The Decision to Downsize and Delay Claiming Retirement Benefits

A person entering retirement without a mortgage or with a negligible level of mortgage debt can often delay claiming Social Security benefits and disbursing funds from retirement plans. This strategy leads to a more prosperous and secure retirement.

Situation:  A 62-year-old person is debating whether to immediately claim Social Security and start 401(k) disbursements or downsize, live off her capital gain for five years, and start spending retirement benefits at age 67.

She lives in a $1,500,000 house with no mortgage.  She has $1,000,000 in a 401(k) plan.  She cannot afford to delay spending retirement savings unless she downsizes to a smaller home.

  • What are the potential consequences of these decision on the person’s financial well-being in retirement?

Analysis:  The cost of downsizing (sale commissions, purchase commissions and moving costs) from a $1,500,000 home to a $1,000,000 home might be $80,000.  The person would net $420,000 after selling the $1,500,000 home and purchasing a $1,000,000 home.  This $420,000 should be more than enough to live on for five years without tapping retirement savings and without claiming Social Security benefits.

A person born after 1960 claiming at age 62 receives 70 percent of the Social Security benefit of the person who claims at age 67 as noted here.

  • Projected annual Social Security benefits are $15,960 at age 62 compared to $22,800 at age 67.

The delay in disbursing retirement plan benefits delays depletions from spending and allows for increased accumulation from compounding of investments inside the retirement account.  Projected retirement plan balances assume a 5.0 percent annual return on invested assets and disbursements based on the four percent rule with an annual inflation rate of 3.0 percent. 

  • The projected retirement balance at age 67 are $1,024,527 for the person initiating retirement plan disbursements at age 62 and $1,276,282 for the person delaying disbursements until age 67.

The person who delays retirement plan disbursements could implement the four percent rule at age 67 and receive an annual inflation adjusted benefit of $51,000.  The person who downsizes and delays retirement savings has more to spend early in retirement prior to spending retirement resources and more to spend after age 67.

Concluding Remarks:   The decision to downsize and delay spending retirement assets will often lead to a more prosperous and secure retirement.

Authors Note:  David Bernstein is the author of both Financial Decisions for a Secure and Happy Life and A 2024 Health Care Reform Proposal.

The House Downsizing Decision: Options for the 401(K) Rich Person with a Mortgage

A 401(k)-rich person entering retirement with a mortgage should probably downsize to a less expensive home.

Situation One:  A person with $1,000,000 in a traditional retirement plan has a house valued at $700,000 and an outstanding mortgage with a balance of $152,576.  The monthly mortgage payment is $2,387.   This mortgage payment and outstanding mortgage balance is consistent with the person taking out a $500,000 mortgage 24 years earlier.

The only other source of income for this person is her Social Security benefit of $20,000 per year.  Should this person downsize to a smaller house?

Analysis of Situation One:  This person is in a difficult situation.  This retiree is in danger of quickly depleting her retirement account or having insufficient funds for basic consumption, under standard guidelines governing the disbursement of retirement assets.  

Financial advisors often recommend retirees follow the 4.0 percent rule.  This rule sets the initial disbursement from the retirement plan at 4.0 percent of the plan’s assets and adjusts future assets for inflation.

Under the four percent rule, this retiree’s annual mortgage payment during the first year of her retirement is 71.6 percent of her total 401(k) disbursement.  Higher disbursements could lead to rapid depletion of the retirement account and higher taxes because disbursements from traditional retirement assets are fully taxed.

The most obvious solution to this person’s situation is to sell the home to pay off the mortgage.  The person might be able to pay off the mortgage and buy a home for $596,000.  (Assuming selling, buying, and moving costs are around 7.0 percent of the value of the home.). 

Other options involve a new traditional mortgage, or a reverse mortgage. Both options are unattractive and of limited practicality.

A refinancing of the $157,425 mortgage to a 30-year term would lead to a $728 monthly payment or annual mortgage payments of $8,741.  The mortgage is probably not available for someone without wage income.  Also, current interest rates are now higher than 4.0 percent.  

A reverse mortgage allows a person to tap equity and stay in their home. The largest amount a person could borrow on a reverse mortgage is 80 percent of equity. However, a 60 percent borrowing limit is more practical since the borrower is responsible for taxes and maintenance on the home.  Obtaining additional resources from a reverse mortgage might make sense for an older borrower nearing the end of her life.  A younger borrow using a reverse mortgage is highly likely to outlive both her 401(k) wealth and the additional wealth obtained from the reverse mortgage.

