How do FIRE folk retire early *and* max out their retirement accounts?

[Swansong]

I'm sure this question has been asked before but I can't seem to wrap my head around the answer.

A lot of popular personal finance advice - such as this Reddit post / flowchart on how to prioritize spending your money - https://www.reddit.com/r/personalfinance/comments/4gdlu9/how_to_prioritize_spending_your_money_a_flowchart/ - recommends contributing to an employer-matched 401(k) and maxing out a Roth or Traditional IRA before accumulating savings outside of tax-advantaged accounts. I understand that the 401(k) employer match is basically free money and it rarely doesn't make sense to take it.

This all sounds well and good if you are planning to retire at 59 - but if you are planning to retire any earlier (say, at 40) and a significant portion of your funds are in these accounts, you will not be allowed to make withdrawals without paying a stiff penalty.

Let's say I'm 22 years old and choose to contribute $6,000 to my IRA and $4,000 to my 401(k) each year for the next 18 years. Let's also say my employer matches 401(k) contributions at 25%, so my annual retirement savings would be: $6000 + $4000 + $1000 = $11,000.

After contributing for 18 years at 7% annual interest, this amount would grow into roughly $382,319.85. However, I would not be allowed to start withdrawing without penalty until I turn 59 - 19 years later - at which point my nest egg would grow to $1,382,670.26 assuming I "retired" at 40 and didn't make any more retirement contributions.

If I didn't commit the $10,000/year to retirement accounts, I would have an extra $ 347,563.50 (less taxes) of liquid funds to help me retire at 40. If I didn't touch this money for the next 19 years and let it continue to grow at 7% without contributions, I would end up with $1,256,972.97 before taxes at age 59 - still probably around $1m after taxes without using retirement accounts at all.

I get that not using retirement accounts could mean paying an extra ~$250k in taxes over the next 37 years. I think where I'm getting stuck is that $250k will probably be a much smaller fraction of my overall net worth when I'm 59 compared to ~$300k when I'm 40.

For those of you who made it post-FIRE - did you contribute to your retirement accounts in your 20s knowing you wanted to retire early? How did you save enough money to retire young if you also contributed aggressively to your 401(k) and IRA? I'm curious to know if you were able to put money aside for the long-term while also saving for an aggressive medium-term goal.

[Telecaster]

This post and thread are informative:

https://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

Note:  If you intend to retire at 40, you almost certainly have to save far more than is allowed in a 401(K) and IRA anyway. 

[SimpleCycle]

There are two main methods - the Roth conversion ladder and SEPP.  The first is more common these days.

[maizefolk]

For those of you who made it post-FIRE - did you contribute to your retirement accounts in your 20s knowing you wanted to retire early? How did you save enough money to retire young if you also contributed aggressively to your 401(k) and IRA? I'm curious to know if you were able to put money aside for the long-term while also saving for an aggressive medium-term goal.

I am post-FI but not FIRE yet. I got here with a significant part of my net worth in tax advantaged retirement accounts (IRA, 403b (essentially a 401k, just for different types of employers), and 457).

If you have enough assets outside of retirement accounts to cover your expenses for five years, that will give you enough time to start tapping into the assets locked up in traditional IRA/401k accounts using the Roth conversion pipeline.

[zinnie]

This post and thread are informative:

https://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

Note:  If you intend to retire at 40, you almost certainly have to save far more than is allowed in a 401(K) and IRA anyway.

Pretty much this. I've been at this for ten years and will retire before that age, but I still have a lot more in taxable than retirement. Even after maxing out 401k + Roth for the majority of that time I still invest more in taxable every month than retirement.

I didn't max out 401k in my earlier 20s (a mistake, looking back), but as soon as I decided to pursue FIRE it was a no-brainer.

I'll most likely get to age 60 without needing to pull from retirement, but if for some reason I don't I'll plan for SEPP or Roth pipeline.

[PhysicianOnFIRE]

There are many, many ways to access 401(k) / IRA money early. 457(b) money is available at any age.

SEPP / 72(t)
Roth conversion ladder
Roth IRA contributions always available
401(k) available if you leave employer in the year you'll turn 55

And most of us will build up a taxable brokerage account, as well. Cashflowing investments like real estate can also provide early retirement income.

