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Mindy:
Your withdrawal strategy can save or cost you hundreds of thousands of dollars in taxes. Having a plan when you want to access your hard-earned money is crucial. So today, we’re going to share the six frameworks for early retirement withdrawal.
Hello, hello, hello and welcome to the BiggerPockets Money podcast. My name is Mindy Jensen, and with me as always is my not withdrawn co-host, Scott Trench.
Scott:
Thanks, Mindy. That’s a great frame for today’s show. We’re excited to talk about this. This is a big topic. It’s really complex. Things get really hard. Accumulation is pretty simple. You spend less than you earn, you invest according to a tax efficient order of operations, you invest aggressively for long-term growth, and you keep piling it up for 10, 15 years.
Withdrawal sequencing is harder. It’s more of an art than a science. I don’t think the word optimal can be really applied here. I think you can only approach optimal or, you know, within the context of a coherent worldview. I think it’s really hard, and there’s a lot of competing prioritizations that we have to deal with, right? We’ll preview this very briefly, but like, MAGI and Affordable Care Act subsidies conflict with converting Roth conversions, for example, up to certain tax thresholds.
So we’re going to talk about six frameworks that are all independently ideal, and then how they conflict and how that can help you make better decisions. If you’re a Harry Potter fan, yes, I’m going there, in the sixth book, you’ll remember that Harry gets this like textbook that’s the Half-Blood Prince’s textbook, and it gives him all the answers to the potions, right? That’s like the accumulation phase journey.
But then one day, they have this class where you’ve got to brew your antidote to a poison, and you got to actually understand the theory and go after it. That’s kind of like what withdrawals like, right? You can’t just like follow a rule of thumb blindly. You’ve got to understand the theory and be able to play ball. And hopefully this episode will help you play ball. So that’s for you all Harry Potter fans. If you’re lost, well, the episode is not going to get any better from there.
Mindy:
Yes, it is going to get better. People are going to turn it off, Scott. If you are in or approaching early retirement, or if you are thinking about early retirement, this episode is for you. It’s not only how you are withdrawing, but you need to have funds in these different accounts in order to be able to withdraw them. Plus, I’ve got a fun little extra bonus tip halfway through the show.
Scott:
By the way, we have a slide deck here. It’s just like 15 slides. It’s pretty easy. What it I think it will be valuable for though is if you’re trying to play around with this and get some kind of like first rough draft or begin learning these concepts, go download these slides at biggerpocketsmoney.com/withdraw, and then upload it to your favorite AI. There’s a prompt at the end there as well that will help get things going. And that will frame the discussion about withdrawal in a way that is not as simplistic as if you just ask it, hey, what’s the right way to withdraw? It’ll tell you taxable first, pre tax, then Roth, which is right, but it’s missing these other frameworks. So go ahead and download this presentation, upload it to your favorite AI. It’s designed to be compatible with that and help sharpen your thinking there.
Mindy:
Yeah, you know how when you ask an attorney a question on the podcast, his answer is always, “Well, it depends.” The answer to everything in this show is, it depends. It depends on what your specific situation is and your specific goals. So this is a great framework, a series of six great frameworks, and then you have to actually do the work to figure out which one works for you.
Scott:
Awesome. Well, let’s get into those six frameworks. The first framework is going to be the withdrawal sequence. Like this is the kind of traditional taxable first, pre-tax, then Roth kind of thing. Then there’s healthcare subsidies, which we’ve talked about at length here on BiggerPockets Money. We’ll talk about how that interacts with the withdrawal sequencing. We’ll talk about tax optimization across a lifetime. We’ll talk about the target portfolio that you’re holding. We’ll talk about asset location, right? If you’re going to hold 60-40 stocks bonds, you’re going to want to have all the stocks in some accounts and the bonds in other accounts.
And then last, we’re going to talk about a framework which I call your worldview. And this is where things get contestable, right? So, for example, I have a worldview that for people like me who are, you know, fairly entrepreneurial, will probably have many investments and business interests in a 30 year financially independent adult lifetime. I think I’m going to become fairly wealthy over time and my tax bill is going to go up. But somebody else may feel like, hey, I’m going to probably spend down my portfolio and I will live my entire life, my entire financially independent life in a low tax bracket.
That worldview, how you view yourself and how you think that political environments will change your tax situation, for example, change, they impact how you’re going to approach withdrawal sequencing. So you can see how this gets very complicated very quickly. And that’s why I’ve provided six frameworks and how they stack or rank or inter-interact with one another as you think about planning withdrawal sequencing for your early retirement.