Concluding Remark:  The person in situation one prioritized savings inside a traditional retirement plan over the elimination of a mortgage during her working years. This person also chose to contribute to traditional retirement plans instead of Roth plans.   Go to my collection of essays Financial Decisions for a Secure and Happy Life for discussion on prioritizing debt reduction and the use of Roth retirement accounts.  

The only real option during retirement for the 401(K)-rich person with non-trivial debt is downsizing to a less expensive home.  More posts on the downsizing decision will follow.

Financial Impacts of 401(k) vesting requirements

Many people with unvested 401(k) contributions, who lose or change jobs for a wide variety of reasons, end up losing retirement wealth. Should workers with unvested benefits choose to forego 401(k) plans in favor of Individual Retirement Accounts or Health Savings Accounts? Should 401(k) vesting requirements be eliminated to better assist workers who are struggling to save for retirement?

Employer matching contributions are often called “free money.” Virtually, all financial advisors recommend workers take full advantage of employer matching contributions to 401(k) plans.  

However, workers at firms with 401(k) plans with vesting requirements do not immediately own the employer match.  

Information on the prevalence of 401(k) vesting requirements is found here.

  • Around 56 percent of plans have vesting requirements which delay receipt of the ownership of the 401(k) match. 
  • Around 30 percent of firms use a graded vesting schedule where the employer match vests over a five or six year period.
  • A saver with a 401(k) plan that has three-year cliff vesting will lose all benefits unless she stays at a firm for three years.

Many workers especially young adults will leave the firm prior to fully vested and will lose some or all the unvested employer matching contributions.  The high level of job mobility, especially among young adults, leading to a likely loss of some retirement wealth due to vesting requirements, is documented by this BLS report.

  • Americans born in the early 1980s had an average of 7.8 jobs between age 18 and 30.
  • Young adults from age 27 to 30 had on average 2.2 jobs during that period of life.

There are many reasons why people leave one job for another.  In 2022, 50 million people quit their jobs, there were 15.4 million layoffs and 40 percent of Americans had been laid off or terminated from a job at least once in their life.  A recent Gallup report found that 60 percent of respondents reported they were emotionally detached at work and that 19 percent of respondents reported being miserable.  

All workers with unvested 401(k) contributions who switch jobs will lose retirement wealth due to the change in their employment status, regardless of the reason for the switch in jobs.  

People in a work situation where their place of employment offers a 401(k) plan with slowly vesting employer contributions should forego contributions to the firm-sponsored 401(k) plan and consider some other tax-preferred investment vehicle.

Investments in Individual Retirement Accounts and Health Savings Accounts are both preferable to investment in a 401(k) plan when the receipt of matching contributions is uncertain.

Individual Retirement Accounts often have lower fees than 401(k) plans and the fee differential can result in a large loss of lifetime income as discussed here.  The use of short-term bond and CD ladders inside an IRA can substantially reduce risks associated with interest rate changes compared to investments in bond ETFs inside a 401(k) plan.

Health Savings Accounts allow for an immediate tax deduction, are available for immediate health expenses without penalty or tax and provide penalty-free access to all funds after age 65.  The use of funds in a Health Savings Account reduce medical debt and the number of people forgoing necessary medical procedures.  Finance tip number eight states that contributions to health savings accounts must take on a high priority even at the expense of contributions to 401(k) plans.

The Secure Act 2.0 mandated automatic enrollment for new workers inside 401(k) plans.  The existence of vesting requirements creates an incentive for savvy workers to opt out of their 401(k) plans.

There are compelling arguments for a new law outlawing all vesting requirements on firm 401(K) plans, even if this change increases turnover and training costs for some firms.   Taking money from an employee that the employer chooses to terminate or leaves because she is miserable seems unfair and is a recipe for low productivity.  The next generation of workers is likely to have a higher Social Security retirement age because of pending Social Security deficits.   The forfeiture of employer contributions because of vesting requirements will reduce the accumulation of retirement wealth. 

It is time for policy makers to abolish 401(k) vesting requirements.  People currently subject to 401(k) vesting requirements need to consider other investment options.