[MoseyingAlong]

Another aspect to consider is that even if you end up paying the 10% early withdrawal penalty, your total tax may still be less if you contribute while in your high-earning/high-tax years.

For example, high earning years, you're in a 35% tax bracket.
After early retirement, you might be in 12% tax bracket + 10% early withdrawal penalty so total 22% which is less than 35%. And you will probably have some savings in a taxable account so will have more control over your tax bracket.

[Swansong]

Thanks for the thoughtful responses everyone! I didn't realize that most of these early withdrawal strategies existed. Also, that's a good point that you can still save money potentially by paying the penalty while in a lower tax bracket @MoseyingAlong.

Looks like I have a lot more reading to do :)

[dandarc]

"Wait - I can get to my retirement accounts without paying a penalty before 59.5" was the "aha" moment for me when what to do right now became painfully clear and I stopped hesitating worrying about details and really got us moving in the right direction. Max the tax advantaged accounts first. Only if you have no more tax-advantaged space available start investing in taxable.

Hopefully this has the same affect for you.

[lhamo]

Another option if you are in a HCOL area is to use the cash freed up by selling a house/moving to a lower COL area to fund your living expenses for a few years.  We didn't necessarily plan it that way, but it is what ended up happening.  Retirement accounts are continuing to grow in the meantime, and it will be 8-10 years before we need to tap them.  And we didn't move to podunkville, either -- we bought a very nice house in Seattle with cash, but still had a bunch left over to live off of.

[Sandi_k]

Also: downsize your house, or buy rental real estate such as a duplex, and house hack prior to 59.5...

[seattlecyclone]

Note:  If you intend to retire at 40, you almost certainly have to save far more than is allowed in a 401(K) and IRA anyway. 

Exactly this. I FIREd last year. Even maxing out our retirement accounts (including two mega backdoor Roths for a few years), we still have about half our investments outside of retirement tax shelters.

[DK]

"assets outside of retirement accounts to cover your expenses for five years"

i know this is what i've been struggling with lately on how to get this, it seems the only way is to pay higher taxes to build this up, or face the 10% penalty for the rest of the early retirement yrs.

outside of saving in cash for it, i've also thought about starting the 5yr pipeline while still working. while this will result in higher taxes a couple yrs on the rollover amount into the pipeline, it does allow access. trying to justify that with knowing that from ages 55-59 you will be able to stop the pipeline, and only convert the amount up to 0% tax rate.

[ixtap]

"assets outside of retirement accounts to cover your expenses for five years"

i know this is what i've been struggling with lately on how to get this, it seems the only way is to pay higher taxes to build this up, or face the 10% penalty for the rest of the early retirement yrs.

outside of saving in cash for it, i've also thought about starting the 5yr pipeline while still working. while this will result in higher taxes a couple yrs on the rollover amount into the pipeline, it does allow access. trying to justify that with knowing that from ages 55-59 you will be able to stop the pipeline, and only convert the amount up to 0% tax rate.

Are you counting existing Roth contributions as part of this five year buffer? For us, we each have one year's expenses in Roth contributions before we even start conversions.

[maizefolk]

"assets outside of retirement accounts to cover your expenses for five years"

i know this is what i've been struggling with lately on how to get this, it seems the only way is to pay higher taxes to build this up, or face the 10% penalty for the rest of the early retirement yrs.

outside of saving in cash for it, i've also thought about starting the 5yr pipeline while still working. while this will result in higher taxes a couple yrs on the rollover amount into the pipeline, it does allow access. trying to justify that with knowing that from ages 55-59 you will be able to stop the pipeline, and only convert the amount up to 0% tax rate.

If you're earning enough money that all of your retirement account contributions are going in at extremely high marginal tax rates, it might be worth just paying the 10% penalty to withdraw money to spend the first five years. Presumably your other taxable income would drop to zero, so you'd be paying an average of about 20% tax+penalty on the first $45k of money you pulled out (or about $90k if you are married).

If starting the roth conversion pipeline while you were still working and/or stopping retirement contributions to build up a cash cushion would be in a higher tax bracket than this it might be worth paying the penalty.

