Deep Dive: Set Yourself Up to Pay No Taxes in Early Retirement

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If you’re normally a “casual commute” listener of The Money with Katie Show, prepare to park your car and whip out your notebook—today’s episode is a complex deep dive into exactly how you can set yourself up to pay no taxes or penalties in retirement on any of your pre-tax, taxable, and Roth funds, even if you retire in your thirties.

We’ll dig into how much a couple would need to save and invest to retire early and then break down how they can strategically access those funds for the most optimal tax-free outcomes. Remember to caffeinate before this one—your brain cells are about to be workin’ and twerkin’.

If you’re a visual learner, the YouTube video for this episode or the episode transcription may be your best friends.

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Our show is a production of Morning Brew and is produced by Henah Velez and Katie Gatti Tassin, with our audio engineering and sound design from Nick Torres. Devin Emery is President of Morning Brew content and additional fact checking comes from Scott Wilson.

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Mentioned in the Episode

• IRS Tax Code: https://www.irs.gov/privacy-disclosure/tax-code-regulations-and-official-guidance

• Standard deduction for 2022: https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2022

• 0% capital gains tax rate brackets for 2022: https://www.kiplinger.com/taxes/capital-gains-tax/602224/capital-gains-tax-rates

• Required Minimum Distributions (RMDs): https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmds

• Roth IRA Five-Year Rule: https://www.investopedia.com/ask/answers/05/waitingperiodroth.asp

• Compound interest calculator: https://www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator

• Combining finances for marriage: https://moneywithkatie.com/blog/what-to-consider-when-combining-finances-with-your-partner

Katie: Welcome back to The Money with Katie Show, #Rich Girls and Boys. I am your host, Katie Gatti Tassin. And this week, we are diving into the weeds together for one of my favorite topics: the little-known ways to use your own investment gains later in life without paying any taxes on them. Also known as how #RichGirl millionaires don’t pay any income tax. This is my Super Bowl, and by the way, this episode is going to be pretty numbers-heavy. So if you’re a fairly visual person, I recommend also tuning into the episode on YouTube or reading the episode transcription afterward.

Let’s begin with a little bit of context. When we say the word “millionaires” colloquially, we could be referring to people who have jobs or people who don’t have jobs. In this context, for this episode, it is safe to assume from here forward that when I’m referring to the hypothetical “millionaire,” I am talking about someone who no longer has a job, so we can use the word “retired” to describe them, sure, but what we really mean is regardless of age, this individual is now at the point where they’ve amassed enough wealth that their investments are probably paying them more than their typical work or labor would.

After a certain point, if you are generating a hundred thousand dollars per year from an investment portfolio, will you feel as motivated to work 40 hours a week to earn another hundred thousand? Maybe, but no, probably not. So here you found yourself with at least a million in the bank, and now it’s time for the fun part: using the money. Before you push back and say, well, I’ll never have millions in the bank, keep listening. Because at the end of this episode, I’m going to do an example that shows how much money a married couple would have to earn and invest between ages 25 and 45 to end up with roughly $2 million and leave traditional work behind. It’ll be less than you think. So stick around. But if you’ve never given any thought to how you’re going to use that money, like the logistics—which accounts you’re going to pull from, the when, the why, the how—in the most optimized way possible, you’re now faced with a dilemma. Say you were a devout Money with Katie listener during your wealth accumulation years. So you’ve got the tax diversification thing down. You’ve got pre-tax funds in things like traditional IRAs, HSAs, and traditional 401(k)s. You’ve got tax-free funds and things like Roth IRAs and Roth 401(k)s. And you’ve got taxable dollars in taxable brokerage accounts.

Now, what do you do? Which do you use first? In what proportions? Maybe the biggest question: Does it matter? Yes. Yes, it does. It’s important to have this conversation now, so you can contribute the quote unquote “right” amounts to the right accounts. We have to set ourselves up for success, right? I’m going to break down the exact strategy for creating the most optimal tax-free outcome based on combining two things: the standard deduction and the entirety of the 0% capital gains tax bracket.

I’ll explain why these numbers are the most optimal shortly, but in the meantime, for the tax year 2022, a single person’s most optimal tax-free outcome is generating $54,600 in tax-free income per year, enough to spend $4,550 per month. A single person earning $54,600 will pay a whopping $9,265 in income taxes. But a single person generating that income from their investments will pay $0 in taxes. And I will show you how.