The Individual Retirement Account Quiz

Eighteen True/Fales Questions: Topics include – advantages of investing in IRAs, differences between conventional and Roth IRAs, permissible investments for IRAs, conversion strategies, state taxes and the choice between Roth and conventional IRAs, rules governing inherited IRAs, and the Secure Acts.

Question 1:  True or False: The sole tax advantage of conventional IRAs is the tax deduction in the year the contribution is made, and the sole tax advantage of Roth IRAs is the tax savings in retirement. 

FALSE:  People can trade inside both a conventional and Roth IRA without paying any federal or state income tax on capital gains, interest, or dividends in the year the of the trade.  The tax deferral provision inside retirement accounts allows investors to take profits and reallocate assets without paying tax.   

Question 2True or False:    An extremely successful investor that earns spectacular returns on their investment should choose a Roth IRA over a conventional IRA.   

True: There is no limit on the future balance of an IRA, hence successful investors should use a Roth account.  Disbursements from a large conventional account will be fully taxed while disbursements from a Roth will not be taxed during the lifetime of the owner of the account and for the first 10 years of the inherited account.  Investors receiving spectacular returns will be in a high tax bracket when they are forced to distribute funds.  Peter Theil provides the prime example of why successful investors use Roth accounts.

Question 3True or False:   Municipal bonds are an excellent investment to hold inside an IRA.

False:  Since the interest on municipal bonds is not taxed at the federal level and may not be taxed at the state level the yield on municipal bonds is less than the yield on federal or private securities of equivalent risk. (On January 5, 2024, the interest rate on three-month AAA municipal bonds was 3.67 percent while the interest rate on the three-month T-bill was 5.1 percent.). The IRA investor does not gain from the tax advantages of the municipal bond so the IRA investor should purchase the bond with the higher pre-tax yield.  

Question 4True or False:   A middle-income married couple where both spouses work should plan on putting a higher percent of retirement wealth in a Roth than a married couple with identical income where one spouse does not have a career outside the home.

True:  One of the tax advantages of Roth IRAs is that the distribution is not included in AGI and therefore does not impact the amount of Social Security benefits subject to federal or state income taxes.  The savings from the use of Roth IRAs from this provision is larger for the married couple with two working spouses than for the married couple with one working spouse.  

Question 5: True or False:  Both IRAs and 401(k) plans allow account holders to invest directly in Treasury bonds, corporate bonds, CDs, or agency bonds.

FALSE:  The investment options of 401(k) plans are determined by the plan sponsor and are usually if not always limited to a small number of equity and fixed income funds.  By contrast, a worker or retiree can roll over a 401(k) plan to an IRA at a firm like Fidelity, Vanguard, or Schwab and directly purchase fixed-income securities. This is a huge advantage of IRAs because the lack of a maturity date on fixed-income funds will result in large losses during a period of rising interest rates.  The bond investor can always hold the asset to its maturity.  The fund investor does not have this option.  

Question 6True or False:   Series I savings bonds and Series EE bonds can be purchased inside an IRA.

FALSE:  I read an article saying this was possible, but the article appears wrong because IRA contributions involve cash followed by investments and firms sponsoring IRAs do not allow for purchases on Treasury Direct, the primary place where Series I and Series EE bonds are purchased.

Question 7:  True or False:  The optimal disbursement strategy between spending from assets in brokerage accounts, conventional retirement accounts and Roth retirement accounts remains constant after retirement.


The appropriate disbursement strategy depends on the age of the retiree, whether the retiree is claiming Social Security and whether the retiree is attempting to maximize the wealth of an heir.

  • Early in retirement, prior to claiming Social Security, live on funds in brokerage accounts while converting traditional retirement assets to Roth assets.
  • Delay claiming Social Security to age 70 if possible.
  • After claiming Social Security distribute assets from the Roth account to both avoid tax on the distribution and reduce the amount of Social Security benefits subject to tax. 
  • Older taxpayers with heirs in a high tax bracket should spend from the conventional account to reduce tax burden on heirs.

This question pertains to Tip #7 here.  Go here, for an interesting discussion of reasons to convert traditional assets to Roth assets early in retirement.

Question 8True or False:  A 62 year-old retiree with a very small amount of liquid assets outside of her retirement plan, around $1,000,000 of assets in a traditional retirement plan and no assets in a Roth account is well positioned to convert the traditional retirement assets to a Roth.

