Too much money in 401K/IRA?

[primalnuke]

First time poster here.  Just discovered MMM ~1 month ago and it’s been a huge time suck ever since. 
***
Out Stats
Me (35, Electrical Engineer) – 160,000-180,000 + Cash balance pension +small 401K match
Husband (34, Mechanical Engineer) – 90,000-105,000 + small 401K match
Boy (3, future engineer) – 0.  But he does have his grandmother wrapped around his little finger and therefore she buys him almost everything he wants or needs.  So we spend very little on him.
6 week old parasite living in my uterus that potentially will become future engineer #2 this spring.
***
Debt – Mortgage 124,000 (Interest rate 4.25% fixed)
***
Savings
401Ks – 460,000
Roth IRAs – 82,000
Cash Balance work pension – 120,000 (will roll into IRA/401K when I retire)
ESPP – 22,000
Mutual funds- 51,000 (includes college fund for future engineer(s))
Cash – 133,000
***
Our spending/saving.  Not a concern for me. I’m sure there are areas we can improve but for now we spend WAY less than what we make. Hence the large amount of cash.  I have no doubt we will be able to happily live and save on my husband's income. 

**
Onto the questions.  Do we have too much in our 401Ks/IRAs?  And what should we do with the large cash surplus we have?
Even before I found out I was knocked up again, I was considering retiring in 6 months to 1 year.   Mostly because I am getting big-time job burn-out.  I work in a demanding industry that pays well.  But I recently I came to the realization that we don’t need to make that much money to live the live we want to live.  So it’s making working less and less bearable.

Husband stated he will keep working, for at least 10 years.  He works for a good company, and likes his job.
Here’s my thought process that leads me to think we have too much in 401K:  Right now we’ve got ~662K tied up in funds we can’t touch, without penalty, until we are 59.5. That’s ~60% of our net worth and over 75% of our liquid funds.   If we want the option for husband to retire at 45, I think we need to start scaling down our IRA/401K investing and start putting more in other mutual funds.

As long as I am still working we will keep maxing out our 401K contributions b/c we need every friggin tax break we can get.  But when I retire, I think husband should drop down his contribution to the min that his company matches and we should put the difference in other after-tax.   Any fatal flaws in this logic?  Other options to consider?

As far as the 133K we have sitting around doing nothing. I’m trying to figure out the best decision for what to do with it.  Should we pay off all or part of the house or invest?   Is it stupid to pay off all but 50-60K then refinance the remaining balance?  Right now we could get a 10 year fixed at ~3.25%.  My reasoning for this is that it would lower our required monthly payment by about 1200/month, which would give us more money to invest now.

I’m new to this early retirement and managing my money stuff.  We’ve been pretty much operating on auto-pilot in this area for our whole lives.  So I’m learning a lot, very fast.   Any input/thoughts/pointing out of things I am missing will be greatly appreciated.

[rtrnow]

Personally, I have almost all my ER savings in tax advantaged accounts. Read about ROTH conversions and 72t withdrawals. In short though, there are ways to access your 401k/IRA without penalty regardless of age. It does seem a bit crazy to me to have that much cash though.

[nereo]

Here’s my thought process that leads me to think we have too much in 401K:  Right now we’ve got ~662K tied up in funds we can’t touch, without penalty, until we are 59.5. That’s ~60% of our net worth and over 75% of our liquid funds.

No.  You absolutely CAN get access to that money, penalty free, before you are 59.5.  This might be one of the most mis-understood parts about retirement funds.
Two simple ways of accessing this money is through utilizing a back-door ROTH (http://www.bogleheads.org/wiki/Backdoor_Roth_IRA
or through SEPP payments: http://retireplan.about.com/lw/Business-Finance/Personal-finance/Taking-Advantage-of-Substantially-Equal-Periodic-Payments-SEPPs-.htm

Read this MMM thread as well:

http://www.mrmoneymustache.com/2011/11/11/how-much-is-too-much-in-your-401k/

[Señora Savings]

For taxable accounts: You've got enough in the taxable accounts to fill up Roth conversions to the 10% bracket for quite a while, and there's no guaranty the strategy will continue to exist in 10 years.

