The problem with IRAs, 401ks, and retiring early - help please!

[jprince7827]

Hey guys, I just opened a 3k IRA this year to get some saver's credit tax breaks. I've also got a 401k with company match, which I use to the max. I also put money into non-special-retirement accounts, too. My question is, since i'm 25 and I plan on retiring in my late 30s, why should I be throwing money into accounts like the IRA which I can't touch until I'm 59.5? Shouldn't I just be throwing all the money into normal accounts, even though I have to pay taxes on it?

Thanks in advance,
Jordan

[Devils Advocate]

No

At least continue to get 401k match ("free money"), max out IRA, and then max out 401k. Any left over funds invest in taxable.
DA

[DreamingofFreedom]

MMM has a great post on the topic here: http://www.mrmoneymustache.com/2011/11/11/how-much-is-too-much-in-your-401k/

Personally, I hope to contribute significantly to my 401k until I retire.

[unpolloloco]

look into 72(t) distributions

[No Name Guy]

What unpolloloco said:  72(t) means you can get at 401k's / IRA's BEFORE 59 1/2 without the 10% additional penalty.  You still pay normal taxes on the 401k / traditional IRA.

With proper planning it's easy to structure things to get the amount you want / need.  Roll the 401k into a or several IRA's.  Set up the IRA or one of the IRA's with a 72(t) plan (if you have several IRA's you don't have to 72(t) out of all of them).

[Jamesqf]

I think you said it yourself: for the tax credits (or reduced taxes if you don't qualify for credits).  Beyond that, you have a chunk of money out there growing tax free, so your early retirement fund only has to carry you from retirement to the age (59?) where you can access your IRA/401k stash (which you haven't overspent in your early retirement period). 

Remember what happens to those best-laid plans?  Suppose you retire in your late 30s, then after a decade or so discover that your safe withdrawal rate from your stash wasn't as safe as you thought?

[the fixer]

Roth IRA rollovers are IMO the best way to game the retirement accounts for early retirement. jlcollinsnh discusses this more (http://jlcollinsnh.com/2013/01/11/vita-income-taxes-and-the-irs/ at the end), as does MMM in the above link.

With any plans like this or the 72(t) grocery money, it's a good idea to consider how likely these laws are to change, since these accounts are meant to be used in your 60s and older, and Congress certainly doesn't care about early retirees so they could change the tax laws in ways that break all of this. So how likely is that? Here's what I think:

• Roth IRAs are popular for Congress because they increase tax revenue to the government in the short-term. The theory goes that if they didn't exist, you'd contribute more to tax-deferred accounts like traditional IRAs, and the government can't get those taxes until you turn 59.5 (which is a really long time as far as budget projections are concerned). So you can expect Roths to stick around for a while.
• Roth IRA conversions are popular for the same reason: the government gets to collect taxes on your 401(k) and IRA before you'd normally start making withdrawals. The government keeps removing restrictions on Roth conversions, like income limits, because of this. Roth contributions and conversions will probably continue to get easier over time.
• It makes very little sense to apply penalties or restrictions to non-earnings Roth IRA distributions because contributions are made with after-tax dollars; intuitively, it's your money and you already paid taxes on it once. But it is possible that Congress could someday change the rules, for instance by extending the waiting period to get your money out of a rollover.
• Seniors are an extremely strong lobby in this country and have been for decades. NO ONE is going to propose extra taxes on retirement accounts even if everyone in their 60s was paying zero taxes due to having everything in Roth IRAs. Look at the current fiscal crisis and how difficult it is to even propose any changes to Medicare and Social Security. If you can move as much money as possible into a Roth, once you turn 59.5, you're set for life.

In the end, the safest thing to do is save everything in a taxable account. The quickest thing to do is be self-employed and save everything in a solo 401(k). But the smartest thing to do is somewhere in between, so you aren't paying unnecessary taxes but also aren't planning too heavily around what some would consider a tax loophole.

[Nords]

Hey guys, I just opened a 3k IRA this year to get some saver's credit tax breaks. I've also got a 401k with company match, which I use to the max. I also put money into non-special-retirement accounts, too. My question is, since i'm 25 and I plan on retiring in my late 30s, why should I be throwing money into accounts like the IRA which I can't touch until I'm 59.5? Shouldn't I just be throwing all the money into normal accounts, even though I have to pay taxes on it?

I think you could throw some of that after-tax money into a Roth IRA instead of a taxable account to hedge your bets.

If you need the money that you put into the Roth, then you can withdraw the contributions at any time (assuming the Roth is at least five years old). 

If you had put that money into a taxable account, then every year you'd be paying taxes on dividends & cap gains.  (Even if it was a hugely tax-efficient account from Vanguard, you'd still have taxable annual gains.)  Meanwhile the money in the Roth could be compounding totally tax-free.

Hence the "conventional wisdom" to max the 401(k) (for the "free" match), then max a Roth IRA (for the tax-free compounding), and then save as much as you can in a taxable account.  That taxable account should bridge the gap between the day you declare your financial independence and the day you need the Roth or the 401(k) funds.

As an alternative to MMM's post on the subject, here's one from the military aspect:
http://the-military-guide.com/2013/02/14/when-do-you-stop-contributing-to-tax-deferred-accounts/

[jprince7827]

Thanks for all the advice, guys! I am going to read the sources you sent me now, come to a decision. I hope it doesn't cost much to roll a traditional IRA into a Roth! I'll obviously keep it at Vanguard, either way.