False:  Since the retiree has little in the way of liquid non-retirement assets, she must distribute funds from the conventional asset to fund current consumption.  Both the funds she uses for consumption and the funds that are converted to the Roth are fully tax as ordinary income.   The incremental costs of the conversion are high because the person is in a relatively high tax bracket.  By contrast, a person with liquid assets outside of her retirement account will only be taxed on the capital gain and the capital gains tax rate is lower than the tax rate on ordinary income.

The cost of converting traditional retirement assets to Roth assets is substantially higher for a person who must use traditional retirement assets to fund current consumption. 

Question 9True or False: A person who graduated college, works four years, puts $20,000 in her traditional 401(k) and leaves the workforce for two years for graduate school should convert her assets in her traditional retirement account to a Roth account while in school?

True: Converting traditional retirement assets to Roth assets is probably the last thing on the mind of person a person in their twenties returning to school but it is a great move.

Any conversion by a person with AGI less than the standard deduction is taxed at the 0 percent rate.  Even conversions at a 10 percent rate (taxable income less than $11,000) or 12 percent (taxable income less than $44,725) will prove profitable.

Bottom line, as discussed here, is that costs of converting traditional IRAs to Roth IRAs are low when a person leaves the workforce.  

Question 10: True or False:  The total rate of return on a conversion of a traditional retirement asset to Roth by a 62-year person prior to claiming Social Security and who distributes funds in a Roth IRA after five years will be around 8.0 percent

False:  The total return from this transaction, under reasonable assumptions, will be around 30 percent.

Key features of the transaction:

  • Person relies on liquid savings and no Social Security benefits at age 62.
  • Converts around $35,000 in traditional retirement assets to Roth and pays an additional $1,975 in tax.
  • Assets in Roth earn 6.0 percent per year for five years.  
  • Roth assets grow to slightly over $46,000.
  • Person lives off Social Security and Roth assets instead of conventional assets after five years.
  • Tax savings from the use of Roth instead of conventional assets after five years is 
  • The use of Roth assets instead of traditional assets would reduce tax by $7,000 after five years and $700 after six years.
  • The return on this investment calculated with XIRR is 30.7 percent.

A detailed discussion of this calculation and the regulations governing Roth conversions can be found in this Tax Notes article.

Question 11True or False:  A workers who resides in California one year and Florida the next year should wait until moving to Florida before converting conventional retirement assets to Roth assets.

True:  The cost of conversion, the tax paid on the amount converted, depends on both federal and state income tax.   California will tax the conversion to a Roth.  Florida, which lacks an income tax will not.

Question 12True or False:  All else equal people who reside in California throughout their working and retired life should contribute to a conventional retirement account while people in Florida should always contribute to a Roth account.

False:  Benefits of tax deduction from the contribution to the conventional retirement plan are higher in California, the state with a state income tax but benefits from distributions from the Roth account in retirement are also larger in the state with the income tax.  All taxpayers should seek a mix of conventional and Roth assets regardless of the state where they are domiciled.

Question 13True or False:  The rules governing the tax and penalty on the distribution of funds contributed to a Roth IRA and funds from a conversion of traditional to Roth assets are identical.

False:  All distributions from a converted IRA are subject to a penalty for five years from January 1 of the year of the conversion.  

This penalty applies even if the taxpayer is over age 59 ½ at the time of the distribution.

A taxpayer who distributes funds on the converted Roth prior to five years from January 1 of the year of the distribution will pay both tax on the amount converted and a penalty. 

There also exists a five-year rule on contributions to a conventional IRA but it appears to only restrict access to investment earnings on funds that have been in the account for less than five years. 

Go here for a discussion of different aspects of the five-year rule.

Question 14True or False:  The Secure Act 2.0 requires the owners of all inherited IRAs to distribute all funds over a 10-year period after the death of the original owner.

FALSE:  There are two exceptions. 

  • Non-spousal beneficiaries who inherited IRAS prior to 2020 can stretch payments over their expected lifetime.
  • All spouse beneficiaries can spread payments out over their expected lifetime.

This article by TheStreet is a good resource.

Question 15True or False:   The increase in the age for required minimum distributions will substantially reduce the number of people who are likely to outlive their retirement savings.