For putting in enough to get in the 15% tax bracket: No capital gains on you taxable accounts!  If you do this, watch taxable accounts carefully to see what they're spitting off in dividends, cap gains, etc because that will kick you up a tax bracket.  If you go over you can put extra in your two Trad IRAs when you're doing taxes.

I like the idea of decreasing your mortgage at the same time that you decrease your income, it gives you more wiggle room if something goes wrong.  Then get that leftover cash invested in mutual funds.

I assume that you're not posting spending because you're already doing  okay but think you can optimize.  Just make sure that you know what it is before you give up 2/3rds of your income.

[primalnuke]

Thank you for the info!  I will be doing some research on your suggestions on how to access your 401K/IRAs early.

I agree, it is too much cash.  We plan to do something with most of it very soon.  Probably keep 20-30K in the bank.  It will probably be a combo of mutual funds and paying down the mortgage.

Senora - you lost me a little on the roth conversions and tax bracket discussions.  anyone care to help me out on her points?

As far as our spending.  Since I got serious about leaving my job, we've started to track our spending.  I don't have a lot of data to share at this point.  Once we have the house paid off, my husband and I figure we can maintain our current lifestyle on 35000-40000 a year.  This is with 2-3 vacations a year and some discretionary spending.   So there is definitely wiggle room in the figure. 

Thank you again!

[DK]

Per the house vs cash situation, I would either do:

1 - Pay off house with cash.
2 - Refinance.

Splitting it between them, just lessens your emergency fund, while still keeping a cash outflow every month. Paying it off completely takes out a big payment every month and increases cash flow.

In your situation since it sounds like you might retire when you have your second I would:

Pay off house.
Continue saving as much in tax-advantaged counts as possible, but live off your husbands income to see how that would work until you have your second kid, all your money would be invested/saved.
If you can live off his income easily, consider retirement (remember there will be another child to add to the costs though) or see if that "break" of maternity leave gives you back the motivation to continue working a couple more months/years (it would be tragic to lose that high of income, but since you don't need it, I can see where you are coming from. I wouldn't be surprised though if both of you kept working a few more years, you could both retire).

Per the saving for college, once they are ready to go to college, you will actually be near retirement age where you can take out whatever you need from the 401ks, or could even setup a SEPP to get it a bit early to help out.

If you decide to refi, the 10yr mtg coincides closely with your husbands guess he might be ready to retire in 10 years too.

[beltim]

Thank you for the info!  I will be doing some research on your suggestions on how to access your 401K/IRAs early.

I agree, it is too much cash.  We plan to do something with most of it very soon.  Probably keep 20-30K in the bank.  It will probably be a combo of mutual funds and paying down the mortgage.

Senora - you lost me a little on the roth conversions and tax bracket discussions.  anyone care to help me out on her points?

As far as our spending.  Since I got serious about leaving my job, we've started to track our spending.  I don't have a lot of data to share at this point.  Once we have the house paid off, my husband and I figure we can maintain our current lifestyle on 35000-40000 a year.  This is with 2-3 vacations a year and some discretionary spending.   So there is definitely wiggle room in the figure. 

Thank you again!

Senora's comment about Roth conversions was referencing the strategy of a Roth pipeline as a way to access your 401k before age 59.5, which Nereo provided a link to.  Based on your expected spending in retirement, you're much better off using the other strategy Nereo described as a way to access your 401k before age 59.5: SEPP (substantially equal periodic payments).  Basically, this allows you to withdraw a certain amount from your 401k before age 59.5, as long as you stay within withdrawal limits and as long as you continue withdrawals until you reach age 59.5 years (or for 5 years, whichever is longer).