On to the married couple. A married couple’s most optimal tax-free outcome is generating $109,250 in tax-free income per year, which is enough to spend $9,104 per month. A married couple earning $109,250 would pay $18,368 in income taxes every year. But not you, dear married millionaires. You are rewarded for your responsible saving and investing, and you will pay $0 in taxes on your investment income if you know what you’re doing. So how is that possible?

Let’s keep going. Let’s talk age and account types. So one thing I know about you, if you are listening to this show, is that you’re probably interested in reaching this millionaire tax-free status before you are 59 and a half years old. So there’s probably some small part of you in the back of your mind tapping you on the shoulder and saying, “But Bridget, you are investing a lot of money in your retirement accounts, and those are not going to help you live the millionaire lifestyle in your thirties and forties, sis.” And on the surface, you would be right. These accounts are not designed to be used in your forties. And many of them often attempt to punish you for not playing by the rules. You want the sweet nectar of your 401(k) fruit tree at 35, you’d better be prepared to show proof of hardship, a first-time home purchase, or pay a 10% penalty. Except for the fact that there’s a great way around that, which we’re going to weave into our overall strategy today.

But before we start getting into the thick of it, let’s pause and get that brain fired up. Frequent Money with Katie listeners will know when that music starts, it means it’s time for The Money with Katie Quiz show. Okay. So according to irs.gov, my second favorite site after treasurydirect.gov, which ancient civilization revered the tax professional as the most noble person in society? Was it Greece, Rome, Egypt, or the Incas? That answer and so much more when we return.

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Katie: Welcome back to Money with Katie, my friends. Do you have your answer? Well, let’s see how you did. The correct answer is…the Greeks. I wonder if that still holds true today. Okay. So let’s start breaking this down. So you’ve got your money in your different investment accounts, right? You’ve got some nice tax diversification happening: you got your pre-tax, your Roth, your taxable. Let’s do Roth first. The first notable thing we’ll call out here is that your Roth funds are your most precious, and therefore, probably what we want to use last, okay? You’ve already paid taxes on the contributions. You will never pay taxes on any of it ever again, you know, legally and in a straightforward manner. So we want to leave those Roth funds to grow for as long as possible. They require no fancy footwork, because after age 59 and a half, we can use however much of them we want, whenever we want. Moreover, the funds in our Roth IRAs are not subjected to what’s called required minimum distributions in retirement, which is great, because RMDs occur when the federal government makes you pull out a certain percentage of your funds to realize the gains, and pay a tax bill on those gains. Roth funds are not subjected to this, which makes them even more valuable and flexible. So this is why we want our Roth funds to continue to grow for many, many years without being touched at all. So on your little mental scorecard here, you can just push those bad boys to the back burner to use later.

And at this point you might be like, damn, these Roth sons of bitches sound pretty good. Like why wouldn’t I just only contribute to Roth funds for everything that I can? Well, the main reason is because you get no up front tax breaks for your Roth contributions. And we love our current year tax breaks, since they create even more investable income for us, which is going to be most impactful for those in higher tax brackets. To put a finer point on this, I would say 22% and above marginal tax rate, and even lower than the 22% bracket, if you’re in a high tax state like California. So that’s kind of the gist on the Roth.

Let’s talk pre-tax and taxable, because this is going to bring me into the meat of our strategy: the combination strategically of your pre-tax and your taxable funds. So for the person listening who does not spend all of their time reading personal finance blogs (hashtag #guilty, anyone other than me), let’s be more specific here. When we say pre-tax funds, for most people, we’re going to be referring to things like traditional 401(k)s, traditional IRAs, SEP IRAs, and HSAs, though HSA funds don’t really give us that level of flexibility until age 65. So back-burner those two. When we pull funds from our pre-tax buckets, they are treated in our tax system like earned income, because technically you’ve never paid taxes on them before. And when you were investing them back in your youth, you were really just deferring that income to later. So you can think about it a little bit like you’re paying yourself a salary when you withdraw the money from the account later, and you’re going to be taxed on that quote unquote “salary” accordingly. So hold that thought. Pin that. When we say taxable funds, we’re referring to regular brokerage accounts, okay?