FALSE:  Most people who are in danger of outliving their retirement savings are distributing sums earlier than 73, the new age where RMDs start and are distributing sums greater than the minimum once distributions become mandatory. The RMD is only 3.8 percent of retirement assets at age 73.  Go here for a useful RMD calculator.   

Bottom line, the new RMD rules benefit the relatively affluent retirees and firms managing IRAs and 401(k) plans, not people struggling to survive in retirement.

Question 16: True or False:  Some IRAs allow for alternative often non-liquid investments including real estate and private equity.

True:  But they are complex and entail risk.  Go to this nerdwallet article for some information.

Question 17: True or False:  An IRA is an excellent vehicle for investment in a vacation home.

False:  You can purchase real estate in a self-directed IRA, but it can’t be used as a vacation home, a second home or a place for your parents.  The IRS is very strict about this.  This Investopedia article is a good resource on this issue. 

Question 18:  True or False:  The recently enacted Secure Act 2.0 substantially expands the ability of IRA and 401(k) owner to distribute funds prior to age 59 ½.

True:  Although the increased access to funds prior to age 59 ½ is much larger for owners of conventional retirement plans than owners of Roth retirement plans because Roth accounts already allow for early disbursements of contributions. 

The Secure Act 2.0 allows for additional penalty-free withdrawals including – (1) one withdrawal per year up to $1,000 for unforeseeable financial needs, (2) withdrawals for permanent disabilities, (3) victims of domestic abuse, (4) medical insurance when unemployed, (5) qualified education expenses, and first-time home purchases.  

This Wall Street Journal article has a more complete list of expanded penalty-free disbursements.  

My view is that these liberalized disbursement rules will result in an increased number of people retiring with insufficient retirement income.   Go here for my empirical research on the issue of early disbursements from retirement plans.

Question 19. True/False:  When tax rates are certain and identical in working years and in retirement a person will be indifferent between saving X dollars in a conventional deductible IRA and (1-t)*X dollars in a Roth where t is the tax rate that would have been applied to the funds placed in the deductible IRA. 

True:  The easiest way to check this is true is to plug in some numbers

  • Tax rate 10 percent,
  • $2,000 contributed to a conventional IRA,
  • $1,800 contributed to a Roth IRA,
  • 8.0 percent annual return for 30 years,
  • Amount available for consumption in Roth after 30 years is $18,113 

(1.0830 * 2000),

  • Amount available for consumption in conventional account also $18,113.

0.90*(1.0830 * 2200),

Note the tax savings from Roth distributions instead of conventional distributions will be much larger than 10 percent for most workers who have some working-years in the 10 percent tax bracket because they will be in a higher marginal tax bracket based on lifetime earnings or high expenses and disbursements in a particular year and tax savings from the exclusion of Social Security benefits from AGI.

Question 20: True or False:  A spouse who is not in the workforce cannot contribute to a retirement account.

False:  A non-working spouse can create and contribute to a spousal IRA, if he or she files a joint return and satisfies the IRS contribution limits, income limits, and federal deduction limits.  Even if the joint return has a high AGI the non-working spouse will be able to create and fund a non-deductible IRA, which is legally owned by the non-working spouse.  Go here for more information.

Question 21:  True or False. A person with adjusted gross income over the income limits for Roth IRAs cannot add to a Roth IRA

False:  The income limits on Roth IRA contributions are easily circumvented through a procedure called a backdoor IRA.  The steps used to create a backdoor IRA involve:

  • Create and funds a non-deductible IRA.
  • Immediately convert proceeds in the non-deductible IRA to a Roth account.

Since the funds in the non-deductible IRA were fully taxed you will not owe any tax on the amount converted.  Conversions from a deductible IRA or a traditional 401(k) plan would be fully taxed, hence, people using the backdoor IRA should use funds from a non-deductible IRA to fund the conversions.  Additional conversions from deductible IRAs and 401(k) plans could occur when household earning is low. 

As noted in this Smart Asset article

“If your income leaves you locked out of the Roth option, you can simply contribute to a non-deductible IRA and then convert that IRA to a Roth IRA. Voila! You’ve got a Roth.”

Question 3: The benefits of early investment in Roth IRAs

Question on reasons why young adults need to use a Roth IRA.