Mindy:
Okay, Scott, let’s go to the withdrawal rules of thumb.
Scott:
Great. Mindy, you want to take this one?
Mindy:
Yeah. So the typical withdrawal rules of thumb are the orders in which you are decumulating. So, number one is your after tax cash flow, your interest, dividends, pension, social security, rental cash flow. These are kind of the passive income that’s already coming in. Spend that first. It’s already coming in. Don’t continue to reinvest it because you’re still getting taxed on that. You might as well use that to live your life.
Number two, after tax brokerage. Sell to rebalance to your target portfolio. Number three is your pre-tax accounts, your traditional 401k and IRAs. You can either withdraw after age 59 and a half or Roth convert or use a 72t to access those funds before age 59 and a half.
Number four, HSA receipts. Reimburse your banked medical bills if that is how you’re choosing to use your HSA plan. That is tax-free in any year you choose. You just have to have receipts and then you turn those in, you get the money. It’s really awesome. And number five, last, is the Roth accounts that you have. These are last for your spending and there are some conditions that apply.
Now, Scott, this is all well and good for most of our listeners, but I want to caution people who have huge gains in their after tax portfolio to look at every bucket available before making any moves. So Carl and I have a nice chunk of our net worth in our after tax stock, but our cost basis is practically nothing, which would make our tax obligations almost the entire amount that we would be selling. This is not an issue until it is. For a listener in a similar position, this could throw them off the subsidy cliff. So this is what you’re talking about with the interlocking, and we’ll get to that a little bit more.
Scott:
So, you know, just just to recap what you said here, you have your after tax cash flow, your after tax brokerage, your pre-tax, your HSA and your Roth. But this is going to intersect. Like that’s the, that’s the perfect worldview, you know, if taxes, you know, if if if tax brackets were flat and there was no complications or whatever, we would want to follow something like this for a variety of reasons, right? The Roth is the best thing, Roth and the after tax, for example, are generally speaking better things to leave to your descendants than pre-tax or HSA components. There’s an estate planning component to this.
In practice, we have also three sources of cash with our cash balance, our Roth contributions, not the gains, but the contributions, and HSA reimbursements that can float liquidity for us. And we may use those from time to time in certain years if we want to control our income to maximize, for example, MAGI subsidies in another framework or keep below certain taxable cliffs. So this is like the the starting hypothesis, the bias that we order to when attempting to accumulate, but there are many things that break this bias as we’ll get into as they conflict with other frameworks.
So the next framework is at least for now, healthcare subsidies. We’ve talked about this at length, but if your modified adjusted gross income is too high, if it goes over 400% of the federal poverty line, then you get zero Affordable Care Act healthcare subsidies. So most people know that there’s a cliff and that you don’t want to go over that cliff. You don’t want to have too much modified adjusted gross income, MAGI, in a given year, so that you exceed 400% of the federal poverty line and get no credits.
But what you may not be remembering or thinking through is that the lower your MAGI, the higher those credits. So for example, someone like me in Colorado, if I were to just stay a hair under the cliff for my family, I might get a $7,600 credit this year in 2026 for Affordable Care Act subsidies. But if I were to keep my MAGI much lower in the $45,000 range, my credit could be as high as $18,000. So I’ve got two decisions here. One, I want to stay under that cliff, and two, I may want to keep my MAGI as low as possible to maximize those credits.
And depending on which tax brackets I’m in or how I’m thinking about my long term portfolio construction, maximizing credits this year may be more important than taking advantage of Roth conversions up to some tax bracket, right? So you can see how we already in framework two, right? We have our optimal withdrawal sequence in a perfect fictional world. And now we’ve got MAGI stacking in it, and they conflict.
And that’s why this is impossible to get to, I think, I think perfection. I think you can only understand the trade-offs and begin to make better quality decisions about what makes sense in your situation for you. And by the way, this is going to vary by state. If you’re in a place like Vermont, this might be very, very meaningful for you to stay under the MAGI cliff. But if you’re in a state like New Hampshire and you already have reasonably high MAGI, then going right through the cliff and doing Roth conversions up to the 20% or 22% tax bracket may only cost you like $3,000 in subsidies. So it’s really important to understand this in your situation, how that’s going to impact you because it will impact whether you decide to optimize for these subsidies or you decide to optimize for some other tax goals.