[DK]

i was talking a bit in general, but yeah, will likely have 3ish yrs in roth accounts.

so do you mean per penalty, for the year do a
pipeline amount for a year (no penalty)
+ cost of living for a year (penalty)
? so something like pull out 40K to pipeline and 40K + penalty amount for the year?

that's an interesting route that i didn't think of. i know i'll be trying to thread the aca needle a bit so not sure how well that will end up working out. but that would likely be slightly better if just worrying about the taxes and penalty amounts.

[kpd905]

Also realize that you only need 4 years of expenses, not 5, to do the Roth ladder.  The 5 year rule starts on the first day of the year in which you make the conversion, so if you make your first conversion in late December, that whole year will already count.

We don't have anything in taxable accounts, and probably won't end up with much at all.  We max out all tax advantaged accounts, but don't really have much leftover after that.  But between Roth contributions and HSA withdrawals for medical expenses, we should have a few years expenses pretty easily.

[Fishindude]

There is no magic one size fits all answer to this, but retiring as young as 40 is not going to be easy.
I don't think tapping the 401k early and taking penalties is a great idea.   Would be better to save some additional money or invest and create additional sources of income to bridge the gap between the age you retire at at the age you can begin using your 401k and / or receiving SS income, etc.

[use2betrix]

Note:  If you intend to retire at 40, you almost certainly have to save far more than is allowed in a 401(K) and IRA anyway.

This note has summed it up pretty perfectly. I’m 31 and maxing out my 401k and HSA yearly, but saving around 4x that in my taxable accts each year..

The only way I would see it being hard is if someone had insanely low living expenses, started maxing out tax advantaged accts right after high school/college, with no savings elsewhere, to retire at 40. Those cases are typically less common.

[maizefolk]

In average years, yes.

But considering stock market returns over the last twelve years or so it wouldn't surprise me if there are a lot of people in their mid-30s who have been maxing out their 401ks/IRAs and now find themselves FI or near FI based solely on tax advantaged accounts. Somebody who started out from $0 and has been maxing out those two accounts since 2009 would have something like $600,000-$750,000 in tax advantaged accounts today (very rough estimate on my part, would be nice to run the actual numbers).

[SimpleCycle]

In average years, yes.

But considering stock market returns over the last twelve years or so it wouldn't surprise me if there are a lot of people in their mid-30s who have been maxing out their 401ks/IRAs and now find themselves FI or near FI based solely on tax advantaged accounts. Somebody who started out from $0 and has been maxing out those two accounts since 2009 would have something like $600,000-$750,000 in tax advantaged accounts today (very rough estimate on my part, would be nice to run the actual numbers).

https://dqydj.com/sp-500-periodic-reinvestment-calculator-dividends/

Based on this calculator, investing $1500/month since January 2009 in the S&P 500, you would have $431,586.  That's roughly equivalent to maxing a 401k every year since then.  An IRA would be another $130k-ish.

[maizefolk]

Thanks! I was ballparking from looking at the CAGR over the whole period (14.7%) and just plugging that into a regular compound interest calculator with annual additions of the full 401k+IRA amount.

From your calculator, it looks like the Internal Rate of Return for monthly investments over that period and using the month by month stock market returns is more like 13.6%.

Still an exceptional period for a young person to start saving for retirement, but not quite as exceptional as I believed.

[use2betrix]

Thanks! I was ballparking from looking at the CAGR over the whole period (14.7%) and just plugging that into a regular compound interest calculator with annual additions of the full 401k+IRA amount.

From your calculator, it looks like the Internal Rate of Return for monthly investments over that period and using the month by month stock market returns is more like 13.6%.

Still an exceptional period for a young person to start saving for retirement, but not quite as exceptional as I believed.

Exceptional, yes. However, If I was in that position, I would not FIRE assuming that I have achieved my number based on todays current market. If I was 35 and FIRE’ing today, my number would be higher than if I achieved my FIRE number after a big correction/recession.. If I hit my FIRE number in 2010, I would be much more comfortable than someone who would achieve their FIRE number in 2020 (in my opinion).