Question 3:  The benefits of early investment in Roth IRAs

Question 3:  What is the amount available for consumption after tax from a $6,000 contribution to a conventional and a Roth IRA funded at age 20 and distributed at age 65 when the underlying assets earned 8.0 percent per year and the tax rate is 20 percent?   

What additional considerations favor the choice of the Roth IRA over the conventional IRA?


Basic Calculation:

  • The total wealth accumulated in a tax-deferred IRA of $6,000 invested for 35 years earning an average annual return of 8.0 percent per year is $88,712.
  • The distribution of the conventional IRA is taxed at a 20 percent rate, hence the amount available for consumption from the conventional IRA is $70,970.
  • The entire distribution of $88,712 from the Roth account is available for consumption. 

Additional Benefits of the Roth:

  • The contribution to the Roth could be used for an emergency without payment of tax or penalty.
  • The distribution from the Roth is not included in AGI and does not increase the amount of Social Security benefits subject to tax.  As a result, the tax savings for a person in the 20 percent marginal tax bracket may be higher than 20 percent of the distribution.
  • People in retirement who have a year where they must distribute substantial funds from their retirement accounts will be forced into a higher tax bracket if their only source of funds is a conventional retirement account.
  • All inherited IRA funds must be disbursed within 10 years, but Roth disbursements will not be taxed, and conventional IRAs will be taxed as ordinary income.

Go here for a list of financial tips, here for an article on why a Roth should be the vehicle of choice for young adults,  and here for an article on the advantages of Roth articles.

Question 1: Is it time to invest in small-cap growth stock?

Examaination of valuation of top-10 small-cap and large-cap growth stocks indicates both sectors are overvalued at the start of 2024.

True/False:   Small cap growth stocks are obviously a much better value than large-cap growth stocks?

Hint: You are pretty safe saying false whenever the word obviously is used in a true-false question.

FALSE:  Many analysts pointing to the stellar 2023 year for large-cap growth stocks are saying 2024 is the year for small-cap growth stocks like VBK the small-cap growth fund offered by Vanguard.  My analysis of the data indicates that both VBK, the small-cap growth fund and VOOG, a large-cap growth stock fund, are overvalued at the start of 2024.


Both funds did well in 2023 due to a strong end-of-year winning streak.  The gain for 2023 was 23.15 percent for VBK and 30.43 percent for VOOG. 

An analysis of PE ratios for the top-10 holdings in the two funds suggests that small-cap firm valuations may be higher than large-cap firm valuations.

Small-cap firm valuations:

  • Six of the top-ten small-cap firm holdings had a PE ratio over 50, including one firm with a negative PE ratio.
  • Three of the firms had a PE ratio between 25 and 30.
  • None of the firms had a PE ratio less than 20.
  • The correctly calculated PE ratio for the ten small-cap growth stocks is 70.97.  (See methodological note below.)
  • The top 10 holdings in the small-cap growth portfolio represent less than 8.0 percent of holdings in VBK.

Large-cap firm valuations:

  • Four of the ten large-cap growth valuations had a PE ratio over 50.
  • Only one of the 10 firms, Exxon (PE=9.93) had a low PE.  All other firm PE ratios were over 20.  (I am not sure why XOM is included in a growth portfolio, all though it does provide balance)
  • No firm had a negative PE ratio.
  • The correctly valued PE ratio for the 10-stock large-cap portfolio is 30.94.  (See methodological note below.)
  • The top 10 holdings in the large-cap growth portfolio represent over half of the portfolio.

Concluding thought:  A quick snapshot of the top ten holdings of VBK (a small-cap growth portfolio) and VOOG (a large-cap growth portfolio) found that top holdings of VBK have higher valuation than top holdings of VOOG.  The top holdings of VOOG clearly skyrocketed in 2023 and many investors are now seeking diversification, but VBK is NOT A BARGAIN and is in fact probably riskier than VOOG.

Methodological Note:  A portfolio PE cannot be estimated from the average of stock PE ratios because firms with negative earnings do not have a defined PE ratio and firms with earnings near zero have PE ratios that are outliers that dominate the average of the PE ratios.  One way to calculate the official PE ratio for a portfolio described in this post and in this longer paper involves a transformation of the statistic f=(p-eps)/eps.

Question 2: Tax and penalties on early distributions from a conventional and Roth IRA

Info on tax and penalty from early distribution on different types of IRAs.

