Author Topic: 401K as Old Age Money  (Read 10184 times)

LiseE

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401K as Old Age Money
« on: November 08, 2014, 07:03:04 AM »
Hi ..

We will soon be out of our debt emergency situation. and will be working toward both paying down our mortgage and building an investment portfolio outside of our 401K's.  One thing I've recently come to understand is this two tiered retirement outlook where in order to FIRE we need some income generating investments to live off of prior to our official retirement ages of 65 (for example).  My hubby's company contributes 100% match up to 20% of his salary so we have to take advantage of that amazing benefit but here is my question ..

Our combined 401K balances = 500K

When I look at the future value of that in 15 years at 6% I see that will grow to 1.2M - more than enough for our old age money.

Our current mortgage rate is 4.125 which is so low that I'm thinking it's more of a priority to start building our income generating portfolio now while paying down the mortgage in smaller chunks.

If hubby continues to contribute 20% which will be matched 100% our old age money is going to grow to a lot more than 1.2M.  Our problem (and I'm grateful to have such a problem!) is that we have too much old age money and not enough current income generating investments.

My employer matches 6% of my salary at 50% match .. i'm thinking of stopping my 401K contributions in favor of putting that money into income generating portfolio.  I realize that this is still a 50% return on my money though but I feel we have too much going into 401K!

Thanks for any input .. appreciate it!

PS.. we don't qualify for Roth IRA because of our combined income total but I recently learned that there is a backdoor to opening a Roth in spite of the income rule.
« Last Edit: November 08, 2014, 07:18:27 AM by LiseE »

dapo

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Re: 401K as Old Age Money
« Reply #1 on: November 08, 2014, 08:00:16 AM »
Hi Lisa,

The company matches on your 401Ks look too good to pass up.  I would think investing enough to receive 100% of the benefit would be priority 1.

On 401Ks, you can start those withdraws, at 59.5, that saves 6 years.

Is there anything interesting you can do with your mortgage?  Maybe a refi to push more of those payments into post-retirement phase 2.  At least that will drop your expenses during phase 1.

There are some more complicated techniques to to pull early from your retirement accounts but they look complicated and I have no experience with them.

Glad to hear you are out of the debt emergency.  These are good problems to have.  :)



Jessa

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Re: 401K as Old Age Money
« Reply #2 on: November 08, 2014, 08:49:08 AM »
How old are you? You mentioned 15 years, is that 15 years until you are old enough to draw down on them? Or 15 years until you FIRE?

What are you goals for FIRE? Once you pay down your debts, can you take what you were using toward debt and put that toward taxable investments? How much is that, and how quickly will you build that up?

It's my understanding that you really only need enough taxable investments to cover you for about 5 years or so, if you use the Roth conversion ladder. Once you RE, you convert your 401k to an IRA. Then convert whatever you expect to be your expenses 5 years hence to a Roth IRA, pay the taxes on that, each year while living off your taxable investments. After 5 years, you can draw down that converted money from the IRA. So if you think you can generate enough in your taxable accounts to last you at least 5 years before you FIRE, you should keep putting everything you can into your 401k.

Cheddar Stacker

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Re: 401K as Old Age Money
« Reply #3 on: November 08, 2014, 09:02:46 AM »
So it sounds like you are about 50 years old, yes? If so, you sound like a very good candidate to be using the 55 years old rule. It's not talked about around here as much as the Roth Pipeline so I'm not intimately familiar, but here's my understanding of this rule. If you work until 55 and leave your money in your 401k rather than moving it into an IRA you can begin to withdraw the funds without penalty right away.

You make way too much damn money to stop 401k contributions. They will save you a ton of taxes. You both should contribute the max (18k next year) as long as you are both working. You will have enough in no time. Awesome macthes, take advantage.

LiseE

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Re: 401K as Old Age Money
« Reply #4 on: November 08, 2014, 09:53:50 AM »
Sorry I left out some pertinent iinfo ..  I am 47 and hubby 46.  I would like to retire from the full time corporate rat race by 50 but I do plan on finding work and continuing to pull in a smaller income.  My dream once we are FI is to focus on taking care of and enjoying my family (two young sons and hubby) and getting more involved in volunteer work.  My hubby loves his work and has no desire to stop but it will be a great relief to not 'have to work' .. but working because you want to when you become FI.

