Whitecoat Faceoff: Unballing your Yarn

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One of the most valuable things about writing regularly, is that it frequently brings into stark relief my own biases.

Many of the errors that I make come from a place of utter blindness.

Although I’d like to think of myself as a fairly empathetic dude, it becomes clear that I spend all of my time staring out at the world from my own unique lenses.


(The Hanson brothers stole my lenses.)

My understanding of the tax code is admittedly skewed towards the world of high earned-income earners.

My budgetary priorities are those of someone in the early accumulation phase of their life.

My idea of frugality, is pretty minor league.

And the list goes on.

But publishing my own little thoughts in this format opens me up to challenges from people with different perspectives.

Which is like trying on their lenses for a while and snapping out of my own unconscious myopia.

And one of my biases is that I’m an accumulator. So Right now I’m overly focused and saving more and investing it wisely.

As a result I post about legal tax avoidance, and saving money with travel hacking, and the variable value of spending.

But the supposed point of all of this saving is to one day build up a large enough nest egg to live off of the passive income that it will provide.

So what about then?

Which brings me to the Whitecoat Investor’s reason number six why you shouldn’t retire early.

You’ll have to figure out how to get your money out of retirement accounts before age 59 1⁄2. Both IRAs and 401Ks have a 10% surcharge if you want your money for early retirement. Now there are several ways to get at least some of your money out without the penalty, but a traditional retiree doesn’t have to deal with any of them.

Which is a good point. After all, as you know, I advocate for saving every dollar possible in tax-advantaged retirement accounts. (Because untaxed money is more valuable than taxed money and is thus able to more grow more efficiently and compound over time, which means you will need less time to reach financial independence saving pretax dollars.)

But how do you get your money out of your tax advantaged accounts, once retired,  without paying penalties?

The best article I’ve seen on the subject is this one from Mad Fientist. 

In it he focuses on two strategies.

1. The Roth conversion ladder. 

This approach involves converting a standard amount of money each year into a Roth IRA.

(And remember that if you keep your spending under control in retirement this conversion will be entirely tax-free.)

After five years, assuming that you keep the yearly conversions up, that same amount of money can then be withdrawn tax-free from the Roth  each year until age 59 1/2 (when the money can be withdrawn without penalty, regardless.)

Of course you will need enough accessible money your expenses during your first five years of retirement either in a taxable account or a 457 retirement account (my plan.)

2. Substantially Equal Periodic Payments.

It turns out the IRS allows you divide your retirement savings over the rest of your life expectancy into a series of equal payments.

As long as you withdraw precisely this amount of money at regular intervals until you turn 59 1/2 , you will not have to pay any penalty on it.

-Other ways of accessing your retirement money not mentioned in The Mad Fientist article are:

3. Withdrawing from your 457 plan. (There are no penalties for withdrawing from this type of plan once you have separated from your employer. )

4. Withdrawing from your health savings account for previously deferred qualified medical expenses.

5. Withdrawing (at least 5 years old) principle from your  backdoor Roth IRA.

6. Withdrawing principle from your (at least 5 year old) conventional Roth IRA.

7. Withdrawing from previously accumulated cash value life insurance policies. (If you don’t know what this nasty financial product is pretend you never read this. It is a terrible product to invest in. Really.)

So as Whitecoat Investor admits, there are a lot of ways of accessing your money penalty free.

Which leaves us with really only the-“but the traditional retiree doesn’t have to deal with any of them”-part of his argument.

Which I think is pretty easy to pick apart.

Point 1: Unlike the yet-to-be-59.5 year old traditional retiree, the early retiree does not work anymore.  Given this fact, I think It’s safe to assume that he has plenty of time to spare a few hours of each year managing backdoor Roth conversions.

Point 2: The early retiree is flipping financially independent! Complaining about the burden of managing your own stash in early retirement reminds me of the high school girl who loudly complains to her friends about being “too thin.” Everybody resented that girl.

So the key points here are,

  • There are many clever ways to access your tax-advantaged retirement funds prior to age 59 1/2.
  • From this realization it follows that you should load up your tax advantaged retirement accounts while young and employed to the greatest extent possible for you.
  • There still aren’t too many convincing reasons not to aspire to achieve early financial independence.