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Mindy:
Scott, you just said something that I really liked. You said if you’re going to do this in a given year, I think a lot of people kind of get stuck on, “Well, this is my plan and that’s it. I have to do this every single year.” There’s a lot of different ways to do a lot of different things. One thing that comes to mind is when you’re contributing to a donor-advised fund. If you know that you want to give every single year, maybe this year you fund two years or five years of giving, even though you’re not giving it to the charity at that moment, you fund the donor-advised fund, and that gives you a huge tax reduction. So maybe you’ve decided that you want to do a Roth conversion, and you want to make a big Roth conversion. Well, then you can also do a big contribution to your donor-advised fund and kind of balance that out. This is where having a conversation with a tax professional or a CFP can be really beneficial because you’re not just playing for today, and this year’s decision doesn’t have to be the decision for the rest of your life.
Scott:
I’ll go a step further. I think that there’s a room for a CFP or a tax professional in this, and that at the end of the day, you’ve just got to understand how to play ball here. Let’s use your example. We actually have three case studies here that I’ll go through later on in the in the deck. But for example, if you know you’re going to go over the MAGI cliff anyways and you have a big pre-tax balance, maybe you just Roth convert up to the 20 or 22% tax bracket that year because you’ve already lost your subsidies and you might as well take advantage of the fact that you’re not going to get any. So you’re going to go big and convert.
Maybe you work half the year, and so those subsidies aren’t even a big deal, and you’re firing then, and then that’s, you know, that’s another component of this. The giving is another component of that. Maybe you do that in a high tax year, or maybe you do that to maximize your subsidy in a year if you’re afraid they’re going to go away in a few years. Like, that’s why you have to understand and stay stay abreast of all these things and understand the conflicting frameworks. And we’re only on framework two here, right? We have our theoretical, you know, in isolation, idealized withdrawal order of operations, and now we’ve got the healthcare subsidies.
Framework three, by the way, if you want to play around with those healthcare subsidies, go to biggerpocketsmoney.com/healthcarecosts. I built a calculator. I’m not shy about telling everybody in the world that I built this calculator. I’m very proud of it. It was a lot of work. Go check it out and it will help you kind of understand these. There’s a little dial that helps estimate the subsidies in your state this year, and there’s a projection for the next 30 years there as well.
Mindy:
Yes, Scott built an awesome calculator. He’s going to be too modest to say how fabulous this calculator is. There’s all sorts of things you can play with. And this is the biggest question that people have about early retirement. How am I going to get healthcare? There’s a lot of moving parts to healthcare. So understand what your costs are going to be, not only now in your 30s and 40s, but when you’re my age in your 50s and 60s, your healthcare costs go up.
Scott:
Okay, so that brings us to the third framework, which is use the standard deduction and the 0% long-term capital gains tax brackets. So if you’re married filing jointly, you get a $32,200 standard deduction in 2026. That’s a big deal. That’s a lot of income. Like effectively all the interest income from your emergency reserve or high yield savings account, if you have REITs or rental income, like those can all go in there, and you can have a 0% tax bracket up to a pretty reasonable amount of income there.
And then there’s the 0% long-term capital gains tax bracket, which stacks on top of ordinary income. So let’s say you realize 32,200 in ordinary income, and then you have another $98,900 in long-term capital gains, you paid zero federal tax. Now, some states may charge you tax, so you can play around with that kind of stuff, but that’s a really valuable gift from the tax code to early retirees. And we want to take advantage of that.
But we should know that those income sources count towards MAGI. So they are going to impact your subsidy. So it may be in your state that you don’t want to in some years take advantage of the $98,900 0% long term capital gains tax bracket for a married couple joining, because that may actually reduce your subsidy by more than whatever those benefits are. And again, that’s why this is so hard, right? We’re only on the third framework here, which is we want to use the 0% long term capital gains tax bracket, we want to use the standard deduction, but we also want to keep in mind the trade-offs that come with that in terms of our subsidies for health care. And we want to also think about how that intersects with the ideal order of operations for withdrawal sequencing.
Mindy:
Scott, at the bottom of this slide, there is a link to an article that I wrote about the 0% capital gains tax bracket and how you can take advantage of it in a couple of different ways. The tax gain harvesting can also be part of this 0% capital gains. And the tax gains harvesting is actually something I want to talk about with our listeners who are not yet financially independent.
Capital gains harvesting is selling investments that have appreciated in value while staying under your income bracket’s 0% or into the 15% if you have a lot of these gains that you want to realize, to lock in the gains tax-free. And then you are opting to rebuy if you choose the same or similar assets to reset your cost basis higher. This is something that I wish that Carl and I would have done over the years. Our cost basis on Tesla is incredibly low. So when we go to sell, the amount that we’re selling is almost entirely taxable.