So my 401K is at 350K.  If I quit my job in two years and just let that 401k continue to grow at 6% for 15 years (until 65) it will be around 700K.  Hubby's 401K is 150K.  we're not currently maxing out that 20% 100% company match but will starting 2015.  He's just now fully vested and we had a priority to get our debt emergency eliminated.

So with my future part time income along with my hubby's continuing to work at his current job I guess there isn't a need for income producing investments since we will be able to pay our expenses and then some??

Lastly, part of me is concerned/nervous/scared to cut the cord and retire from my corporate job ... will we have enough?  If we left our 401K's alone today without contributing another cent we will have 1.2M at age 65 and we also have a house worth 500K.  I know we have to live somewhere but we could downsize at that point.

GGNoob

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Re: 401K as Old Age Money
« Reply #5 on: November 08, 2014, 10:24:10 AM »
I'm not sure we have enough information to know if you'll have enough. $1.2M would only give you $48k a year to live on plus SS. That may sound like enough now, but would it be at age 65 with inflation? Of course it may grow more than 6% and you'll continue contributing for a little while yet.

Personally, We aim to have $3M saved by age 50 (23 years). To get there, we only need a 6.5% return. Considering we are and will be 100% stock, I'm assuming the return will be higher and we'll hit our goal a lot sooner. But we plan to work into our 50s or later anyhow. It will just be nice when we hit FI and only have to work because we want to.


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msilenus

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Re: 401K as Old Age Money
« Reply #6 on: November 08, 2014, 11:15:10 AM »
Look into 72(t) distributions.  You can tap your 401(k) early and without penalty with those.  I don't think Roth conversion pipelines make sense for you because you only have a 5 year window.  Those are the two tricks people use to tap their 401(k)s early without penalty.  (Along side Roth principal withdrawals, but it sounds like you're making a go of it with almost all pretax money.)

I'm not sure the two-tiered approach is right for you.  If I were in your shoes, I'd be asking how much money I need to make it from age 50 to age 55, given the spend rate and estimated inflow from 72(t) distributions.  (Which I believe will be considerable, given your ages and balance, but there are calculators online.)  I'd then be trying to get that much money into taxable accounts (but not much more --they're taxable.)  This is money that I'd probably want to eventually have positioned into a bond ladder for those 50-55 years.

Anyway, if that's the sort of approach you wind up going with, then your dilemma disappears.  The distinction between 50-55 and 55+ money blurs into irrelevance, freeing you up to just take all the free money.

I'd definitely try to get some Roth action going.  Between you and hubby you can get in $11k/yr with just the backdoor.  That's not a huge amount, but it might take something off your post-retirement tax bill if you don't get your spend rate down low enough to avoid all tax.  Which you might, come to think of it.
« Last Edit: November 08, 2014, 11:17:03 AM by msilenus »

LiseE

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Re: 401K as Old Age Money
« Reply #7 on: November 08, 2014, 11:21:16 AM »
Subtracting our mortgage from our current expenses our monthly expense when we FI would be approx 3700.  so the 48K will leave us a bit extra and the 1.2M will not go down with the 4% draw.

If Hubby works until 60 and continues to put in 20% (which is matched 100%) @ 7% his 401K will be worth 1.2M
Leaving my 401K balance to sit for the next 15 years @ 7% will be worth 1M
Plus we will have a 600K paid off home at that point.

Going back to my original question, we have no outside investments other that 401K's ... should we have some taxable investment accounts?  Is the purpose of the taxable account simply to generate income during the years prior to full retirement?  If so, and my hubby wants to continue to work until 60, having an income generating account seem's moot?

LiseE

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Re: 401K as Old Age Money
« Reply #8 on: November 08, 2014, 11:28:00 AM »

I'm not sure the two-tiered approach is right for you. 

The distinction between 50-55 and 55+ money blurs into irrelevance, freeing you up to just take all the free money.


I think I'm just beginning to understand this .. that we're closer in age than we though (can't believe i'm approaching retirement age i guess!) I do like the idea of continued saving and investing when in retirement though.  Just because we have XXX to spend doesn't mean we should?  48K a year sounds like a lot when I read about MMM living on 24K a year and other families living well below 48K. 

