped increase my Roth savings significantly.

The problem I run into is how to balance this with a 401k. Should I fully fund the 401k and the rest into the Roth or fund 401k to company match and the rest in Roth.

I’m in a high tax bracket, so I fully fund the 401k. But I realize it might not be the best decision in the long run.

I can’t help OP regarding how to get to 59.5. With the Roth approach, if available to you, you might be able to take out your principal before 59.5, even though that would be a shame. I think I’d prefer to setup a SEPP instead. I’m banking on rule of 55, which is why I have very little in after-tax accounts.

 

[Kings over Queens]

Thanks in advance for your thoughts/input.

You're 35, right.

My thoughts are "Men make plans and God laughs."

If I were to give you advice, I'd say in very general terms, find some balance, and tweak in 20 years.

Don't let perfection be the enemy of good.

 

[Aerides]

Retiring at 46 with a brokerage balance of 2.3 vs. 2.6 isn't that big of a difference in reality (and of course neither of those numbers will be accurate because of all the unknowns between now and then. But if your budget is so tight that 2.3 is making you nervous for covering 13-14 years, maybe... but then another 300k isn't that much difference over that much time.

It's really a matter of expenses, and how much income that taxable account throws off. Your current plan will have you about 50/50 in tax deferred vs taxable retiring at 46. That's about where we were in ratio, and we retired at 46/47. Maxed our 401ks and everything we could every year, still do as I have a tiny business that allows us to continue to contribute to IRA's and HSA's.

8 years in and we have no worries about running out of taxable money before hitting 59.5. We probably won't touch our deferred accounts until 65 or so at this rate.

I do see far too many folks coming here, with their egg ready, early 50's, asking but what do I spend before 59.5? And the answer is...sorry mate you did it wrong (or some stuff about the rule of 55). In your case, you'll be fine either way.

 

[ut2sua]

For those looking to retire early and live off of a brokerage account, does it make sense to divert more funds towards a brokerage account so that when we retire, we have a larger balance to float us until we can start accessing those tax-advantaged funds, or begin pulling on accessible Roth conversions?

Your thinking above is correct. Without a taxable account (or a large enough pension) to bridge the RE years to 59.5, one will have to do some fancy move to avoid the 10% penalty in order to access IRA/401K monies.

 

[pb4uski]

In your situation, I would consider what would be needed in after-tax accounts to pay for living expenses and taxes on Roth conversions from when you retire at age 46 until you have penalty free access to retirement funds at 59-1/2 and target taxable account savings to have, along with estimated growth, what you expect to need at age 46 (or perhaps even 120% of what you expect that you will need).

Then put the difference between the total savings and what you need for annual contributions for taxable accounts into tax-deferred savings to get the tax benefit.

From the numbers that you have shared, if you had $2.3m in taxable accounts at age 46 off-the-cuff that would seem to be enough to cover spending and taxes for 13-1/2 years.