If you’d like to see the prior posts in this series:








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7 Responses to “Whitecoat Faceoff: Unballing your Yarn”

  1. Robert May 30, 2014 at 5:07 am #

    Alexi, I enjoyed reading this post. Several good points. I am basically there, at the point in life you are talking about. (Retired couple years ago at Age 53). I have a pension, so situation is a little different. But still, a lot of money tied up in tax-deferred accounts. When/how to withdraw is indeed an issue worthy of careful consideration. The Rule 72(t) procedure is appealing in many respects. That is my backup if I need it. But I’m focused on ROTHs. In that regard, a couple quick points:

    1) I might be wrong, but I believe your point #5 is slightly incorrect. You said, “5. Withdrawing principle from your (at least 5 years old) previously contributed backdoor Roth contributions.” I think it might be more accurate to say, “5. Withdrawing principle from your previously contributed backdoor Roth contributions provided the account was established at least 5 years ago.” i.e., I believe the contributions don’t have to be 5 years old, just the account. Correct me if I’m wrong (I’m leaving in a few minutes and haven’t time to research this, but that is my memory).

    2) I did a conversion of IRA to ROTH IRA funds last year with the intent of pulling that out in 5 years (5 years DOES apply to conversions). But as I’m gearing up to convert another chunk this year, I’ve been starting to question that strategy. I need to do more analysis, but things that bother me: (a) 5 years is a relatively short timeframe for equity investments, and the market could go down leaving my ROTH account with a loss for which I get no tax deduction; (b) if one’s retirement income is low enough to be able to capture LT cap gains tax-free, one is missing out on those if money is tied up in a ROTH. It may make more sense just to convert IRA money into a regular taxable account and harvest gains/losses than convert to a ROTH with 5-year lockup. Yes, you pay a 10% penalty, but do the math. It might make sense depending on your situation. I’m still studying this in my case, as the spreadsheet gets rather complicated. But it is something I’m chewing on.

  2. Miles Dividend M.D. May 30, 2014 at 6:18 pm #

    1) Robert you are correct. And the worst part isn’t even the incorrect statement, it is the horrible writing! See if the new incarnation is more to your liking. It’s still not well worded.

    2)I have some questions about this one.

    How can you harvest tax losses from a traditional IRA? It seems to me its a wash from the tax loss harvesting.

    At your age wouldn’t a ladder strategy be unnecessary since you will be 59.5 before it matures?

    • Robert May 30, 2014 at 6:47 pm #

      (1) I think you still have it wrong. I believe it can still be a backdoor or converted ROTH. The key thing is that the ACCOUNT has to be at least 5 years old. If a conversion, then the contributions (each of them) has to be there 5 years IF you are withdrawing them before 59-1/2. Here’s a good brief summary of the rules: http://online.wsj.com/news/articles/SB125754645803734655
      (2) Can’t harvest losses from a traditional IRA. What I’m debating is whether it might be better to move funds from an IRA to a taxable account rather than convert them to a ROTH. Even though have to pay penalty, that way can harvest LT cap losses/gains.
      As for the ladder strategy question, the reason to still convert an IRA to a ROTH would be to escape mandatory min. distributions at Age 70-1/2, and to move money into a non-taxable format so that when I take distributions it won’t reduce future Social Security benefits. If I left it in an IRA, and then took distributions, that would count as ordinary income and would reduce my after-tax SS benefit (tax torpedo effect).

      • Miles Dividend M.D. May 30, 2014 at 8:25 pm #

        I guess I misunderstood your intentions because of this statement,

        “I did a conversion of IRA to ROTH IRA funds last year with the intent of pulling that out in 5 years,”

        You will be able to pull the conversion principle out the minute you turn 59.5. (That’s how read the WSJ article.)….

        “If you already are 59½ and you convert traditional IRA assets to a Roth, you can withdraw the assets you convert at any time without worrying about a five-year deadline or penalties.”

        The tax torpedo effect is interesting, but seems to be a slightly different issue.

        Oh and I edited 5 and added a new 6 to my post…check it out.

        • Robert May 30, 2014 at 8:36 pm #

          You are correct. I’d only have to wait about 5.5 years to be 59-1/2 so it is only a half year period we are talking about. That’s more a backup plan, i.e., if I should need the money then, that’s an option. Otherwise, the primary objective is simply avoiding RMD at 70.5 and staying in a low tax bracket to maximize SS benefits once I start drawing those.

    • Robert May 30, 2014 at 6:51 pm #

      Oh, and I should mention that I do have one other unique characteristic that drives me on the IRA to ROTH (or maybe taxable account) conversion. That is that I will star receiving a second pension from another company in a couple years or so (whenever I trigger it). That will kick up my income, leaving less headroom before exceeding the 15% tax bracket. So it makes sense to do those conversions now while I can pay the lower tax rate on the distributions. By the time I’m 59-1/2, I expect to be in a higher tax bracket, and even more so by 70-1/2 (assuming investments do OK). So it is advantageous for me to move that money now.

  3. Miles Dividend M.D. May 30, 2014 at 8:26 pm #

    interesting. Simple tax rules become complex in a hurry.

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