FIRE Strategy for High Income Earners

15 Replies

Financial Independence Retire Early (FIRE).  It seems to be everywhere these days.  I just heard on a podcast that there is a movie coming out in a few months about the FIRE movement - which sounds awesome.  I'm sure the general answer, as it seems to be for most things, is "it depends," but I'm curious about FIRE strategy for higher income earners specifically, for those of you who earn high incomes.

I work a W-2 position with what most would consider a higher income ($150K+/yr) than many positions.  I am passionate about becoming "job optional" as soon as reasonably possible, which I estimate to be about 15 years or so.  By that time, my goal is to have passive income that exceeds living expenses - which many would say is the definition of "retirement" in and of itself.  I could likely do this sooner, but I feel like this is a reasonable goal.

The internal struggle that I constantly think about has to do with strategy to get there.  For example, there are many people in the FIRE community that are all about pre-tax investing, maxing out 401(k) and IRAs pre-tax, and later doing Roth conversion ladders and the like in order to convert all that money to Roth and have it all become tax-free and effectively pay little, if any, tax in the process.  The logic seems to be that once FI is reached and they no longer work a W-2 position or have earned income, their income will be lower which puts them in a lower bracket and allows them to take advantage of this strategy.  In a way, I think it's brilliant.  The flip side of that is being in a lower bracket also assumes income as a whole is significantly less.  I want to "retire" on more, not less, don't you?  If I am building up passive income now - investing in turnkey SFRs, multi-family syndications, international agricultural real estate, note funds, etc. - to eventually replace (and hopefully exceed) my current earned income, then would I even theoretically be able to take advantage of such a strategy?  Yes, I realize there are tax benefits like depreciation shelter, not having certain payroll taxes, etc., on the investment side, but would that be enough of an offset to still allow a Roth conversion strategy?

I guess what I'm saying is that I have high goals and expectations on what I want my income to look like, both now and in the future, and while sheltering everything (retirement plan wise) pre-tax now and converting to Roth over time at little/no tax later initially sounds good, is that really an effective strategy?

I'm a big fan of Roth contributions to start with for employer-sponsored retirement plans like 401(k) (and for Roth IRA, the "back door Roth IRA" method with initial non-deductible contributions to Traditional IRA and converting to Roth IRA). My thoughts are that even though my income is "high" today, tax rates are near/at historic lows, I'd rather take the tax hit now and get all that money out tax-free with certainty later. My income hopefully continues to grow, tax rates IMO will likely go up over time, etc. I just want to make sure that me "taking the tax hit now" at a lower bracket makes sense versus sheltering as much as possible for a "gamble" that I can do Roth conversions later and pay less/no tax. Most people that are "higher income" typically favor pre-tax investments now with an expectation that their income needs will be lower later and theoretically they'll pay less in taxes later. I'm just not so sure how much I subscribe to that.

The other thing that comes up for higher income earners investing in rentals (assuming you're not a real estate professional, which I am not) is the inability to take passive losses against ordinary income once your income rises above $150K.  I know that's a "good problem to have," but how are some of you higher income earners factoring that into your strategy?  I know passive losses can offset passive income, which is nice, but what am I missing here?

I know this is a very long post - much longer than I initially intended for it to be - but I guess it breaks down to:

If you're a higher income individual who aspires to FIRE, what is your strategy and what adjustments might you be making versus someone who is more "median income."  How do you think about pre-tax vs. Roth, passive losses now and later, income goals now and later, etc.

Thanks in advance to anyone who responds.  

I think you've essentially answered your own question.  I'm  in a similar situation, though not making quite as much as you.  I, too, believe that I will have more income in retirement with my current investing strategy.  Given that it is likely that taxes will raise in the future, it still makes sense to do Roth Conversion ladders.  I am going to convert enough each year so that that "income" I produce from the conversion keeps me in my current tax bracket.  

I’m not sure I’m following you @Frankie Woods .  If you expect your income to be higher in retirement and you expect tax rates to go up, why wouldn’t you utilize Roth vehicles NOW to get the taxes out of the way as opposed to the ladder conversion strategy later when both your income and taxes are higher?

@Mark S. I am maxing out both my Roth IRA and 401k. When I was younger, I invested in a traditional 401k as there wasn't a Roth 401k option then. I was able to save a considerable amount in that account by maxing my contributions as well as taking advantage of the GFC recovery. Now as I see my passive income trajectory, it makes sense to use the Roth Conversion ladder to get the traditional 401k funds into a Roth account.