Minimizing taxes right now seems to be the name of the game.  Taxable accounts for later when we're retired and able to still save and invest?

72b .. I'll check that out .. thanks!

LiseE

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Re: 401K as Old Age Money
« Reply #9 on: November 08, 2014, 11:38:12 AM »
Going back to my original question though .. now that we're out of debt and only have the mortgage to payoff, since our mortgage rate is so low (4.125% = almost free money) is it better to put our excess earning into a taxable income generating account (and reinvest the dividends for now) than paying off the mortgage?

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Re: 401K as Old Age Money
« Reply #10 on: November 08, 2014, 11:52:33 AM »
What's your income?
What do you owe on the home?

Are you sure it's a 20% match?  That's incredibly generous to just give out free money from a company trying to make a profit

I say pay off the house then you can quit and your husband works another 13 years.

I also think you should plan on lowering your expenses and get used to that level of comfort.   With a paid off home I would think $2000 a month for retirement is more than enough.   People do it all the time :)
« Last Edit: November 08, 2014, 11:57:18 AM by surfhb »

GGNoob

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Re: 401K as Old Age Money
« Reply #11 on: November 08, 2014, 12:58:17 PM »
Going back to my original question though .. now that we're out of debt and only have the mortgage to payoff, since our mortgage rate is so low (4.125% = almost free money) is it better to put our excess earning into a taxable income generating account (and reinvest the dividends for now) than paying off the mortgage?

You say that your husband will continue to work until he is 60. Assuming that, then you have no need for a taxable account. At age 59.5, you can both start withdrawing from your 401k if you need to. So once you retire or drop to part time, you can live off of the income you both earn until you both retire . As long as one of you is still working, you should be trying to live off of that income alone without drawing from investment accounts.

Instead of making additional payments to your mortgage or investing in a taxable account, you should be putting as much as possible into your tax-advantaged retirement accounts.

sol

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Re: 401K as Old Age Money
« Reply #12 on: November 08, 2014, 01:10:38 PM »
There is nothing you could do to dissuade me from a 100% match on 20% of my salary.  I would literally run up a credit card debt in order to maximize that benefit.  Do not pay down your mortgage.  Do not divert money before that 20% match to your taxable accounts.  Capitalize.

You don't really have a problem with having "too much old age money" despite what you may think.  That money in your 401k is available to you in a variety of different ways.  Someone already mentioned the 72t distributions and the 55+ rule though that one doesn't sound like it will work for you unless you stick it out a little longer.  The 5 year Roth pipeline will get that money out penalty free five years after your retire (or 4 years and 1 day, if you schedule it just right). 

And as a last resort, and this is a huge point that people here miss, you can always just pay the damn 10% penalty.  If your marginal tax rate after you retire is 10% or more lower than your current marginal tax rate (which is likely for most folks here) then you still come out ahead even paying the penalty.  And there is NO POSSIBLE WAY that paying the 10% penalty is going to be worse than turning down the 100% guaranteed return of your employer match.

Contribute as much as it takes to get the full match, before you do anything else.

 

LiseE

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Re: 401K as Old Age Money
« Reply #13 on: November 09, 2014, 05:45:24 AM »

Are you sure it's a 20% match?  That's incredibly generous to just give out free money from a company trying to make a profit

Yes ..it's 20% match at 100% .. I didn't believe it either at first. :)  He works for a hedge fund.

I also think you should plan on lowering your expenses and get used to that level of comfort.   With a paid off home I would think $2000 a month for retirement is more than enough.   People do it all the time :) 

I agree our expenses could be and probably will be lower but erring on the higher side for a safety margin.  We currently live in the northeast where property taxes and heating expenses are higher than average.  Not to say we couldn't/wouldn't move when retired to minimize these costs.

So .. we are maxing out hubby's 401K .. and my company match.  401K IRS limits are being met.  We cannot contribute any more to our 401K's but we still have approx. 4K excess cash each month. 

What would you do with this excess cash?
1. Paydown the mortgage (owe 250K at 4.125% on a 600K property
2. Open a taxable brokerage account and start investing in a Roth via the backdoor approach (Question: if we reinvest dividends and do not sell from this account, are our gains taxable?  I thought gains are only taxable once realized?)