If we would have reset our cost basis, and trust me, we had some years that we had some room in that 0% long-term capital gains bracket. If we would have reset it, our cost basis wouldn’t be so low anymore. We still get to own the stock. There’s no wash sale rule with the capital gains harvesting. This is a really interesting strategy that I want to encourage our listeners to go and check out. There’s an article in there called at biggerpocketsmoney.com/capital-gains-harvesting, and we’ll include a link to that in the show notes as well.
Scott:
Love it. We’re through three frameworks now, right? Our withdrawal sequence that we want to do in a perfect fictional world, which is, you know, the the the taxable, pre-tax, and then the Roth, right? With some other other components in there like cash in income streams and the HSA as a bridge or liquidity source when we need it. We’ve got the healthcare subsidies and we’ve got our 0% long-term capital gains tax bracket and the standard deduction and using those up and how they intersect and conflict already.
Now we’ve got to layer in our target portfolio, right? And the target portfolio, we’ve had many brilliant people with conflicting opinions on the BiggerPockets Money podcast talk about what portfolio you ought to have in early retirement. And and we don’t give specific portfolio advice here, but we’ve had certainly had very strong opinions represented on the show. And I think four of those buckets that have emerged here are the all equity portfolio, just keep it all in the S&P 500 and accept the the larger volatility. The stock bond, you know, 80/20, 60/40, 90/10, whatever it is that you’re comfortable with. The risk parity or golden ratio portfolio where we have got multiple uncorrelated asset classes in differing amounts and constantly rebalance towards that target portfolio by selling off the the relative winners, the the positions that are highest. And then we’ve got we’ve had Paul Merriman come on and talk about tilts like factor investing, small cap value, international small cap value, those kinds of things.
So you’ve got to pick one of these. And I will say that as as time goes on, for early retirees, I’m personally more and more leaning towards the higher equity concentrations. I I briefly drifted off that a few years ago. But as I’ve learned from these experts, I’m like, hey, it is a really long time horizon. There’s going to be volatility. And I think that those those all equity portfolios including these factor tilts have a certain appeal to me personally that make them more interesting here, especially if you’re worried about, you know, risk in the S&P 500 or whatever. There’s the there’s a really good and compelling evidence from the factor tilts that Paul Merriman and Ben Felix have shared on the on the show here that have really swayed me and made me feel more comfortable with higher equity concentrations there. So, that’s one man’s view, but there’s a lot of conflicting opinions on this and depending on whether you want to draw down or spend more than, you know, a three and a half or 4% withdrawal sequence, there are other portfolios that have good arguments for them.
So you’ve got to pick a portfolio as the fourth framework. We won’t spend too much time on this because we talked about that on other shows, but what that now has to intersect with is where that portfolio goes. So the fifth framework is asset location for that portfolio. And now we’ve got to say where we want, like let’s say we have our risk parity or stock bond portfolio. Let’s use the stock bond portfolio for the simplicity here. I’m targeting a 60-40 stock bond portfolio. I’m going to keep my most aggressive positions, as a rule of thumb, in the Roth and my HSA. I’m going to keep the most conservative positions in the traditional or pre-tax IRA. And I’m going to use my taxable brokerage account to balance that distribution, right?
So let’s say I have 30, 40, 30, right? 30% of my wealth is in pre-tax, 40% is in after tax, another 30% is in my Roth. Well, I’m going to put the 30% in my pre tax account into the bonds. I’m going to put the 30% in my Roth into the stocks. I’m going to use the after tax brokerage position to bridge that gap. And so that’s kind of the rule of thumb there. In reality, very few people have this balance in these ways. There’s always a really big third or, you know, a different position here or that old stock investment that was one off from back when you used to pick stocks before you switched over to index funds. That’s now a huge position and you’ve got taxable consequences for for realizing that gain and moving towards your target portfolio. So that conflicts with this framework, and that’s probably arguably a seventh or eighth framework that we have to talk about here. But these assets and these right accounts and then rebalancing as we withdraw or decumulate towards that target portfolio, that’s the the next piece that needs to come up here. And again, that also intersects with MAGI, with the right decumulation sequence, with the way that we think about harvesting the 0% long-term capital gains tax bracket and the standard deduction. So it gets very complex here, but that’s the fifth framework is the right assets in the right accounts.
Mindy:
I think this is really good, Scott. I think that this is a lot more complicated than even we have alluded to in the past because there’s so many moving pieces. And when this turns a little bit, then this one turns too, and then this one turns, and you’re like, oh, wait, I didn’t mean to turn this one so much. So understanding what is going to affect all of the different things that you want or don’t want them to affect is going to be key to having as optimal as possible, which is not possible, but as optimal as possible, a withdrawal strategy. My goal in retirement is to reduce the taxes that I’m paying.
