Have I already saved more than I thought for my traditional retirement years?

[mjb39618]

Hi, I'm new to the forum.  After devouring the blog, I took a closer look at my family's assets, and I think we may already have more than I thought saved for retirement at 60 (now I just have to worry about those pesky years before that).  I tried to demonstrate this to my wife, but I couldn't get the message across.  Somebody please sanity check me!

Our facts:
We each are 33 years old, so 27 years until the age where we can take no worries withdrawals from our 401(k)s (ignoring the exceptions that exist).
$272k in 401(k)s, mostly Roth money (so tax-free on withdrawal)

Assuming a 5% after-inflation annual return, this sum will be worth $1,015,500 in today's dollars when we are age 60.  A 4% withdrawal rate would provide us with $40,620 annually.  Our current spending is $60,000 annually (which we are taking steps to reduce to more Mustachian levels).

Additionally, we will continue to contribute enough to 401(k)s to earn the employer match as long as we both work, so the actual balance in 27 years will be somewhat higher.  Plus social security will kick in at age 67 and will provide something as well.

Is it useful to look at it as we've saved 2/3 of what we need for the years 60 onward already?  I was really pleasantly surprised to reach that conclusion.  I'm finding that the mental gymnastics of splitting the goal of "enough to retire" into pieces like that makes it more real than just gunning for one huge number.

We have been aggressively paying down our mortgage for the last 4 years, and it will finally be gone in September (the $60k number above doesn't include any mortgage payments as we have all of the debt on a HELOC, so we just pay as much as we can each month).  We don't have much in the way of liquid assets due to the focus on the mortgage.

Our plan has always been to finish off the mortgage and then max the 401(k)s, but now I am rethinking this.  I may be better served to keep the 401(k) contributions at just enough to receive the match, and divert anything after that to building up a nice big base of liquid assets.  I understand that I would be losing the tax deferral on the growth, but that is a trade I'm willing to make for liquidity.  Thoughts?

[gimp]

Well, let's see. $40k today is, at (let's approximate) 2% inflation, $68k.

A 7% return on $272k is just shy of 1.7m. 4% of that is just shy of $68k.

So that deserves a hat tip. If you can reduce your current spending to an inflation-adjusted $40k in today's money - quite reasonable, assuming a paid off house, grown children, and slightly less energy and mobility - you get the hat tip. If not, you are indeed 2/3 there.

The math works, assuming nothing incredible happens in the next 27 years to make all our investments obsolete, at which point paper money is the last of your concerns.

For tax purposes, I think it makes sense to at least get the employer match on 401k, if not max it out entirely. Unlike a traditional IRA, the tax benefits don't go away until a very high salary indeed, and the tax benefits are really quite lovely.

[Joel]

Keep in mind 40k 30 years from now will not buy the same things 40k will currently buy.

[mjb39618]

Thanks for the thoughts gimp.  Since my wife wants to max her 401(k) after the mortgage is paid off, we may find middle ground and have her do that while I just go for the match and some investments in taxable accounts.

Joel, I've already accounted for the inflation by stating the return is 5% after inflation (so 7-8% total), and stating the future balance and 4% withdrawals in today's dollars.  Unless I'm still missing something?

[desk_jockey]

Sounds like you’ve got everything under control.  5% over inflation *might* be aggressive, but as you continue to contribute to get the employer match you’ll compensate for that assumption and then some leaving you a conservative plenty at 59 ½.   

Ramp up above the employer match if the reduction in your current income it’s going to have a significant impact to your taxes.  Otherwise stash outside of  pre-tax retirement plans so you can bring the FIRE date well forward from 59 ½.

[defenestrate]

Well-- If you switch to only investing into Roth accounts, I believe you are able to withdraw the principal investment with no penalty at any time. This could be a way to start distributions earlier. Another strategy is to convince your wife to make investments in assets that have other tax advantages, like real estate--this may have more benefits than a 401K as you could build a private business that has losses and expenses in the short term that could benefit all your taxable income.

Sounds to me that there is a heavy attachment to tax advantaged accounts, which may not be beneficial without a substantial taxable account that you can access in FIRE.

[mjb39618]

Thanks for the input!  I'm going to gain a better understanding of ways to tap retirement accounts early and then we'll sit down and make a decision.

[RyanHesson]

At the very least it will mean that you can draw down on savings (take out more than the 4% "safe" withdrawal rate) that aren't retirement savings pretty quick. It only has to last until you're 59.5 years old. That can greatly reduce what you need.

[seattlecyclone]

You have more options besides taxable accounts for the years between ER and 60.

Two important facts to be aware of:
1) You can withdraw Roth contributions at any time, penalty-free.
2) Any money you convert from a pre-tax 401(k) or IRA to a Roth IRA can be withdrawn penalty-free after five years.

Both of these provisions only apply to the amount you initially contributed or rolled over. Any earnings on the money after it enters the Roth zone is subject to penalties if you withdraw it early. However, many folks around here plan to use a "Roth pipeline" to minimize their taxes while still ensuring they have enough money to live on during ER.

The idea behind a Roth pipeline is that you should max out pre-tax retirement accounts while you're working, since you're unlikely to have a higher taxable income in retirement than you do right now. Then you should make sure that you will have enough money available to be withdrawn from your Roth accounts to last the next five years.

Someone who starts out with all their money in pre-tax IRA/401(k) accounts would want to convert some of this money to Roth five years before retiring, enough to cover their first year of retirement expenses. Then four years before retiring they would convert enough to cover their second year of retirement expenses, and so on. Every year they would keep converting enough to meet their expenses five years in the future. A frugal person who uses this strategy will end up paying very little income tax during retirement since the first $20k of income for a married couple is tax-free (standard deduction and personal exemptions), and so you'll pay just 10-15% on whatever amount exceeds $20k.

Since you already have a fair amount of money already in your Roth 401(k), you may be able to skip a few years of the pre-retirement conversions. So what I would suggest is that you first switch your 401(k) contributions from Roth to pre-tax going forward, since you won't be paying much income tax during early retirement. Then max out these contributions every year, starting right now. If that means you pay off your mortgage a little bit more slowly than what you're doing now, that's probably worth the trade. When your mortgage is gone and you're still maxing out your 401(k) and you still have extra money to invest, that's when you should open up a taxable account. Until that happens, take advantage of all the pre-tax investing you can do. The Roth pipeline provides a way to access this money if you need it.

[mjb39618]

Ryan - that's exactly what I was thinking.  I'd never seen it presented like MMM did, where he called it old man/woman money, and segmented the idea of retirement savings.  Original post is http://www.mrmoneymustache.com/2011/11/11/how-much-is-too-much-in-your-401k/.  So yes, the idea would be that I could eat the principal of my ER savings until theoretically there was nothing left when I turn 60 - accounting for some safety margin of course.

SeattleCyclone - I appreciate the detailed response.  The wife and I are changing from Roth 401(k) contributions to traditional 401(k) ASAP.  When the Roth 401(k) became available, I was excited at the prospect of paying the taxes up front and getting it all back free later (We are delayed-gratificiation/take-your-medicine-now oriented).  Now that I am a few years older and wiser, and I have a concrete plan to not work until I'm 65, I realize that I'll likely never be in a higher tax bracket than I am today.  So I'll take the tax break today in exchange for paying some tax later.

Now with a better understanding of the five-year rule on Roth conversions, the Roth pipeline is a strategy I will put into play.  I can get the tax benefits of 401(k) contributions and still gain access to them when needed, and it is not that complex.  I was originally leaning toward the lazy way out of taxable accounts, but this will put more money in my pocket and therefore I won't have to work as long!