I was thinking about alternating on a monthly basis putting excess monthly cash against the mortgage principle one month and then into taxable account the next.  I would like to experiment with P2P Lending as well.

GGNoob

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Re: 401K as Old Age Money
« Reply #14 on: November 09, 2014, 08:02:56 AM »
Why can't you max out your 401k?

I would invest in a taxable account. You'll be taxed on dividends (most will be qualified dividends so they will be taxed at the long term capital gains rate). Otherwise you won't pay taxes until you sell and realize your gains.

I personally like P2P lending, but the interest you make is taxed as normal income. So in a higher tax bracket, that can really eat away at your returns. You could always have a P2P account be your back door Roth.


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sol

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Re: 401K as Old Age Money
« Reply #15 on: November 09, 2014, 09:34:52 AM »
I would start by maxing both of your 401ks, not just your husbands.  In such a high tax bracket, your primary concern is avoiding paying your marginal tax rate.  That should still leave you with over $30k per year to invest somewhere. 

The usual advice after that is to start a taxable investment account before you pay down your mortgage.  The returns are hopefully a little better, and you keep access to that money as an emergency fund. 

If you husband works for a hedge fund then you probably don't need any advice on what to put in your taxable account.

And I think you have some confusion about your Roth option.  You can't move money from a taxable account to a Roth IRA just like you can't move money from your checking account to a Roth IRA, because you are income-restricted.  Normally you can move money from a traditional IRA to a Roth, but it sounds like you also make too much for a traditional IRA. 

The only way that I know of for you to put money in a Roth is through the mega backdoor Roth conversion, which you do by overcontributing to your 401k in excess of the tax-deferred limit, and then rolling from there.  You can only contribute up to $52,000 total to your 401k, though, and that includes the employer match, so you may be up against that limit already in your husband's account.  Not all 401k plans offer this option, but if yours does then it's probably your only option for adding to a Roth.

LiseE

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Re: 401K as Old Age Money
« Reply #16 on: November 09, 2014, 10:27:09 AM »
Thanks for all of the great feedback and helping to clarify some of this for me. 

Regarding the 401K .. isn't there a 17500.00 max annual limit per person?  If DH earns 120K he can only contribute around 15% before he reaching this limit, correct?  I also can max mine out but with the same limitation, right? 

We have been more focused on getting the full match on DH's 401K but it is true .. that I should max mine out as well .. but the same limitations apply . 17.5K?

BTW .. he works on the IT side of the hedge fund so no investment knowledge there really (except for water cooler talk).  I actually need to understand if he's bound legally to not trade in a certain amount of time.  While a taxable account would be for buying and holding, I think he's legally ok in that scenario.  I used to work in the finance world and I remember having to sign documents stating that I would hold an stock purchases for 90 days or more (something like that .. it was long ago) .. this was to rule the use of insider information, etc.


Quote
And I think you have some confusion about your Roth option.
Since we do not have any other IRA accounts the backdoor conversion is an option for us to get a Roth IRA set up and this is my understanding of it ..

"Anyone can contribute to a nondeductible IRA, in which only the earnings are taxed when withdrawals are made, according to Bankrate. And since 2010, anyone, regardless of income, can convert those nondeductible IRAs into Roth IRAs, hence the term backdoor. "  http://www.newsmax.com/Finance/Bankrate-backdoor-Roth-IRA/2014/08/18/id/589423/

Further down in this article it outlines that concern to using this backdoor conversion is that all IRA account balances are taken into account.  Since we only have 401K's this should not apply to us?

sol

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Re: 401K as Old Age Money
« Reply #17 on: November 09, 2014, 11:20:33 AM »
Regarding the 401K .. isn't there a 17500.00 max annual limit per person?

That's the limit for tax deductible contributions.  But in some 401k plans you can contribute up to the IRS limit of $52k per person including employer match, you just don't get the tax deduction on any contributions above $17.5k.  The earnings are still sheltered from taxes until withdrawn, so it's usually a better deal than a taxable account.   