Brokerage accounts have no contribution limits, no penalties for withdrawing before a certain age, and no rules like the qualified retirement accounts do, but they also offer no tax incentives. For example, if you were to go to Robinhood or Fidelity and start trading stocks in an account that you open, technically you’re doing that within a brokerage account. Here’s where things get tricky while we’re accumulating wealth, and where we have to figure out how to strike a good balance. This is also why it’s good to understand this stuff decades ahead of time. And probably why most regular retirees today are more unable to take advantage of this, because a lot of these strategies have been popularized in recent years by FIRE circles of nerds who read irs.gov all day, and who weren’t traditionally part of the widely known financial planning playbooks.

So I won’t bury the lede any further. The goal is to strategically combine our withdrawal from our pre-tax account, like our 401(k), with a taxable withdrawal from our brokerage account, in order to take advantage of the way our tax system taxes both of those things, to pay no income taxes on any of it. Of course, we have to acknowledge the obvious. If we are 40 years old, we might think there’s no way to make withdrawals from our pre-tax accounts without paying a penalty or tax. This is why we have to get creative and take advantage of the rules around something called Roth conversions, in order to turn our pre-tax funds into something usable.

So let’s break down exactly how this works. In year one of retirement and our millionaire investment income strategy, we would use a Roth conversion to begin the early access process to accessing our pre-tax accounts like our 401(k). Technically speaking, we would probably roll over our old musty work 401(k) into a Traditional IRA. Then once we’ve got it in that more malleable IRA format, we would convert a chunk of it to Roth. So by converting just that chunk (I love the word chunk), the entire conversion amount now becomes our new cost basis in our Roth IRA, all right? So we’re just taking a chunk. We’re not converting the entire thing. We’re just converting a piece of it to Roth, and that conversion amount is now the cost basis in the Roth IRA. Since the cost basis of a Roth IRA can be accessed at any time before age 59 and a half, you have now successfully weaseled your way into accessing your previously pre-tax funds early. Congratulations.

There are only two caveats to note. Roth conversions must settle for five years before you are allowed to use them. Technically, you’d be able to use this conversion that we just talked about, that chunk, on day one of year six. For example, if you started this process at age 35—say you quit your job and you have no other earned income—and then you roll over your 401(k) to a traditional IRA and you convert a chunk to Roth at age 35, on day one of the year you turn 41 (okay. So that’s year six, right?) I believe you would have access to the entire amount. So by doing so we have successfully accessed funds in our 401(k) before age 59 and a half, without paying a 10% penalty.

So you might be like, all right, well, how do we know how much to convert? How big should our chunk be? Easy. We let the standard deduction tell us. So in 2017, the Tax Cuts and Jobs Act raised the standard deduction, making this strategy even more viable. Obviously it does remain to be seen whether it’ll stay high, but we’re going to manifest that. So for example, if we’re starting this process in the year 2022 (again, manifest), and we are married, filing jointly, we would convert $25,900 from our pre-tax rollover IRA to Roth, eating up our entire standard deduction for earned income, and completing the entire conversion tax- and penalty-free. That means your money went into your pre-tax accounts tax-free, grew tax free, and thanks to this little loophole, came out tax-free. Remember, it’s coming out tax-free because every year the IRS is granting you that standard deduction-sized amount of earned income that they’re not going to touch. So by converting the amount to Roth, you’re keeping it within the bounds of your allowable tax-free income limit as defined by that standard deduction. Now, of course, age and timing really matter here. If you won’t be retiring until you’re already taking Social Security and a few years away from required minimum distributions, which happens around age 72, you will have less flexibility with this. But retirees in their forties and even fifties should theoretically have a pretty easy time converting a lot of their 401(k) to Roth before they hit age 72, when they’d have to start taking RMDs.