Scott:
When?
Mindy:
When?
Scott:
That’s the question, right? Like I I want to reduce taxes too. But do I want to reduce them now, or do I want to reduce them in the future? And that may be a big decision. And that that’s where we come back to a world view, because here’s what a linear thing would look like in a nice, smooth continuum. The real world is going to have a Monte Carlo, right? Where things are going to go up in some years and down in other years, and the tax code is going to change. Maybe it gets even lower. Maybe it goes up. Maybe it goes way up. And so we all want to pay lower taxes. How do we do it? I don’t know.
Mindy:
Oh, don’t look at me. I don’t have the answer. I’m still searching for them. But but I think that’s really important, Scott, is to your worldview. I do want to pay all of my fair share. I am not a taxation as theft person. I think that taxation funds the roads and the schools and and the police department and the fire department and all the things that you need in a society. But also the government sometimes tends to waste my tax money, so I want to keep as much of it as I can. That has always been my goal, which has caused me to be a little shortsighted.
So now I am looking with my worldview and seeing all the things. Here’s a maybe some breaking news, Scott. I am going to die. I hope it’s not for a really, really long time, but eventually I will cease to live. And I want to leave my children the money that I have. And I want to do it in a very optimal way, tax wise. So now all of my money, I love your your middle point here, don’t overfund your pre-tax. Thanks a lot. I could have used that information about 25 years ago, Scott. Where were you? Fifth grade?
Scott:
Yeah, well, and look, I get that that’s controversial. I don’t think it’s that big of an issue. I think it’s going to be a real problem for many of the BiggerPockets Money listeners in particular. I think, you know, again, if you’re in the Lean FIRE or Traditional FIRE camp and have very very, you know, modest spending or wealth targets to achieve financial independence, that’s great. You may not have this problem. I think that there’s a fair argument that this is not something to worry about nearly as much. But if you’re in that Chubby or Fat FIRE range and you have a huge balance in your 401k, you have this problem. And now that’s going to be a for me, I think, one of the top tax planning items for the next, you know, few decades is how do I get that money out and when do I pay the taxes and how do I manage that effectively?
So that’s going to be the problem here. And that brings us to the last framework here, which is have a a worldview, right? I shared this earlier. I think my worldview is that for me, I will be in a high tax bracket for most of my adult life, and there’s a good chance, I believe that tax brackets go up for folks like me that are high earners and have wealth that is compounding. and that will be taxed. And so if all else is equal, then I’m willing to pay a little bit more tax right now to reset my basis to convert, you know, pre-tax positions to Roth, those kinds of things. And I understand the gamble I’m taking with that. And that may not work out. It’s an unknowable. It’s a political bet, right? But that’s a worldview I have that then informs the rest of the strategy. You need to write that down, I think, about what you believe, right?
Maybe you believe, listening to this, maybe somebody else believes that, um, hey, I’m gonna I’m going to have a $1.5 million position and I’m going to draw it down and I’m not going to ever really get into these high income tax brackets and I don’t think that they’re ever going to go up for me for people like me, you know, materially. So I’m going to keep my taxes low now and I think that they will be low for the rest of my life. That’s a very coherent and and valid worldview. Just make sure that you understand that that’s what you’re betting on here because I think a lot of advice in the space fixates on that lower kind of modest FI number and presumes that if you have larger balances, that’s a good problem, who cares? I care. I think that’s a big deal for some people and I think you got to understand that.
The second worldview you got to have, I think is is around kids. How much do you want to leave and when? Mindy, probably a good idea if you to get a state planned if you’re trying to leave money to your kids.
Mindy:
If you listen to the show, you know that I recently did finally get an estate plan.
Scott:
Oh, good. Okay.
Mindy:
Now that my oldest is an actual legal adult.
Scott:
Well, great. So so yeah, so you got to have that. And then and then you got to say, okay, how do I want to leave it? And and any money you leave in the 401k needs to be distributed and there’s going to be ordinary income, and that may be left to your kids in their high income years, which is very tax inefficient. That’s one of the reasons why we want to get that money out of the 401k, if we can, in lower income tax brackets here.
I think the third worldview we got to have is is this concept of drawdown nerve. Is that got another framework here? What do I want from a drawdown perspective here? And I’m I’m still building this. I’m not yet confident enough to fully publish my Monte Carlo simulation here. But what I’ve found is is when I think about, you know, running a portfolio and assessing risk, I want to zoom in on those tails, like the worst case scenarios here. So if I have a two and a half million dollar portfolio, I want to look at the absolute worst tail out of a, you know, several thousand simulation history. I want to look at the bottom second percentile, the bottom fifth, the bottom 10th. I don’t care about the best one, right? I know that there’s potential I win huge and my portfolio goes up, but I don’t want to look at that.