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BTW .. he works on the IT side of the hedge fund so no investment knowledge there really

Okay, well here's the abbreviated version.  Some investments, like most bonds, generate the bulk of their profit as interest income that is taxable.  Some investments, like an S&P500 ETF, generate most of their profit in the rising price of the stock and are only taxable as capital gains upon sale.  So to be tax efficient, you generally want the interest-generating taxable bonds to be inside of a tax shelter like a 401k, and you want your investments that do not generate taxable income (like that ETF) in your taxable accounts.

Bogleheads has a decent write up about tax-efficient asset placement.  Give it a read:  http://www.bogleheads.org/wiki/Principles_of_tax-efficient_fund_placement

Quote
I actually need to understand if he's bound legally to not trade in a certain amount of time.

Many of us here are professionally prohibited from investing in specific asset classes or even specific companies.  I've never worked in the hedge fund industry but my understanding is that the rules there are a little more lax about what you can buy, but a little more strict about how you can sell it.
« Last Edit: November 09, 2014, 11:22:36 AM by sol »

msilenus

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Re: 401K as Old Age Money
« Reply #18 on: November 09, 2014, 04:45:45 PM »
So .. we are maxing out hubby's 401K .. and my company match.  401K IRS limits are being met.  We cannot contribute any more to our 401K's but we still have approx. 4K excess cash each month. 

What would you do with this excess cash?
1. Paydown the mortgage (owe 250K at 4.125% on a 600K property
2. Open a taxable brokerage account and start investing in a Roth via the backdoor approach (Question: if we reinvest dividends and do not sell from this account, are our gains taxable?  I thought gains are only taxable once realized?)

I was thinking about alternating on a monthly basis putting excess monthly cash against the mortgage principle one month and then into taxable account the next.  I would like to experiment with P2P Lending as well.

That's a good healthy surplus.  Here's what I'd do with it:
1) Be sure you're fully maxxing  out both 401(k)s.  You say you're maxing your match and that you cannot contribute any more.  One of those is a little wrong.  If you're only maxing your match, then you can get more free money by contributing more pre-tax up to the pretax max ($17.5k.)  Always take all the free money. 
2) $11k/yr in Roth via backdoor conversions.
3) Anything else you can in Roth via after-tax contributions to your 401(k) and subsequent rollovers.  (Most people can't do this because their plans don't allow it.  Worth mentioning because it's getting more popular.)
4) Taxable securities account.

If you go down the road of paying down the mortgage, there's nothing wrong with that either.  Lower-risk/lower-reward --a matter of taste.  I'd just do the math and make sure you can pay it off before you retire.  Also make sure that it doesn't keep you from being able to meet your needs before you can freely take money from the 401(k)s.  It would be awkward (and inefficient) to retire with only a few years of payments left, or to wind up having to choose between a 401(k) early withdrawal penalty tapping home equity to meet basic expenses.

webguy

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Re: 401K as Old Age Money
« Reply #19 on: November 11, 2014, 06:57:44 PM »
If it was me, I'd continue to max out retirement accounts. Not to be too much of a pesimist but that expected 7% return over the next 15 years could end up actually being -7% a year.

wtjbatman

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Re: 401K as Old Age Money
« Reply #20 on: November 11, 2014, 09:43:35 PM »
If it was me, I'd continue to max out retirement accounts. Not to be too much of a pesimist but that expected 7% return over the next 15 years could end up actually being -7% a year.

I think your picture is next to the word "pessimist" in the dictionary.

sol

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Re: 401K as Old Age Money
« Reply #21 on: November 11, 2014, 10:45:32 PM »
Not to be too much of a pesimist but that expected 7% return over the next 15 years could end up actually being -7% a year.

I suppose that could happen, but it never has.  Through the great depression, two world wars, stagflation, the threat of nuclear armageddon, the .com bust and a global recession, there has never been a 15 year period that averaged -7% per year.

In fact, I'm not sure there's every been a 15 year period that was below 0%, if you include dividends as part of your total return.

webguy

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Re: 401K as Old Age Money
« Reply #22 on: November 12, 2014, 07:52:00 AM »
I think your picture is next to the word "pessimist" in the dictionary.

Lol :) I think that may be the most pessimistic statement I've ever made. It even made me chuckle when I was writing it.