So what about the taxable funds? And maybe more importantly, what are you doing during years one through five, when you can’t touch that money yet? As we’ve highlighted, years one through five are the trickiest. You won’t have access to your first chunk of converted Roth funds yet. And logistically speaking, I think it makes sense to convert your 401(k) into a separate Roth IRA, to keep that money distinct and separate from your original Roth IRA that you’ve been contributing to your whole life. That way you don’t accidentally pull out the wrong funds after the five-year mark. So what do you do instead? Well, the normal business as usual would be withdrawing enough to take full advantage of the 0% capital gains tax brackets. So that’s $41,675 per year if you’re single, and $83,350 per year if you are married, filing jointly. That would be coming from that taxable account that we talked about. Now, you may not need that much money to live on. If your spending as a married couple is only, say, $70,000, you could theoretically withdraw less than the maximums allowed by our tax code at that 0% capital gains tax rate. After year six, you now get to use that chunk of converted Roth funds, your $25,900 if you’re married, and you get your $83,350 of 0% capital gains from your brokerage account. But in years one through five, you only really have tax-free access to the $83,350 of capital gains.

So to reiterate, because I know that it was a lot of numbers, a married couple can withdraw and use up to $83,350 of capital gains per year, in those years one through five, without paying any taxes. That is the top of the 0% capital gains tax rate for the taxable brokerage accounts. And they still achieve their tax- and penalty-free Roth conversions of that rollover IRA. They just can’t touch the conversion amount, the $25,900, until year six, and every year after. Once you hit year six, you’re in the clear to take full advantage of the combined amount, which is, you know, $54,000 for singles and that $109,000 or so for married couples, the standard deduction, plus the 0% capital gains tax bracket.

So keep in mind, you are only withdrawing what you actually need to spend, and the rest is just staying invested, which means your income from investments in the eyes of the IRS is likely a lot lower than your job income used to be. It’s a little bit like you’re living paycheck to paycheck on your investment income. This is fundamentally different from your earned income from your job. Why? Well, for starters, you have to pay taxes on all of your earned income, which eats up quite a bit of it. So in our married couple example, if it’s earned income from a job, $18,000 of it has to go to the IRS. Number two, you have to save part of your income for later, and in retirement, that’s not the case. My guess is, if you’re single, you probably spend less than $54,000 per year. And if you’re married, you probably spend less than $109,000 per year. Because as a reminder, that’s $4,500 a month if you’re single, and $9,000 per month if you’re married. You can live pretty high on the hog with that much tax-free income.

Okay. So let’s all take a breather, settle back into another Money with Katie Quiz Show—a segment so nice, we always do it twice. Here is your quiz, buckaroos. Which US president introduced the first federal income tax? Was it Honest Abe Lincoln, William McKinley, Teddy Roosevelt, or Franklin Roosevelt? That answer when we return.

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And we are back with an answer. Are you ready for this? It was…Abraham Lincoln who signed the Revenue Act of 1861, creating the first US income tax, a flat tax of 3% on incomes above $800, which is $24,100 in current dollars. Not to brag, but I would’ve gotten it down to 0%. And so will you, because you listen to Money with Katie. Okay. So to summarize where we left off before the break, you will put your Roth IRA that you’ve been contributing to throughout your entire life on the back burner. You’d convert a standard deduction-sized chunk of your 401(k) to Roth every year by first rolling the entire thing over into a Traditional IRA in the beginning, and then strategically converting those little pieces of it every year to Roth, based on what the standard deduction is in each year. Now, if you itemize your deductions, you might be able to deduct even more than the standard. But I would note that I think more than 90% of people take the standard deduction. So it’s statistically unlikely that you’re itemizing.

Now in years one through five, you would try to keep your spending under the 0% capital gains tax allowance threshold, which is pretty high as of 2022, only withdrawing and using funds from your taxable brokerage accounts. That’s about, let’s call it, $42k for singles, $84k for married couples…I’m rounding up. Then in year six onward, you still have access to that full 0% capital gains tax bracket in the taxable accounts. But now you also have your standard deduction-sized Roth chunks of your pre-tax accounts if you need them, because in year six, your conversion from year one will become available. In year seven, you’ll get your conversion from year two, and so on and so forth.

