Author Topic: 401K vs invest account analysis  (Read 2259 times)

morninglightmountain

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401K vs invest account analysis
« on: December 10, 2016, 08:19:08 PM »
I've been questioning what my approach to my 401K account through my employer will be. 

If my savings, salary, and stock market performance assumptions hold true, I'll be financially independent (according to my own needs) in 5-6 years.  My salary+bonus next year will be $131K and I currently contribute the minimum amount (5%) needed to maximize my employer match (1.25%).  My MO is to take income net of expenses next year and to put it into my index investment fund instead of increasing my 401K contribution. 

Here's the thing: after 6 years, my passive income potential (with no reinvestment) would be $91K, which isn't that much less than my 2017 salary in terms of tax brackets.  Now, I'll be charged a 10% penalty (I'll be 35) for pulling money out of my 401K.  If I wanted to pool my 401k assets into my general investment fund to live off of, I'd take the 10% haircut as soon as I retired. 

Am I off base for thinking that 401Ks are only beneficial to those planning on retiring after 59.5?  I mean, I don't want to lose the employer match, but I think I'm better off with my personal fund for my real savings.


morninglightmountain

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Re: 401K vs invest account analysis
« Reply #2 on: December 18, 2016, 04:09:01 PM »
Have you read http://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/ ?

Hmm..I did not.  Thanks.  I'll try to incorporate this technique into my financial model to see its effects.

SeattleCPA

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Re: 401K vs invest account analysis
« Reply #3 on: December 19, 2016, 07:38:31 AM »
Just a comment from a tax guy... If you really are going to retire--no going back--I bet the substantially equal payments route works best.

Basically, substantially equal payments let you start drawing down your retirement money because you're retired... but you need to follow some rules to show you've really retired.

seattlecyclone

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Re: 401K vs invest account analysis
« Reply #4 on: December 19, 2016, 10:55:55 AM »
Just a comment from a tax guy... If you really are going to retire--no going back--I bet the substantially equal payments route works best.

Basically, substantially equal payments let you start drawing down your retirement money because you're retired... but you need to follow some rules to show you've really retired.

There's no need to "prove" your retirement to use this method, you just have to start taking money out of your retirement account according to a specific formula and continue that until you're 60. Work or not after beginning these payments, it really doesn't matter. Just keep making those withdrawals each year, else you'll owe the 10% penalty plus interest for all previous withdrawals.

Unfortunately for an early retiree, the amount you can take out per year under this method is relatively small. It depends on your age and current interest rates, but it often ends up being less than 4%. So if you have a taxable account to supplement these payments it can maybe work out for you. If your money is mostly in your 401(k) and/or IRA, you may find yourself needing to work longer than otherwise necessary just to get your balance high enough for the SEPP money to pay your bills.

SeattleCPA

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Re: 401K vs invest account analysis
« Reply #5 on: December 19, 2016, 11:46:21 AM »
Sorry if I was too vague. You're right that you don't need to be retired... I was just trying to communicate that if you really were retired and living off your investments, these will probably work.

BTW, you don't just have to continue taking payments until your age 59.5... the rules are more inflexible than that. You also need to take the contributions for at least five years:

https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-substantially-equal-periodic-payments#12
« Last Edit: December 19, 2016, 11:59:29 AM by SeattleCPA »

seattlecyclone

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Re: 401K vs invest account analysis
« Reply #6 on: December 19, 2016, 12:05:49 PM »
Yep, I didn't mention the five-year rule for substantially equal periodic payments because I tend to make the assumption that most of us are planning to retire prior to age 55, making that rule irrelevant. However I know that's not always the case. Thanks for the reminder.