And what a golden ratio or risk parity portfolio, for example, does, that’s designed to be decumulated at a high rate, is it it pushes out, it it makes these worst case tails, it pushes them out, and it really does a good job of protecting you over a 30 or 40 year retirement. It’s very, you know, you have very few failures in there. But over a a 60 year retirement, for example, if you go to a stock portfolio, you get way, way, way, way better outcomes over that period of time in almost all situations that that explode your wealth, you know, if you’re using using historical or, you know, average return data here, compared to that golden ratio. So it’s not really a decumulation portfolio, but if you do that and you adjust your spending down, all of a sudden you have enormous outcomes and you have to start zooming in further and further on the tail to even begin to to comprehend what’s going on in the worst scenarios.
So I think that there’s a real, like a world view for the FI community of, are you actually going to become comfortable drawing down your portfolio at age 40 through to age 65 and ending with less wealth than you started with, right? The 4% rule, in many cases, you end up with more wealth, but in many cases, you don’t and you just don’t run out of money, and that’s success with the 4% rule. And I think that’s going to be very mentally challenging for a lot of people in the community. And a portfolio that’s a little more conservative that pushes you, you know, you know, where your drawdown, you draw a little bit less can not only, you know, never run out of money, but also begins to compound your wealth over time and increase your options throughout your FI journey. And I think that that’s going to be, you know, heresy in the FI community, but also something that a lot of people are going to be drawn to if they’re honest with themselves around it. So I think that’s something to consider about yourself. What is your worldview on tax rates, your kids, and whether you really want to actually draw down your portfolio or if you want to go that extra hair of conservatively so that your portfolio compounds forever and your spending can increase across your your FI journey there. And I think that plenty of people that are kind of in this cusp FI or fine work in an extra couple years or doing a little bit of side business or whatever to get that option, that’s a very powerful component here. And you got to you got to be honest with yourself about that.
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Mindy:
Scott, last week in our newsletter, I sent out a couple of articles. One of them was called, “What would it take to make you feel secure?” And this was one of the most clicked on articles last week in the newsletter. Basically, I’m asking people, you know, why is it that you don’t feel secure? I have conversations with people coming through Longmont. I see them at CampFI and Economy and all these different FI events.
And I get a lot of the same conversation. I think I’m FI, but I’m probably just going to work one more year. And you look at their numbers and you’re like, you could have a 1% withdrawal rate and you would still be okay. You know, 1% is more than you need and you’re still not ready to retire. I want people to start thinking about what is it that is holding you back from your retirement because I think there’s going to be a lot of people who are in the FI community who never retire because there’s nothing that’s going to make them feel secure.
That’s not a money problem. That’s not a math problem. That’s a psychological problem. I’m going to send you to The Psychology of Money by Morgan Housel. That’s an amazing book. I’m going to send you to my article at biggerpocketsmoney.com/security. What would it take to make you feel secure? I want to know why people don’t feel secure to leave because I have a lot of friends who are retired, and it’s all working great for them. Yes, we’ve had a really great run in the stock market, but most of my friends who have retired have backup plans and backup plans and lots of ways to fund their lifestyle should something change.
Scott:
I also think that the community is too hard on people who are working one more year in many ways. Like this is like a bad thing. Some people like their job and want to pad it and understand that, hey, I can, if I work another year, I can be in all stocks for the rest of my life, compound forever, and still support my lifestyle for that. And and I’m fine with that. That’s not like I’m not like sacrificing my retirement to get there. I actually don’t mind doing that. That sounds great. And and I’m I’m I’m happy with where I’m at in my life. Like that’s fine. That’s different than I’m scared to retire when the numbers say I should or I hate this situation and I’m grinding it out to mass millions I’ll never spend. Those are different. And I think like it’s too simplistic to say that’s unhealthy to to work that extra year. I don’t think it is. I think it’s I think that that’s a that’s a preference and many people seem to be really happy with that preference. I think these things are certainly get challenged.