By the way, I thoroughly enjoyed your thought experiment above!

@Frankie Woods Thanks. So you’re saying that for CURRENT contributions, you’re doing ROTH 401(k) and ROTH IRA, but for PRIOR contributions before these Roth vehicles were available, you’re looking to convert these funds as soon as possible, yet strategically, taking into account your tax situation? Can you talk more about your current cash flow investments? What are you investing in? What types of numbers are you seeing? On depreciation for rentals, are you able to use any of that to offset your ordinary income? Feel free to PM if you don’t want to share publicly, although I feel like it would be very fitting for this forum thread.

@Mark S. that is correct.  I have 11 rentals that cash-flow about 3k / mo.  I recently added an additional rental that will increase my cash-flow by ~$1200 / mo.  I have a mixture of SFRs, which I purchased as primaries and turned into rentals upon moving.  I am a military member and thus move a lot, but I have recently started moving every year to take advantage of the generous owner-occupant financing terms.  I also have 4-plexes.  Each of the SFRs cash flow about $150 / mo after accounting for expenses.  The MFRs cash flow about $400 / month.  The depreciation more than eats up the cash-flow and significantly reduces my ordinary income as I have not broken the $150k annual threshold.  My effective tax rate last year was 5% due to that.  Depreciation is a magical thing if you can use it.  For my situation, doing the Roth conversion ladders now is a good time for me because my taxable annual gross income is so low.  I will most like cross that income threshold in the next few years and the benefit will greatly decrease.

I'm in a similar situation. I have a decent amount of passive losses that I can't offset against ordinary income due to my income. Don't you have enough rentals though for the income to be offset by some of your losses? I keep thinking "when will I ever get to take these losses". I guess the more properties I acquire if they show income I'll get to offset it. Or maybe one year I'll take a sabatical so my income drops just to get to claims the losses! Sounds ridiculous I know, but think how much you'd actually make in tax savings. 

A good tax strategy is definitely maxing out Roth IRA. Another strategy is putting a good chunk in HSAs so that you can eventually use that to pay medicare or healthcare premiums, etc once you're retired. It also reduces your taxable income now which is great. You'll never pay tax on that money and we'll all likely need it in retirement.

I plan on deriving income from a 50/50 split of real estate and index funds. Example on 1 million dollars. 500k index funds x .08 will put you around the mark to pay no taxes on capital gains (38k I believe?). Couple that with the tax benefits of real estate with 500k in equity and hopefully pay 0 taxes, while making around 80k/year.

@Mark S. I am a high income earner and a CPA and in invest in SFHs. My wife qualifies as a real estate professional so I can take losses against my W2 income. I phase out of the Roth IRAs and I don’t like 401ks. I go against traditional wisdom. I love whole life insurance and utilizing the Infinite Banking Concept. I am not a insurance agent so I am not trying to sell anything, but you should really look into it. Really has changed my mindset. Thanks!
Originally posted by @Michael Le N.:

I plan on deriving income from a 50/50 split of real estate and index funds. Example on 1 million dollars. 500k index funds x .08 will put you around the mark to pay no taxes on capital gains (38k I believe?). Couple that with the tax benefits of real estate with 500k in equity and hopefully pay 0 taxes, while making around 80k/year.

Michael, seems to make sense at first glance, but an 8% withdrawal rate on index funds is likely not sustainable, especially if you’re “retiring early.”

Originally posted by @Mark Welp :
@Mark S.

I am a high income earner and a CPA and in invest in SFHs. My wife qualifies as a real estate professional so I can take losses against my W2 income.

I phase out of the Roth IRAs and I don’t like 401ks. I go against traditional wisdom. I love whole life insurance and utilizing the Infinite Banking Concept.

I am not a insurance agent so I am not trying to sell anything, but you should really look into it.

Really has changed my mindset.

Thanks!

 Mark Welp, thank you for sharing.  Could you elaborate on the Infinite Banking Concept and specifically how you’re using it to help you meet your investment goals? Feel free to throw some numbers in there if that’s not too personal.  I’ve heard this discussed on a lot of podcasts and even read a book about it, but haven’t come across enough details yet regarding some of the numbers to truly see all its merits. 

Originally posted by @Mark S. :
Originally posted by @Mark Welp:
@Mark S.