Question 2:  What is the tax and penalty on the withdrawal of all funds from both a conventional deductible IRA and a Roth IRA prior to age 59 ½ five years after an initial contribution of $3,000 assuming a 6 percent return on invested assets, and a marginal tax rate of 20 percent?

Answer:  The entire distribution from the conventional IRA is subject to tax and penalty while only the investment income portion of the distribution from the Roth IRA is subject to tax and penalty.  The calculations below assume a tax rate of 20 percent and a penalty rate of 10 percent on the relevant amount.

  • Total funds in both IRAs after five years is $4,015.
  • The penalty and tax on the conventional IRA is $1,204.40.
  • The penalty and tax on the Roth IRA is $304.40

Also, note the owner of the Roth IRA could have limited her withdrawal to $3,000, kept the investment return in the Roth and paid no penalty and tax.

The lack of penalty or tax on the distribution of the initial contribution makes the Roth IRA the better choice for people starting their careers or for people with limited liquidity.  For more information on the choice between a Roth IRA and a conventional IRA look at the first two financial tips here.

Question One: A question on fees and 401(k) plan rollovers

Even a slightly higer fee level can lead to a large loss of wealth. Don’t abandon your 401(k) to the whims of your ex employer.

True or False:  People with a small amount of funds in a 401(K) plan should leave funds in the employer-based 401(k) plan when they switch jobs.

False:  Many companies will move funds of departing employees to high-fee low-return IRAs.  These IRAs will not benefit their owners.  


  • The Secure Act 2.0 mandated automatic enrollment of new workers in the firm’s small 401(k) plan.
  • Many employees routinely leave 401(k) assets at their old employer.
  • Employers routinely move assets left behind in 401(k) plans to high-fee low-return IRAs.
  • Prior to the Secure Act 2.0 employers had the right to transfer all 401(k) plans with assets less than $5,000 to a high-cost IRAs.
  • The Secure Act 2.0 increased the transfer right to all plans with less than $7,000 in assets.
  • Even relatively small differences in retirement plan fees can lead to a large decrease in accumulated assets as shown in Example Two, here.

The logic of the automatic enrollment provision in Secure Act 2.0 was to encourage workers to start saving early for retirement because automatic enrollment was in their best interest.  Automatic transfers of 401(k) assets to well-run low-cost IRAs would also be in the best interest of workers but the law does not mandate or even recommend automatic transfers to low-fee highly diversified accounts.  

The combination of automatic enrollment and not automatic transfers seems to benefit the wall street firms sponsoring high-cost retirement accounts.

The Secure Act 2.0, a law that was passed with bipartisan support, does more for Wall Street investment firms than workers. It does seem as though that modern capitalism does more to manipulate rules to the advantage of the firm over the consumer than in providing a good reliable product or service.

Problems caused by the forced transfer of abandoned 401(k) assets to high-cost IRAs are discussed in this New York Times article.  Financial tip #5, presented in this list of tips, makes the case for routinely moving 401(k) funds to low-cost IRAs. 

Tip 8b: Impact of Mortgages on Longevity Risk

The Situation:
  Consider a person who took out a 30-year mortgage, 15 years prior to retirement.   The initial balance on the mortgage was $600,000 and the interest rate on the mortgage was 3.6 percent.

The person retires with $1,000,000 in her 401(k) plan but the retiree also has an outstanding mortgage of $378,975 and an ongoing monthly mortgage payment of $2,728.  

The retiree plans to spend $40,000 per year $3,333 per month to cover non-housing consumption in retirement. 

  • The total annual disbursement from a 401(k) plan for a person with a mortgage is $72,735.
  • The total annual disbursement from a 401(k) plan for a person without a mortgage is $40,000.

Question One:  What are the outstanding balances of the retirement plan after 15 years for a person with a mortgage and a person without a mortgage if the rate of return on investments in the retirement plan is 6.0 percent per year?


  • The outstanding 401(k) balance after 15 years for the person with a mortgage is $691,380.
  • The outstanding 401(k) balance after 15 years for the person without a mortgage is $1,484,698.

Question Two:  What are the 401(k) outstanding balances after 15 years if the person started retirement with $900,000 in 401(k) assets.


  • The person with the mortgage has a 401(k) balance of $445,971 after 15 years.
  • The person without a mortgage has a 401(k) balance of $1,239,290 after 15 years. 