So let’s do some housekeeping. When you retire, it’s probably easiest to consolidate all of your pre-tax accounts (with the exception of that HSA) into one traditional IRA. I have multiple 401(k)s, multiple SEP IRAs, a rollover IRA. The best thing for me to do to make this as simple as possible would be to work on consolidating all of them into one pot for easy maintenance. And so I can quickly see at a glance how big that pre-tax pot is. You might be doing the 4% rule math right now in your head already, and noticing that your taxable account will have to be pretty damn large in order to allow you to spin off $40,000 or $80,000 per year. So let’s address that really quickly. The short answer is yes, your taxable account will have to be substantial, but with one small caveat: It does not have to last forever. You can draw it down to zero. It just has to bridge the gap between your early retirement and your traditional retirement. This is another reason why these strategies are not widely used. Most people in the late 20th and 21st century contributed to their 401(k)s and Roth IRAs, and that was it. Even contributing the maximum to those accounts is relatively rare, because current retirees often had a mix of defined contribution plans like the retirement accounts we’re talking about, and defined benefit plans, more commonly known as pensions. They did not have to save as much for themselves, because their employers shouldered the burden. Must be nice. Anyway, to have a million dollars in a taxable account as a single person, which is what you would need to spin off about $40k per year, or $2 million in a taxable account as a married couple, just what you’d need to spin off about $80k per year, requires both high income and sacrifice.

But the good news is because this account is just a bridge, it actually does not have to be that big. I will do an example momentarily, but before I do, I think this highlights how regular savings goals set forth by traditional financial media, like “save 10% of your income,” are insufficient if you are hoping to retire in your forties or fifties with millions of dollars. The earlier you start, the easier it will be. And perhaps more importantly, your taxable accounts don’t need to pay that much in perpetuity, because ideally your Roth IRA that we threw on the back burner will compound untouched for decades, until the point at which you are just about tapped out of that taxable brokerage account, and you’re ready to switch it entirely to the Roth IRA. Since the Roth IRA is tax-free, the growth will be completely unencumbered by taxes.

To put it even more plainly, it is okay if you completely deplete your taxable account throughout this process. You just don’t want to deplete it before you’re 59 and a half, when you’re free and clear to access your Roth IRA.

So by this point, you’ve probably either tuned out your eyes are glazed over, or you’re ready to swear off Money with Katie forever, but let’s do an example for scale. I know it can be tricky to visualize how this would actually play out, and the numbers associated. So I want to do a little example to show how a married couple who begins this process at age 25 could retire at age 45 with two and a half million dollars. All assumptions below are going to use a 7% average rate of return. This won’t be precise, because there are so many assumptions that have to be baked into these types of estimates, but it should give you a general idea of how this might happen.

So for starters, let’s talk pre-tax funds. Let’s say between both partners, they are contributing the equivalent of the maximum contribution limit—so in 2022, that’s $20,500 per year—starting at age 25, either by only maxing out one of their 401(k)s, or they’re both putting half of the maximum into their respective 401(k)s, so $10,250 per earner. And after 20 years of doing this—again, not adjusting for inflation or increases in contribution limits across the board, just to keep things consistent—they will end up with $920,000 of pre-tax funds in today’s dollars.

Next, let’s say Roth. Let’s say they both contribute the maximum to their Roth IRAs starting at age 25. This is $6,000 per year each, or $12,000 together. After 20 years, they will have about $500,000 of Roth funds—again, in today’s dollars. So let’s pause. Between their maximum contributions to their pre-tax and Roth funds, they have got roughly $1.4 million after 20 years. We need the other approximate million or so to come from that taxable account.

So taxable brokerage account time. If you assume they also contributed roughly the same amount to a taxable account every month that they did to the 401(k), they would have another $1 million or so in the taxable account. Let’s bump up that contribution slightly to account for annual taxes that they’re going to have to pay on the dividend income in that account, and say that they’re going to contribute $2,000 per month total, or $24,000 total per year. By age 45, they’ve got $920k in the 401(k)s or 401(k) (depending on if they used both or just one), half a million in Roth IRAs (we had to use both of those because the limit is lower), and nearly a million dollars in their taxable account. So if you were trying to keep track, they would have needed to invest about $4,700 per month between them to make this happen. $1,708 to the 401(k), $1,000 to two Roth IRAs, and $2,000 to a taxable brokerage account. Now these limits will all go up over time with inflation. Everything will adjust upward for inflation over time, but again, we’re keeping everything consistent and baking that inflation into our average return rate instead, just to make this a little bit simpler, but this is really like a roadmap, right? Like you could theoretically re-create this.

