Author Topic: Asset Allocation: Am I putting too much into my 401k?  (Read 1008 times)

Valley of Plenty

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Asset Allocation: Am I putting too much into my 401k?
« on: May 29, 2023, 11:40:11 PM »
This post might be better suited to the Case Studies subforum, but since it pertains strictly to investing I figured I'd post it here.

I recently ran some long term projections in regards to my investments and it seems that I may be focusing too heavily on 401k contributions in regards to my retirement plans. I know the conventional wisdom is to max out 401k and IRA first, then put everything else in a brokerage, but I think my situation differs from most and may require a different strategy. Explanation and numbers to follow.

I am 28 years old, currently working full time in addition to executing a house hack via a triplex I bought 2 1/2 years ago. Total gross income from both is about $85,000. Last year, I was able to max out my Roth IRA in addition to putting $9,000 into my traditional 401k ($12,000 after employer match). After taxes and expenses (including about $15,000 in rental related expenses) I didn't end up having anything left over to put into a brokerage account. I currently have $43k in my 401k and $10k in my Roth IRA, plus $15k in savings (rookie numbers, I know, but all of those numbers were basically $0 five years ago).

I used a compound interest calculator to project what my 401k will look like at age 65 assuming that I continue contributing the same amount that I have been until age 40, then stop contributions altogether (assuming I stop working by age 40, which is my goal currently), with an average annual interest rate of 7%. The resulting figure is $1.7m in my 401k and $745,000 in the Roth IRA, for a total of $2.5m. This is nearly 4x my FI number, so certainly more than I will need once I reach 65 and can start making use of the funds without penalty.

In light of this, it seems to me that my best course of action would be to pull back on my 401k contributions to only capture the employer match, and then funnel the extra $$$ into a brokerage account. Otherwise, I'm going to hit my FI number with no way to actually draw down without incurring early withdrawal penalties. Am I correct in this thought process? All of the traditional advice seems to be max 401k, then IRA, then brokerage, but I feel like that applies more to people with very high income / very high FI numbers. I can FIRE on considerably less than $1m, but not if the vast majority of my investments are tied up in retirement accounts that I can't draw from until I'm 65.

Is there anything I'm missing? Should I go ahead and slash my 401k contributions and start funneling into a brokerage or is there a better way to reach my goals?


ScreamingHeadGuy

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Re: Asset Allocation: Am I putting too much into my 401k?
« Reply #1 on: May 30, 2023, 04:05:12 AM »
https://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

See this thread for the long answer.

For the short answer: your line of thought is incorrect.

nereo

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Re: Asset Allocation: Am I putting too much into my 401k?
« Reply #2 on: May 30, 2023, 04:14:47 AM »
A few things:
First, you can withdraw money without penalty from a 401k at age 59.5, not 65
Second, there are additional ways one can access money in retirement accounts in FIRE. There’s a stickie on it to help you get started.

As you are 28 and hoping to retire at 40 I would not spend too much time worrying about this - hopefully your best earning years are in front of you, and it’s likely that you will have additional funds you can contribute to your taxable brokerage in the future.  However, you can’t go back and fill unused space in your 401k from previous years. When you are 5 years out (age ~35 under your current plan) you may want to re-examine whether you will have enough to bridge the gap and adjust accordingly, but right now I would fill those tax deferred buckets!

MDM

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Re: Asset Allocation: Am I putting too much into my 401k?
« Reply #3 on: May 30, 2023, 11:25:10 AM »
I am 28 years old....
I currently have $43k in my 401k....

I used a compound interest calculator to project what my 401k will look like at age 65 assuming that I continue contributing the same amount that I have been until age 40, then stop contributions altogether (assuming I stop working by age 40, which is my goal currently), with an average annual interest rate of 7%.
What will be your source of income after age 40?  Withdrawals/conversions from the traditional accounts will cut into the expected growth.

The earlier you plan to retire, the lower your expected expenses then, and the greater the difference between the (presumably higher) marginal tax rate you would save now, vs. the marginal tax rate on the future withdrawals, the more likely that following those standard recommendations (e.g., Investment Order) will work well for you.

You might need to cover the first five years (or just pay the extra 10% on early traditional withdrawals) in some special way, but the fifty years or so that will come after that deserve the most attention.