[DK]

Also realize that you only need 4 years of expenses, not 5, to do the Roth ladder.  The 5 year rule starts on the first day of the year in which you make the conversion, so if you make your first conversion in late December, that whole year will already count.

Yeah i had kinda planned on doing that already. the extra taxes wouldn't be great, but an easy way to get a yr of expenses.

You could actually expand on that a bit, and if you can plan on retiring in 5 yrs, for the next 5 yrs do a conversion every Dec and you'll have your pipeline right there. a bit hard to predict the future on where a persons numbers will be, and also if planning to do that while at the same time as contributing to a retirement account, would probably make more sense to just stop contributing and save those amounts in cash. maybe if getting a match amount, still contribute, and start doing rollovers with an old tIRA not currently contributing to?

in addition to the dec conversion, was also tentatively thinking of working the next few months of the new yr to max out tax advantaged space as much as possible for a few months and use up vaca/pto, etc. so frontload hsa, 401k, tIRA while receiving essentially a $0 paycheck.

[ixtap]

We are already maxing out workplace options early in the year while we live off some of the taxable savings.

1) give us the option to leave if DH just can't take it. If he were to quit tomorrow, he would only be leaving behind about $500 in match. Yay! For % contribution matching, rather than % salary matching.

2) we are already practicing cash flow management since pay checks don't cover expenses until late in the year.

[ender]

Note:  If you intend to retire at 40, you almost certainly have to save far more than is allowed in a 401(K) and IRA anyway.

Is this really true?

It's probably more true if you are closer to 30 than 40, but if someone retires in their late 30s I can see it being pretty easy to get there just with retirement accounts.

[ixtap]

Note:  If you intend to retire at 40, you almost certainly have to save far more than is allowed in a 401(K) and IRA anyway.

Is this really true?

It's probably more true if you are closer to 30 than 40, but if someone retires in their late 30s I can see it being pretty easy to get there just with retirement accounts.

It really depends on your actual projected spend level.

We will likely retire before my husband is 40. The vast majority of our funds are tax sheltered, but certainly not everything. I think the current split is about 85/15, but the taxable account should grow faster than tax sheltered from now on, unless I actually get a job that allows me to tax shelter everything. Since I am not looking that seems unlikely.

[Telecaster]

Note:  If you intend to retire at 40, you almost certainly have to save far more than is allowed in a 401(K) and IRA anyway.

Is this really true?

It's probably more true if you are closer to 30 than 40, but if someone retires in their late 30s I can see it being pretty easy to get there just with retirement accounts.

Well, if you start your working career after college, most people would be in their early to mid-20s when they started.   So 15-ish years until you are 40.  That means you need about a 40% savings rate (depending on investment returns, of course).   

Presuming someone has a high-ish income (I realize many REs don't, but most do) max IRA contribution plus max 401(k) won't get you to 40%. 

[kpd905]

Note:  If you intend to retire at 40, you almost certainly have to save far more than is allowed in a 401(K) and IRA anyway.

Is this really true?

It's probably more true if you are closer to 30 than 40, but if someone retires in their late 30s I can see it being pretty easy to get there just with retirement accounts.

Well, if you start your working career after college, most people would be in their early to mid-20s when they started.   So 15-ish years until you are 40.  That means you need about a 40% savings rate (depending on investment returns, of course).   

Presuming someone has a high-ish income (I realize many REs don't, but most do) max IRA contribution plus max 401(k) won't get you to 40%.

Maybe for a single person, but for married it can add up to 40%.

39,000 in 401k's
12,000 in IRAs
3550 in HSA (7100 if you have family coverage)
Employer match (ours is around 7500 total)

So we are putting $62,000 a year into tax advantaged accounts, and have been maxing out for 5 years.  Assuming a couple starts doing this around age 25, that should be enough to retire at 40.

[mistymoney]

This post and thread are informative:

https://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

Note:  If you intend to retire at 40, you almost certainly have to save far more than is allowed in a 401(K) and IRA anyway.

Thanks - this was pretty informative. I had always glossed over referents to the roth conversion ladder but this was easier to understand than I anticipated.

Although - I'm 53 - so too late for me :)