Saving for Retirement… In Retirement

We spent the last six years of our careers furiously plowing funds into our retirement accounts, assuming that that was our last real chance to save for retirement. All the while planning for two phases of retirement, building in only the most conservative growth estimates, baking in scads of contingencies, the whole bit.

So guess what we’re doing this year? Saving for retirement.

Let’s talk about the story of how we came to save for retirement… in retirement.

Deviating From the Plan

We built an early retirement plan that has a very good chance of turning out to be overly cautious and even foolishly conservative. Or, if we hit a bad sequence of returns, we could look like geniuses who had the good sense to save more than the problematic four-percent rule tells us we must. We won’t know which it is — fools or geniuses — for at least a decade. But either way, given who we are and our economic anxieties, we wouldn’t have pulled the plug on our well-paid careers if we weren’t sure that we’d saved enough to last us forever.

Built into that plan was the assumption that we’d start withdrawing from our investments this year, along with using the interest from our personal loan and the taxable dividends from our index funds, to fund our living expenses. But then my lifelong dream came true, and Mark got a very part-time consulting offer on a passion project that was kind of too good to be true, and we suddenly found ourselves earning some money we don’t entirely need and not withdrawing that money from our investments after all.

And we had some decisions to make.

Self-Employment and All Kinds of New (To Us) Rules

A few basics about our current earning situation:

1. Mark and I left our W-2 jobs at the end of last year and since then have been “self-employed” in a tax sense for income we’ve received this year, mostly from my book plus Mark’s small passion project consulting side hustle. “Self-employed” is not the best term for our situation given that we’re really mostly self-funemployed, but we’ll not try to argue with the IRS about this. Audit fears and all.
2. As self-employed people, the IRS considers us each to be sole proprietors, and we owe quarterly self-employment taxes because there is no employer withholding taxes and paying payroll taxes for us. Sole proprietor is a default designation that requires no incorporation or special filings, and after weighing the costs of LLCs and S-corps, especially in light of California’s business tax rules (short version: they tax everything, you don’t really save money and may actually spend more trying to incorporate in another state, and the minimum tax is high), along with the much more relevant fact that we don’t plan to have side hustle income for most of our early retirement years, and it made sense to stay with the default option. Paying quarterly taxes is not especially fun, but we have reminders set up and we’re just making it part of our financial management process. In future years, we’ll likely automate the payments, but we haven’t done that this year, because we’ll owe these taxes even if we don’t work at all on our rental income and any other income that counts as “earned.”
3. Also as self-employed people, we have to buy our own health insurance off of the exchange (in our case Covered California, not the federal Healthcare.gov exchange), and the price we pay is based on the income we projected for this year back in December of last year.

Related post: Signing Up for ACA/Obamacare Health Insurance for Early Retirement

All Kinds of New (To Us) Decisions

So here we are, earning a little money we never expected to earn. Which is obviously great, because no one is ever sad about having more money or more wiggle room. But it does mean we have some decisions to make. With this additional cash, we can:

1. Just treat it like income, spend it if we feel like it, pay the higher taxes on it and owe back some of our health insurance premiums when we do this year’s taxes next spring.
2. Use it to begin funding the Roth IRA accounts we wish we’d saved for ourselves, but because those are after-tax funds, it would mean paying all the income tax and self-employment tax we’d owe on those dollars, along with paying back health insurance premiums.
3. Fund traditional IRA and solo 401(k) accounts with pre-tax dollars above and beyond what we’d expected to earn, on which we then wouldn’t owe taxes (mostly), and wouldn’t have to pay back as health insurance premiums, and we’d have an even bigger cushion for our traditional retirement and later years, especially all those looming health care what-ifs.
4. Add to our donor advised fund (DAF), though given the higher standard deduction built into the new tax law, our absence of mortgage and our now-low state and local taxes, we’d have to give a fairly massive chunk to make it worth itemizing instead of claiming the $24,000 standard deduction for married filing jointly. And in that case, we’d still have to pay back the health insurance piece, because charitable giving isn’t subtracted from modified adjusted gross income (MAGI), the number used to calculate health insurance costs.

Saving for Traditional Retirement in Early Retirement

We ultimately decided to pad our savings for phase two of retirement (our traditional retirement, after age 59 1/2) while in phase one of retirement (early retirement) for several reasons:

1. We don’t have any other demands on the additional funds we’ve earned this year, so can afford to lock them away for the future.
2. The law allows us to save through several different vehicles, including traditional IRAs (that we couldn’t use in our higher earning years because we were above the limits) and solo 401(k)s.
3. We’re already freaked out about high tax audit risk for this year given that we’ll both have gone from well above average salaries to far less exciting earnings in a non-recession year, at a non-retirement age, and fear that doing a big pay back of health insurance premiums on our next tax return could add an additional audit flag. Better to match what we projected.
4. If we later realize we want those funds sooner than traditional retirement, we can do a Roth conversion to access them within five years or — worst case — we could just eat the 10 percent tax penalty because it was gravy money anyway.

With the decision made, it’s now just a question of where to send that money. And we have some choices:

Traditional IRAs — For 2018, the IRA contribution limit is $5,500 per person ($6,500 for those over 50), giving us the potential to save $11,000 this year for traditional retirement.

Solo 401(k), “employee contribution” — Solo or self-employed 401(k)s function much like employer-sponsored 401(k) plans in that they have the same employee contribution limits ($18,500 in 2018, $24,500 for those over 50) and they are also pre-tax contributions. But…

Solo 401(k), “employer contribution” — … They also allow you, a sole proprietor, to act as not only the employee, but also the employer, and to make an “employer contribution” up to 25 percent of your earned income, so long as your total solo 401(k) contributions don’t exceed $55,000 for 2018 ($61,000 for those over 50). Theoretically, this could allow us to save $110,000 combined in tax-advantaged retirement funds, but to do that, we’d each have to earn nearly $150,000, and that is hilarious. We’re still early retired despite some earnings, after all.

SIMPLE IRA or SEP — SIMPLE IRA and SEP plans are other tax-advantaged retirement saving options for small businesses and sole proprietors, but they’re so much more complicated to set up and require filing many more tax forms than solo 401(k)s that they aren’t worth seriously considering.

Our plan, given the choices, is to start basic, with traditional IRAs. If we max those out and still wish to save more, we can move into the employee contribution portion of the solo 401(k). And in some imaginary universe in which we earn multiple six figures as early retirees (ha!), we could pretend to contribute against the employer portion. But if we ever get to that point, let’s be honest: we’ll be jetting off to Singapore instead and gladly paying the income taxes. ;-)

Chime In!

Would you ever consider contributing to your retirement savings after already retired? Have you done something like this, for folks who are retired already? Got a better idea for how we should use this money instead? Let’s discuss it all in the comments!