I suppose that could happen, but it never has.  Through the great depression, two world wars, stagflation, the threat of nuclear armageddon, the .com bust and a global recession, there has never been a 15 year period that averaged -7% per year.

In fact, I'm not sure there's every been a 15 year period that was below 0%, if you include dividends as part of your total return.

-7% is obviously an exaggeration, but it's certainly possible that returns could be well below average over the next 10-15 years. My point was just not to assume that the current 401k balance will automatically grow to 1.2M in 15 years because if they stop contributing to it and are solely relying on investment returns to compound then it could end up only being half of that, or significantly less than planned, especially with the US stock market being at it's current levels. For example, if we entered a bear market and even with dividends reinvested the average return was only 3% per year over the next 15 years then it would only put it at 780k in today's dollars. Continuing to contribute to retirement accounts every year doesn't really have a down side and so in my opinion it would make sense to continue to do so.
« Last Edit: November 13, 2014, 07:06:44 AM by webguy »

LordSquidworth

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Re: 401K as Old Age Money
« Reply #23 on: November 12, 2014, 08:14:24 PM »
Hi ..

We will soon be out of our debt emergency situation. and will be working toward both paying down our mortgage and building an investment portfolio outside of our 401K's.  One thing I've recently come to understand is this two tiered retirement outlook where in order to FIRE we need some income generating investments to live off of prior to our official retirement ages of 65 (for example).  My hubby's company contributes 100% match up to 20% of his salary so we have to take advantage of that amazing benefit but here is my question ..

Our combined 401K balances = 500K

When I look at the future value of that in 15 years at 6% I see that will grow to 1.2M - more than enough for our old age money.

Our current mortgage rate is 4.125 which is so low that I'm thinking it's more of a priority to start building our income generating portfolio now while paying down the mortgage in smaller chunks.

If hubby continues to contribute 20% which will be matched 100% our old age money is going to grow to a lot more than 1.2M.  Our problem (and I'm grateful to have such a problem!) is that we have too much old age money and not enough current income generating investments.

My employer matches 6% of my salary at 50% match .. i'm thinking of stopping my 401K contributions in favor of putting that money into income generating portfolio.  I realize that this is still a 50% return on my money though but I feel we have too much going into 401K!

Thanks for any input .. appreciate it!

PS.. we don't qualify for Roth IRA because of our combined income total but I recently learned that there is a backdoor to opening a Roth in spite of the income rule.

I don't feel you're taking inflation into the equation. That 1.2 mil in 15 years will be 750k. In 30 years 500k.

The employer has a very generous match. One would be unwise to take advantage of it.

LiseE

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Re: 401K as Old Age Money
« Reply #24 on: November 17, 2014, 06:57:31 PM »
Quote
I don't feel you're taking inflation into the equation.

You are correct .. Thanks for pointing that out. 

DH's 401K balance in 10 years (making the max contribution) earning 7% with 3.25% inflation adjustment = 621K
My 401K balance in 10 years (assuming I leave my job in two years) earning 7% with 3.25% inflation adjustment = 583K

We will have a paid off 600K house and this doesn't account for SS.  I would just feel better getting some of that 401K money into more liquid dividend earning income producing investments at some point.  If leave my corporate job in two years (I plan to continue working until the mortgage is paid off) we will then qualify for a Roth IRA .. thoughts?

LordSquidworth

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Re: 401K as Old Age Money
« Reply #25 on: November 17, 2014, 08:51:17 PM »
Quote
I don't feel you're taking inflation into the equation.

You are correct .. Thanks for pointing that out. 

DH's 401K balance in 10 years (making the max contribution) earning 7% with 3.25% inflation adjustment = 621K
My 401K balance in 10 years (assuming I leave my job in two years) earning 7% with 3.25% inflation adjustment = 583K

We will have a paid off 600K house and this doesn't account for SS.  I would just feel better getting some of that 401K money into more liquid dividend earning income producing investments at some point.  If leave my corporate job in two years (I plan to continue working until the mortgage is paid off) we will then qualify for a Roth IRA .. thoughts?

When you leave the job roll the 401k into a regular IRA. Do whatever you want with it.

If you don't have a Roth IRA and you get to a point where you can contribute, I would. It's better to have three buckets than two.

 

Wow, a phone plan for fifteen bucks!