So anyways, have a world view. And then note that we’ve got these six frameworks, right? We’ve got the withdrawal sequence, we’ve got the MAGI cliff, the health care subsidies, we’ve got using the 0% long-term capital gains tax bracket and the standard deduction. We’ve got our portfolio that we want to target. We’ve got our asset location as the fifth framework, and we’ve got our sixth framework of our worldview. And they wait one another, right? There’s, like, which one’s most important? I don’t know. It depends on your situation. If you’re right on the cusp of that cliff, maybe MAGI becomes the most important consideration and begins to trump the other items in your stack here. Maybe if your have a huge 401k balance and you’re going to be over the MAGI cliff anyways, it’s getting that balance out of the 401k and into your your Roth. It’s just going to be so context dependent. And that’s why it’s going to be so challenging.
So I thought I’d illustrate this with three case studies here with three fictional people who I call Barb, Kevin, and Eileen. Barb has got her pre-tax bomb that’s going to become an RMD problem. It’s going to become an RMD problem. She really does have an RMD problem here in this situation is if, you know, 45 year old early retiree with two and a half million, mostly in her 401k. Kevin, you know, got a two million dollar net worth and has half real estate and then half stocks and bonds in his portfolio. And he’s going to handle things differently than Barb and I’ll I’ll get into.
And then I’ve got Eileen. Eileen is actually inspired by a local political candidate, Eileen Lawbacker, who is the challenger to Lauren Boebert, who actually represents our district right now. So Eileen is a retired military and they she’s got a $1.5 million traditional stock bond portfolio spread across pre tax, post tax and Roth or they’re equivalents from the military. She’s got a $50,000 pension and she’s got a $20 to $60,000 side hustle going on. And that variable income and that ordinary income from the pension also impact how we’re going to think about decumulation, right? And how these frameworks intersect. So sound good, Mindy? Should we go through these frameworks here?
Mindy:
Yes, Scott, let’s start with Barb. This one is near and dear my heart because I have a pre-tax balance that is going to become an RMD problem.
Scott:
So Barb’s got, you know, let’s call it two million over two and a half million is in the 401k. We’ve actually talked to several people that have very similar setups here on the BiggerPockets Money podcast in the past. So I’ve had a couple of of thoughts here. So first is, let’s assume in this, you know, first year, you know, Barb is about to on the cusp of of financial independence. She’s working. It’s it’s mid, it’s July right now. She’s already got health insurance for the first six months of this year. Maybe for 2026, you know, we’ve got a $50 to $100,000 in income so far. Maybe this year, we decide, you know what, we’re going to go over the MAGI cliff and we’re going to do a big Roth conversion up to that 20% federal tax bracket or the 22% federal tax bracket.
And I’m going to do that in the year when I’m not going to have the MAGI cliff anyways, or I’m very likely to go over that anyways. Maybe that’s a consideration that Barb brings to her CFP or tax planner because she can make a big dent in that balance in the first year and then spend the rest of the years catching up to some degree with conversions downstream. Maybe in a second year, if the balance is really big, she does it again and we forgo those subsidies and go big on that rollover because those healthcare subsidies will be more and more impactful with each year as she ages as the premiums increase. And then from there, we we optimize for the MAGI subsidies going forward and we’ve got a more balanced position, right? So you can see that that’s one way to apply this framework. Maybe that’s not appropriate for Barb in this situation. Maybe there are drawbacks, but those are the types of questions that I’d be looking at thinking about in the Barb situation in particular with that pretty hefty pre-tax balance, because that is my number one goal is to get that money out of there. And I’m willing to maybe relax on the optimization across some of the other frameworks in order to get it out.
Mindy:
Okay, let’s look at Kevin’s situation.
Scott:
All right, so Kevin’s got a completely different situation, right? Kevin’s got two million bucks and that’s half in real estate, half in stocks and bonds. Now, the depreciation on his rental portfolio is offsetting the cash flow that his portfolio is generating. So Kevin could conceivably have very little if any taxable income from his rental property portfolio in the first few years. And so Kevin has a good chance of avoiding this MAGI problem because his taxable income will be so low. That may give him a lot of Affordable Care Act room, and he may be able to go a little bit more aggressively in filling up those tax brackets. So Kevin, as a real estate investor, there’s certainly drawbacks to real estate on the journey where, you know, he may not have gotten the cash flow he wanted or whatever. But at this point, at the end, there could be some really big advantages because that wealth is actually translating to spendable liquidity for him in a way that it might not be for Barb. And so he can maybe optimize a little bit more for taking advantage of that long term capital gains tax bracket, 0% tax bracket, and his full standard deduction here with Roth conversions, for example. So that may be a game that Kevin is looking at in his first few years of early retirement in contrast to Barb.
Mindy:
Okay, and what about Eileen?