Implications for longevity risk:

The existence of a mortgage payment substantially increases the depletion rate of the 401(k) plan. The mortgage payment cannot be avoided during market fluctuations.  The existence of a mortgage during a market downturn at the beginning of retirement can have an especially adverse impact on retirement wealth.

The discussion presented here does not explicitly consider taxes.

  • All traditional 401(k) assets are fully taxed as ordinary income.   
  • The person with higher spending due to a mortgage will have also have higher taxes.
  • This person may increase spending to have adequate non-housing consumption.

More on these issues will follow.

Technical Note:  Discussion of Financial Calculations

The most straight forward way to obtain the 401(k) balance is to set up a spreadsheet where the loan payment is subtracted from the balance each month and the balance minus the loan payment earns a monthly return.   

A second approach involves the use of the FV function.  

The arguments of the FV function are

  • Rate 0.06/12 or 0.005.
  • NPER 12*15 or 180.
  • PMT 6061.21 for person with a mortgage and $3,333.33 for person without the mortgage.
  • PV -1,000,000. Negative because PV is cash in and must be the opposite sign of the PMT function.

The FV function is set up to analyze loans, so be careful with the sign of answer.

Financial Tip 8a: Payoff the mortgage prior to retirement

Tip #8a: People with mortgage debt in retirement must often take large taxable distributions from their 401(k) plan regardless of the level of the stock market.  The elimination of all debt prior to retirement substantially reduces the likelihood a person will outlive their retirement savings.

General Discussion:  Many financial advisors believe it is appropriate for their clients to keep some debt in retirement.   They will advise their clients to take out a 30-year loan instead of a 15-year loan to increase contributions to a 401(k) plan and to take full advantage of the deductibility of mortgage interest. They also argue that people nearing retirement should make additional catch-up contributions to their 401(k) plan instead of increasing payments on their mortgage.

The decision to keep debt in retirement is a recipe for financial disaster, especially if the household is reliant on fully taxed distributions from a 401(k) plan and partially taxed Social Security benefits.  

Issue One: The person with debt will more rapidly deplete their 401(k) plan and will pay higher taxes in retirement.

Discussion:  A person taking out a 30-year $500,000 mortgage, 15 years prior to retirement has annual mortgage expenses of $26,609.  The person that used a 15-year mortgage enters retirement debt free.  See the example presented in Financial Tip #4 Guidelines for the choice between a 15-year and 30-year mortgage.  

The person with the mortgage debt must either reduce non-mortgage expenditures or distribute additional funds from their retirement account to maintain the same consumption as the person that paid off her entire mortgage prior to retirement. 

Large tax-deductible mortgages reduce payment of federal and state income taxes in working years but increase payment of federal state and income taxes in retirement.

  • Retirees without business expenses generally have lower itemized deductions than people in their prime earnings years, hence, the advantages from itemizing in retirement are often small.
  • An increase in the distribution of 401(k) funds to cover the mortgage is fully taxed as ordinary income. 
  • An increase in 401(k) distributions increases the amount of Social Security subject to income tax as discussed on this page offered by the Social Security Administration.  

Issue Two:  The person without debt is better able to maintain current consumption levels and preserve wealth during market downturns.

Discussion:   Typically, a person attempts to maintain a certain level of consumption perhaps 60 percent of pre-retirement income throughout retirement.  A person with a mortgage or a monthly rental payment is less able to reduce expenditures when the value of stocks in their 401(k) falls because the mortgage payment or the rent are not optional. 

Any reduction in disbursements from 401(K) plans, which are reduced in value due to a collapse in stock prices, would have to occur from a reduction in non-housing consumption.   

The largest financial exposures occur when the market falls by a substantial amount in the early years of retirement when the entire savings from working years is exposed to the market.  The market downturn in stocks in 2008 was somewhat offset by an increase in bond values.   This time around both stocks and traditional bonds appear to be in a bubble.   People may want to consider Series I or inflation bonds as discussed in  financial tip #7.

Still, the best way to prepare for a market downturn is to eliminate all debt prior to retirement. 

Concluding Remarks:  During working years, many households take on a large amount of mortgage debt to reduce current year tax obligations. Failure to eliminate all mortgage debt prior to retirement often leads to rapid depletion of 401(k) assets, higher income tax burdens in retirement and increased exposure to financial volatility.