Now, realistically, if you assume a married couple needs $6,000 per month to spend and has to pay taxes on their income at an effective total tax rate of 25%, they would need roughly $160,000 in income to make this happen. Whether that’s one person earning $160k or two people earning $80k or any breakdown of the two doesn’t really matter. As long as they’re married, we just need $160k total—though I will note, if you are unmarried filing head of household, this will be different for you.

Obviously there are tons of assumptions baked in here about tax rates and spending, but I’m mostly trying to illustrate that a dual-income couple making $160k per year could feasibly retire with $2.4 million after 20 years, assuming they can keep their spending under $6,000 per month. Again, ignoring inflation through and through. There are probably people in San Francisco and New York who pay $6,000 in rent and another $4,000 in daycare. And to those of you in that boat that are choking at this example, I would remind you, if you live in either one of those cities and you plan to spend that much, you are probably also earning more than $160,000 per year between you. And if you don’t, you may need to have a serious talk with your company about compensation being commensurate with your cost of living, or work for someone else if you want to continue to live there. To be clear, $160,000, that is no small sum. That is a lot of money, but it’s also not hard to see how two people could earn that much together. It’s not an unrealistic or completely unattainable household income, especially to achieve something as impressive as retiring as multimillionaires in your forties.

Back to the example. Our friends would begin their conversions and drawdown at age 45 of their pre-tax and taxable funds. And for 15 years, right, until they hit 60, they would rely solely on these two accounts. At age 60 or so, they would be able to tap that Roth account too. But that Roth account having been left alone to compound for 15 years is not worth $500,000 anymore. Now it’s worth $1.4 million. Again, we’re using 7% average rate of return. And technically, I guess if I’m being really, really specific, it would be two separate Roth accounts that are compounding to be worth $1.4 million together. But you know what I mean. And the $25,900 in today’s dollars that we withdrew each year from our 401(k), adjusted upward for inflation, to convert to Roth, it wasn’t even enough to deplete our 401(k), despite pulling $25,900 total from the 401(k) or 401(k)s per year for 15 years. By year 15, we have roughly $1.6 million in the 401(k) still. That is nearly twice as much as we started with. Oops, we may end up being subjected to RMDs, but hey, we’ve got $3 million now between our pre-tax and Roth accounts. So I think we’ll be okay paying a little bit of tax on those if push comes to shove.

Lastly, let’s look at the fate of the taxable account. Our taxable account started with $1 million and it was subjected to $83,000 of withdrawals each year. By year 15, it is almost gone. We’ve got about $200,000 left in today’s dollars, but still we retired at 45 with $2.4 million. We lived on that money for 15 years tax-free and by age 60, we have $3.2 million. Not too shabby, right? Compounding is magic. I used an average annualized 7% return for all of these projections. So hold tight, because I re-ran them with a lower average return of 5% to see how that would change the equation if future returns are consistently lower. We’ll get to that in a moment.

This case study illustrates why focusing on increasing income, aggressive investing, and strategic withdrawals can quickly create a potent flywheel. And of course, astute listeners will notice that our early retirees were living quite high on the hog in retirement, compared to their spending during their working years, While working, in this example, they were only spending $6,000 per month or $72,000 per year. But in retirement, their accounts enabled them to spend up to $109,000 per year after year five, and up to $83,000 per year in years one through five. So theoretically, if they didn’t increase their spending to those maximums, they could have ended up with even more than $3.2 million in their accounts by the time they slid into age 60. But as we know, this hypothetical couple likely had to provide things for themselves after retiring early that their employer used to provide (hashtag #healthinsurance), the good old US of A. So we’ll say the additional $10,000 to $40,000 per year extra can help buffer the budget for those costs, like insurance premiums.