I am a high income earner and a CPA and in invest in SFHs. My wife qualifies as a real estate professional so I can take losses against my W2 income.

I phase out of the Roth IRAs and I don’t like 401ks. I go against traditional wisdom. I love whole life insurance and utilizing the Infinite Banking Concept.

I am not a insurance agent so I am not trying to sell anything, but you should really look into it.

Really has changed my mindset.

Thanks!

 Mark Welp, thank you for sharing.  Could you elaborate on the Infinite Banking Concept and specifically how you’re using it to help you meet your investment goals? Feel free to throw some numbers in there if that’s not too personal.  I’ve heard this discussed on a lot of podcasts and even read a book about it, but haven’t come across enough details yet regarding some of the numbers to truly see all its merits. 

 This is a BP thread that does a deep dive on Infinite Banking and leveraging cash value for investing in real estate...

https://www.biggerpockets.com/forums/519/topics/24...

High cash value life insurance will do three things to help you accomplish your goals...

1. Generate Tax-Free Income. Permanent life insurance is like a Roth IRA. You are paying premiums with after-tax dollars, but the cash accumulation and income will be tax free. What makes it better than a Roth is that there is no limit to the contribution amount.

2. High income to savings ratio - Most people don't "get" this about life insurance. If you have money in a typical brokerage account, financial advisors recommend that you take no more than 3.5 - 4% (The 4%-Rule, google it). This allows your savings to keep up with inflation and ride out the ups and downs of the market. Cash value, on the other hand, can generate income at a 7-8% ratio. Why? Because you access cash value via policy loans. The collateral securing the loan is still growing and earning interest/dividends. You are not physically removing it like you would with any other type of typical retirement savings account. You can expect to get about 2 to 3 times the net income (after taxes) for the same amount of savings.

3. You can leverage the cash value every day between now and the day you retire to create additional wealth.

@Mark S. what you are describing is just becoming "Independently Wealthy". Maybe it is a generational thing, but really FIRE is just a new term that describes this old concept. There is really two forms of retiring early:

1. Large passive income from business or investments that allows for a higher spending life style. Now called FAT FIRE by some, this is just good old fashion independent wealth. You can start a business or make huge investments to accomplish a high income without W2. Most people in this category could be considered retired, because the do what they chose. Very often there is high income here.

2. Small passive income that is sufficient by reducing consumption and spending. This is the FIRE movement, the concept of reducing spending and saving everything. I had a hippie aunt and uncle in the 1970's who saved and lived frugally. They would take long trips in South America or Europe and not work for months. They retired young on a modest income from passive investments. This strategy gives you lower income in early retirement and therefore lower taxes. 

The worst thing you could do is try to reduce your income to reduce your taxes. You are better off to pay 25% taxes on $150K than it is to pay 15% taxes on $30K. The reason people focus on reducing taxes is because it is generally your largest expense. If you buy enough rental properties and eventually quit your W2 job, it should be possible to just claim you are a real estate investor and therefore be able to take any passive loss against your income. That is what I would recommend. 

Good luck.

@Mark S. Hello! We are in process on all of the above. After multiple 7 figure years of being phased out of Roth, paying the AMT & having the bulk of our income in the highest bracket - these are the only things we could do. 1. (I know this Is controversial) Divorce. Each claim head of household. This also (in theory) enabled us to each finance 10 properties conventional 2. We each own a C Corp with different ending tax years so our real estate holding co can pay management fees to them. This helps because we’re taxed at the lower corp rate + run a bunch of expenses through the C’s. And can plan better using different years 3. You need to figure out how to legitimately become a RE professional. Now we are retired and our 1040 income is much lower due to depreciation and the management fees paid to the C’s. Example: our passive RE portfolio CO generates a profit of $300k. Each C Corp receives a fee to manage the portfolio of $100k each. Half (per C) is taken in payroll and the balance used on business expenses / allowable fringe benefits. (Car, travel, medIcal) Now only $50k in w2 and approx $20k in K1 flow through to each of us. After deductions our rate is relatively low and we can convert to Roth. Hope that all mAde sense.

@Mark S. I know this is an older thread and I hope you found your answer. I am following and listening to the financial samurai podcast, he lives in an expensive city and define FI as having enough passive income to finance your best life expenses which is like FAT FIRE and more. Interesting concept, I’m sure you will pick up some good knowledge. Good luck to all of us!