Back of the envelope math suggests that your 401k with SEPP should be enough to fully support your spending in 10 years when your husband retires.  $460k balance now, plus contributions, plus a typical return over the next 10 years gets you to a ballpark of $1 million.  $1 million, applied to a then 45 and 44 year old couple, allows you to withdraw up to $38k per year from your 401k.  That's right in your spending range estimate, and so you probably only need taxable accounts to supplement that for extra spending, emergency funds, and things like college.

Also, this doesn't include your Roth IRA at all, which would probably add another $6k or so, tax-free, from SEPP.

[DK]

Not sure if you took into account inflation in the returns/38k SEPP payout, but if not - 38K today will be equal to roughly 51K in 10 years.

Thank you for the info!  I will be doing some research on your suggestions on how to access your 401K/IRAs early.

I agree, it is too much cash.  We plan to do something with most of it very soon.  Probably keep 20-30K in the bank.  It will probably be a combo of mutual funds and paying down the mortgage.

Senora - you lost me a little on the roth conversions and tax bracket discussions.  anyone care to help me out on her points?

As far as our spending.  Since I got serious about leaving my job, we've started to track our spending.  I don't have a lot of data to share at this point.  Once we have the house paid off, my husband and I figure we can maintain our current lifestyle on 35000-40000 a year.  This is with 2-3 vacations a year and some discretionary spending.   So there is definitely wiggle room in the figure. 

Thank you again!

Senora's comment about Roth conversions was referencing the strategy of a Roth pipeline as a way to access your 401k before age 59.5, which Nereo provided a link to.  Based on your expected spending in retirement, you're much better off using the other strategy Nereo described as a way to access your 401k before age 59.5: SEPP (substantially equal periodic payments).  Basically, this allows you to withdraw a certain amount from your 401k before age 59.5, as long as you stay within withdrawal limits and as long as you continue withdrawals until you reach age 59.5 years (or for 5 years, whichever is longer).

Back of the envelope math suggests that your 401k with SEPP should be enough to fully support your spending in 10 years when your husband retires.  $460k balance now, plus contributions, plus a typical return over the next 10 years gets you to a ballpark of $1 million.  $1 million, applied to a then 45 and 44 year old couple, allows you to withdraw up to $38k per year from your 401k.  That's right in your spending range estimate, and so you probably only need taxable accounts to supplement that for extra spending, emergency funds, and things like college.

Also, this doesn't include your Roth IRA at all, which would probably add another $6k or so, tax-free, from SEPP.

[chasesfish]

Check to see what the closing costs would be to drop your loan to a 10 year at 3.25% or below.  If you can get this done for less than $1,000 out of pocket, then do it.  If not, payoff the darn house.  No sense in having that much cash lying around and paying 4.25%

Remember, at your income level the mortgage interest is probably barely tax deductible.  At a 40% marginal tax rate, this means you have to earn quite a bit more than a $1 to pay that $1 in interest.

If it were me, just send the check in and payoff the house.

[beltim]

Not sure if you took into account inflation in the returns/38k SEPP payout, but if not - 38K today will be equal to roughly 51K in 10 years.

I did - the long term market return is about 10%, or about 7% after inflation.

However, the margins of error here are huge compared to inflation – 10 year stock returns in the US have ranged from about 0% annually to about 20% annually: http://observationsandnotes.blogspot.com/2009/04/best-worst-10-years-in-stock-market.html

[Wile E. Coyote]

Remember, at your income level the mortgage interest is probably barely tax deductible.  At a 40% marginal tax rate, this means you have to earn quite a bit more than a $1 to pay that $1 in interest.

Are you referring to the Pease phase outs?  I think those kick in at 300,000 of AGI for married, so they may not be a problem.  And even when they do kick in, it's only 3% of income over the limit and will not reduce your deduction by more than 20%.

Personally, I'd keep the loan outstanding and refinance into a lower rate/short term if possible and invest the cash.