Like I said, just for the sake of the example, I re-ran projections with a 5% average rate of return, a real rate of return, that is. Here’s how it changed. In the wealth accumulation phase, the 401(k) contributions would have grown to $732k, not $920k. We’re about $200k lower there. The Roth IRA contributions would have grown into about $428k, not $500k. So about $70k lower there. And the taxable account would have grown into $857k, not a million. So with an average annualized 5% real return, we are looking at sliding into age 45 with $2 million even, not $2.4 million. During the drawdown phase, assuming they’re still pulling the same amounts out—so they’re still using the full standard deduction, the full 0% capital gains tax bracket—the 401(k) balance that started at $732k would have turned into $813k after 15 years of withdrawing $25,900, instead of what it would have grown into with that 7% average return in the original example, which was $1.6 million. So quite a difference there. The taxable account that started at $857k would have run out by year 12, at age 57. So they would have been about two and a half years short. And the untouched Roth IRA that started at $428k would have grown into $847k by year 15, instead of, I think what it turned into with the 7% return was like $1.4 million. So quite a bit lower. So that’s how a 5% average return changes things. Two percentage points makes a big, big difference, which also highlights why a 1% management fee can be so damaging over time.

Of course, this assumes that during those 15 years, our married couple was withdrawing the full $83,000 in years one through five, and the full $109,000 in years six through 15. They were living large compared to their working years, when they were spending $72k. Had they cut their spending even a little bit—like for example, let’s say they only withdrew $83k in years one through five, and then only bumped things up to $90k in years six through 15, instead of $109,000, they would not have depleted the taxable account. They wouldn’t run out of money. So my point is that if you’re willing to be flexible and your spending is already substantially lower than these maximum allowed withdrawals, even sustained lower average returns are not enough to derail this plan.

So a popular criticism during tax planning, tax strategy that I hear is, well, should I really let the tax tail wag the dog? We’ve been at this for a while now, right? Like this seems really complicated. And people will say, ah, it’s not worth it. You know, common refrain from those that find this tedious. But I would remind you, we’re not talking about a difference in outcomes of like a few hundred bucks. Remember, if we had just pulled the full $109,000 that we wanted from the pre-tax account and called it a day, we would have paid almost $20,000 in taxes. So a few hours of planning saves, to be specific, $18,000 per year. That’s not insignificant, especially when you consider that those tax savings compound over time. Because the less you can withdraw to spend money on things like taxes, the more stays invested and continues to compound. After all, that tax money has to come from somewhere. So it either means you’re withdrawing the same amount, but allowing yourself to spend $18,000 less, or it means you’re spending the same amount, but withdrawing an additional $18,000 to pay the tax bill.

I would estimate that setting up these systems for automatic distributions from these accounts of these specified amounts on these specified dates is going to take you a few hours to set up at the most, but it will save you tens of thousands of dollars per year. It’s a pretty good return on your time. You can set up automatic distributions with most major brokerage firms. I don’t think you can automate Roth conversions, but to be honest, that process is going to take you half an hour. Then you can set up your taxable and your converted Roth accounts to pay you a paycheck every month. That can be automated. You can have your $9,000 as a married couple automatically deposited into your checking account on the first of the month, with $2,100 of it coming from your Roth conversion account and the other $6,900 (nice) or so coming from the taxable account. It’s not necessarily simple, but I really feel like once you get the hang of it, you spend a few hours putting the systems in place, it’s kind of going to run itself. And you can always taper back spending or crank it up if necessary.

That brings me to my last point for the, ah, the ethical crowd who’s saying, Katie, should I feel guilty for not paying any taxes? And here’s the thing. I appreciate this argument. We should all be paying our fair share, right? Like, I think that is a reasonable premise. However, I would highlight four counterpoints. Number one, you are fully playing within the bounds of the IRS’s rule book. They wrote the rules. You’re just playing their game efficiently. You are not breaking any laws or skirting anything by playing the rules of the game. Number two, in this example, you paid into our tax system for the entirety of the 20 years that you worked, if not more. In our example, wherein a married couple earns $160,000 per year for 20 years in this perfect mathematical vacuum, they earned and paid taxes on $3.2 million. Assuming that effective tax rate of 25%, they paid $800,000 in taxes over their working lifetimes. In other words, you have probably already paid your fair share of taxes by this point. And number three, if you are a middle-class person with $2 million in the bank that you plan to live on until you die, you are not the big potatoes that impact the tax system. The people whose tax money could measurably impact things are the centimillionaires and the billionaires. I would argue that the $18,000 per year that you are keeping, instead of paying into our tax system, is not going to have serious ramifications for our tax revenues. Even at scale, it’s like someone who’s flying commercial worrying that their suitcase is too heavy, and like wanting to pack a little bit lighter for fuel efficiency, while someone else is taking a private jet across the country. It’s just, it doesn’t compare. And last, number four, you are also probably paying taxes in other ways. If you own a home in retirement, you’re paying property taxes. If you buy things, you’re paying sales tax. So it’s not like you’re not contributing at all. You’re just not paying any more additional tax on your own investments.