Scott:
So Eileen, I think is interesting because Eileen’s going to have variable income. I framed it as, hey, one year, she might make 20k from her side hustle, and another year, she might make $60,000 if she gets elected and defeats Boebert, right? So now we’ve got a difference in how we’re going to think about our tax optimization here, right? So the first thing I’d be thinking about for Eileen is because she has self-employment income from her side hustle, there’s a circularity here, but she should be maxing out her HSA because that offsets MAGI and she should be tracking all of her health insurance premiums because she can deduct those against self-employment income.
That’s circular, so she wants to stay far away from the MAGI cliff if she can in most years. But that’s a really important benefit for her and that HSA is going to be directly offsetting her MAGI in her situation because she’s self-employed. By the way, a big vote in favor of some kind of self-employment some years in early retirement. There’s a whole bunch of reasons for why that’s why that’s powerful. And also it’s poo-pooed by a lot of people, a certain portion of the the FI community. But in Eileen’s case, it’s very powerful.
Now, in a strong year, let’s say she has a big year, makes like 100 grand from her side hustle. It goes really well, and she’s going over the MAGI cliff. Well, okay, she’s not going to get subsidies this year, but maybe this is the year where we, again, because we’ve missed that MAGI cliff, maybe this is the year where we do a fairly large Roth conversion of some kind and begin moving that money out of the 401k into her Roth. So you can see why in each of these situations, we get to a different conclusion about how we want to make optimize our our positions here, right? We want to think about the intersection of these six frameworks and make a choice that’s right for us in each given year, knowing that the optimal approach is going to be dependent on a large number of unknowable factors. So this is kind of why it gets so complicated here.
Mindy:
It is complicated, but it’s a lot less complicated once you start seeing how everything interconnects.
Scott:
Because this is complex, I think that one of the ways to get you started on this journey is you just take this deck, we’ve been presenting a deck here for those who are listening on the podcast. There’s not really that many visuals that you missed, so you can watch us on YouTube. It’s always great, but this is fine if you’re listening to it on the audio. But take this deck at biggerpocketsmoney.com/withdraw, download it, and upload it to an AI. And then think about talking about some of the high level number, you don’t want to give him accounts or anything like any of your personal data. But you can begin playing around with these frameworks with the AI grounded in this structure, these six trade-offs, right? If you don’t ground it in the structure, it may give you something very generic that’s very dangerous.
Then you can take that, and you can learn a little bit and understand these trade-offs and have an opinion when you go to your, you know, tax preparer or your financial planner to begin thinking about these things. So that’s the approach. I hope that that’s helpful. I think this is going to iterate a lot in the coming years and you can see why if you talk to the tax guy, you’re going to get a tax opinion. If you talk to the, you know, the the portfolio guy, you’re going to get a portfolio opinion. If you talk to the estate guy, you’re going to get an estate plan opinion here. And you really got to address all the frameworks and ideally not bias any of them going into the conversation except for what you think is most important in your situation. Again, this is not like a potion you can brew up by following a recipe. You’ve got to understand the interlocking frameworks, the conceptual goals that we have here, and the trade-offs. There’s no right answer if you want to do this the right way for you.
Mindy:
Yeah. Scott, I really appreciate you writing this all down and taking the time to create these slides. I think this is really, really helpful. What’s that URL again to find these slides?
Scott:
biggerpocketsmoney.com/withdraw.
Mindy:
Okay, that is great. There’s also on biggerpocketsmoney, we have a ton of resources for you. Scott has been busily coding and working with our tech team to create a whole bunch of things. You can keep up to date with these if you subscribe to our newsletter, which you can do on our website, biggerpocketsmoney.com. We also have calculators, like I said, templates for you to really help you on your path to financial independence. And hey, Scott, what’s the latest thing that you guys created? It’s a forum, a place where you can come and ask questions of Scott and I, chat with your other fellow BiggerPockets Money listeners on our forum. You do have to create an account, but you can find that all at biggerpocketsmoney.com.
Scott:
Yeah, and the goal for this forum, by the way, is to allow people to ask questions anonymously, but for all replies to be from real people with their real names. I think that that will foster a healthy discussion where we can talk about numbers transparently, but also, you know, get real people responding to them versus anonymous handles that you don’t know who they are. So I think that that hopefully that’s helpful. We’ll see if that experiment goes anywhere, but I’m excited about that. The biggerpocketsmoney.com forums.
Mindy:
Yeah, I am super excited. And so we hope to see you there. All right, Scott, should we get out of here?
Scott:
Let’s do it.
Mindy:
That wraps up this episode of the BiggerPockets Money podcast. He is Scott Trench. I am Mindy Jensen saying, see you soon, loon.
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