Cash flow is kind of important, in (early) retirement as in life. No cash flow, no nuthin’ – can’t pay the bills, can’t buy the things, can’t do the stuff.
A couple common cash flow challenges in early retirement involve:
- wanting to spend retirement account income before age 59.5 (you have the funds, it’s just locked in tax-deferred accounts)
- contributing to tax-deferred accounts when you have little to no cash on hand (but have earned income)
I like to get around these challenges with a little legal money laundering.
Legal Money Laundering
Spending retirement account income early
Money laundering as I understand it involves moving money you can’t legally touch into that which you can.
For example, the IRS says the money in your 401k / IRA is locked up until age 59 1/2.
But what if I want/need to get access to some of those funds early? I can’t do so without some significant consequences (10% penalty) or a serious commitment (72t.)
Alas, I do need access – I recently shared how our actual cost of living is ~$25k higher than our income.
If I could only tap into the $25,000 in dividends we are receiving each year in our retirement accounts… we could be completely cash flow neutral. (What are the odds?)
And in fact I can. I just generate my own dividend in our taxable brokerage account.
We receive $25,000 in dividends in a retirement account. This is auto-reinvested in additional shares. For simplicity let’s assume we get 1,000 new shares of $X at $25 each.
To spend those dividends I just sell 1,000 shares of $X in the brokerage account.
I now have $25,000 in cash and the exact same number of shares as we did pre-dividend.
As a bonus – we will pay fewer taxes on the stock sale than we would have had we received the dividend directly in the taxable account. Win win.
Contributing to Retirement Accounts with Minimal Cash
Being cash flow neutral is nice – by laundering our retirement account dividends we are able to fully cover our cost of living with income from our portfolio and part-time hobbies.
But I also want to make some additional retirement account contributions and we are spending 100% of our income!
I want to make retirement account contributions this year but only have about $500 in our checking account. (I intentionally keep the amount of cash on hand low – it yields poorly and doesn’t respond well to inflation.)
What to do?
Earned income: ~$40,000 via blogging
Cash on hand: ~$0 or close enough
Roth solo-401k contribution: $20,500
Employer solo-401k contribution: ~$7,400 (Traditional, deductible)
After-tax non-Roth solo-401k contribution: ~$1,800
His/Her Roth IRAs: $12,000
Total retirement contributions: $41,700 (more than we earned! You have to love IRS math.)
To get these funds I sell $41,700 worth of stock, move it into the retirement accounts, and then buy $41,700 worth of stock.
In a year like 2022 where the market is down I am able to realize a capital loss in the process for a nice tax deduction, possibly offsetting any tax burden from the first example above. (Thanks to prior years’ capital gain harvests.)
All future growth on the Roth contributions will also be tax-free.
IMPORTANT: Avoid wash sale rule violations. This is critical with retirement accounts because we can eliminate the capital loss deduction for all time. The retirement account stock purchase needs to be a different, non-substantially similar, stock than we sold in the brokerage account.
For the math on solo-401k contributions and how we can contribute more than we earned, see: Solo 401(k) Contribution Calculator
Shift Portfolio Towards Tax-Free
Early retirees often (but not always) have a significant percentage of their portfolio in a brokerage account. When you save large sums of money over a short period of time, retirement account contribution limits push excess savings into taxable accounts.
Both of the examples shift funds from taxable into Roth accounts, thereby moving the portfolio ratio of Taxable / Pre-Tax / Post-tax towards post-tax/Roth/tax-free.
When we left our jobs ~20 years ago we were roughly 75/25/0 but most recently we were at 63/29/8. That growing Roth percentage will help significantly with tax minimization later in life.
A lot of people self-restrict retirement spending to income – side hustles, pensions, dividends, interest, etc… I am doing this in both of the examples above.
This is unnecessary unless you have very ambitious inheritance plans, although I understand the appeal. Spending principal is a normal and natural part of retirement (some even go to other extremes, see: Book Review: Die with Zero.)
Spend less than 4%, spending principal is fine. It’s ok to sell some more stock.
Cash flow is king in retirement. A little legal money laundering helps keep the cash flowing smoothly, allowing you to:
- Spend retirement account dividends before age 59.5.
- Contribute to retirement accounts even when you have minimal cash.
- Contribute more than you earn to retirement accounts.
As a bonus, these efforts will shift the portfolio in a way that helps to minimize future taxes.
May your cash be clean, accessible, and tax-friendly.
Have you legally laundered your money?