In conclusion, I will leave the moral and the ethical questions of tax efficiency up to you. But I hope you learned something from today’s episode, and that it may have shown you that a luxurious early retirement is actually way more in reach than you thought.

All right, everybody, let’s dig into another Rich Girl Roundup. As a reminder, we will take listener questions every month. I’ll put a call out for questions on Instagram—follow @MoneywithKatie if you’re not already—and we will pick one that feels interesting and widely applicable and answer it. As my standard disclaimer, I am not a licensed financial professional. This is not financial advice. This is “What would Katie do?” This segment is brought to you by Betterment, giving you the tools, inspiration, and support you need to become a better investor. Here is this week’s question, from Rachel.

Rachel: Hi, Katie. I’m Rachel, calling into Rich Girl Nation from Denver, Colorado. My boyfriend and I have begun to talk about marriage. My question for you is how, if at all, do you suggest merging assets, bank accounts, and budgets once you’re legally bound together? I’ve heard from many friends that they and their partner have one joint account for things like rent, utilities, and food, and then separate accounts for their own spending. In my mind, this is less efficient, and whatever spending my partner does with his separate bank account would still ultimately affect me. What do you think?

Katie: Look, I understand that everyone has different financial comfort levels with how much or how little they’re willing to share in a partnership, both literally and metaphorically. However, this question highlights an important nuance that I rarely hear discussed, and that is “His separate bank account would still ultimately affect me.” That is the challenging long-term implication worth considering when you’re using this “yours, mine, and ours” or roommate model of financial planning within a marriage. At the spending level, it makes a decent amount of sense, right? Like each partner contributes a commensurate amount to the joint account that is used to pay for joint expenses. And then you’re free to do whatever you want with your remaining income. And so are they. Logical so far, but where problems can come into play is when we flesh this out a little bit. Consider this: If one partner is diligently saving for retirement and the other is basically spending the rest of their income, where is that going to leave this couple in 40 years? These are the types of questions you want to consider and decide before committing to this approach.

If I save most of my remaining income for retirement, I am like on it, right? I’m Money with Katie. And then my husband spends his remaining income on cars and golf clubs and whatever the hell else men buy, is funding our retirement my responsibility? Are we setting it up such that we’re both independently responsible for funding our own retirements when we’re no longer working? Or will the better saver bear the brunt of that responsibility when the time comes? That’s a question that we should probably figure out now, rather than later. It would be pretty awkward to slide into retirement someday and realize that you’ve been saving and investing the entire time and kicking ass, and your partner hasn’t. But you’re probably not going to kick them out of the house because they can no longer afford to pay for their half of groceries, right? But it may lead to some resentment if you make sacrifices throughout your entire life and they don’t. To your point, your partner’s separate bank accounts still ultimately affects you in some way.

I’ve talked about this before. I’ll link the blog post in the show notes, but that was a major reason why we just decided to combine. We did not retroactively combine any accounts that we came into the marriage with, but we did determine from a certain point, moving forward, after we got married, that all incoming funds were going to go into our joint checking account. All expenses would be paid on credit cards that would be then paid from that joint checking account. And then any investable income beyond what we were paying into our retirement accounts, that are individual by definition, would then be invested into a joint brokerage account. That felt like the best solution for us: retaining some autonomy over the accounts we had earned and funded separately, but then combining everything after marriage into joint accounts that would further our goals as a team.

All right, y’all, that is all for this week. I will see you next week, same time, same place, on The Money with Katie Show. Our show is a production of Morning Brew and is produced by the talented Nick Torres and me, Katie Gatti Tassin. Sarah Singer is our VP of multimedia, and additional content editing comes from the brilliant Henah Velez. Sam Cat is our VP of chaos, as always, and Beans is our chief bark officer. If you assumed they also contributed roughly the same amount to it…he is just “Serenity now, taxable brokerage account.”