What is the current marginal tax rate you would save by contributing to a 401k now, and what do you expect it to be when withdrawing?

ixtap

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Re: Asset Allocation: Am I putting too much into my 401k?
« Reply #4 on: May 30, 2023, 12:00:15 PM »
Precisely because you plan to retire early you should keep maxing your 401k. You will have much more leeway to control that final balance than the traditional retiree. By using Roth conversions or SEPP, you will have opportunities to finely control your taxable income over decades.

I would also say that 7% real, while not implausible, is on the optimistic side.

Valley of Plenty

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Re: Asset Allocation: Am I putting too much into my 401k?
« Reply #5 on: May 30, 2023, 09:09:26 PM »
https://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

See this thread for the long answer.

For the short answer: your line of thought is incorrect.

I knew about the Roth conversion ladder, but for some reason I was thinking rollovers counted towards the contribution limit (meaning you could only roll over $6,000 this year, for example). Glad to know I was mistaken on this!

That makes things much clearer now. Thank you for pointing me in the right direction!

lutorm

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Re: Asset Allocation: Am I putting too much into my 401k?
« Reply #6 on: May 31, 2023, 01:02:37 AM »
Your FI number is $750k? Using the 4% rule, that would give you a planned $30k/year spend, and that's for a 30yr retirement. You're aiming more at 50, so the real SWR is lower. You might be fine living on ~25k now, but at the very least if you're planning to have a family, you might want some margin on that. $25k is poverty level for a family of 3...

LD_TAndK

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Re: Asset Allocation: Am I putting too much into my 401k?
« Reply #7 on: May 31, 2023, 03:36:42 AM »
Your FI number is $750k? Using the 4% rule, that would give you a planned $30k/year spend, and that's for a 30yr retirement. You're aiming more at 50, so the real SWR is lower. You might be fine living on ~25k now, but at the very least if you're planning to have a family, you might want some margin on that. $25k is poverty level for a family of 3...

Assuming they're currently single, and a potential spouse would hopefully bring additional savings/earnings into the equation, I think they're doing just fine.

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Re: Asset Allocation: Am I putting too much into my 401k?
« Reply #8 on: May 31, 2023, 04:52:28 AM »
Your FI number is $750k? Using the 4% rule, that would give you a planned $30k/year spend, and that's for a 30yr retirement. You're aiming more at 50, so the real SWR is lower. You might be fine living on ~25k now, but at the very least if you're planning to have a family, you might want some margin on that. $25k is poverty level for a family of 3...

Assuming they're currently single, and a potential spouse would hopefully bring additional savings/earnings into the equation, I think they're doing just fine.

The real x factor is kids. A spouse and being DINKs could be a big boost. A large family of kids could change things the other direction.

Valley of Plenty

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Re: Asset Allocation: Am I putting too much into my 401k?
« Reply #9 on: June 02, 2023, 09:35:51 PM »
Your FI number is $750k? Using the 4% rule, that would give you a planned $30k/year spend, and that's for a 30yr retirement. You're aiming more at 50, so the real SWR is lower. You might be fine living on ~25k now, but at the very least if you're planning to have a family, you might want some margin on that. $25k is poverty level for a family of 3...

I'm not planning on having kids, or marrying anyone who would cause my annual spending to increase.

I'm not planning to immediately cut off all income streams the day I hit my FI number either. $750k would be my "lean FI" number, meaning I could support myself indefinitely on $30k a year.

Quote
$25k is poverty level for a family of 3...
There are a great many people on this forum who do just fine supporting their families at below what the federal government considers "poverty level". Anyone who has spent significant time here or reading the blog probably has all the knowledge they need to lead a fulfilling life on a fraction of what most people would consider reasonable. Heck, I could quit my job today and live on just the rental income from my triplex if I really wanted to.

So yeah, I'm not terribly concerned about running out of money in retirement. I doubt I'll ever stop making money anyways, I enjoy being productive and some of the ways in which I'm productive will always remain profitable. Unfortunately I don't think I could go broke even if I tried :(

MustacheAndaHalf

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Re: Asset Allocation: Am I putting too much into my 401k?
« Reply #10 on: June 02, 2023, 10:31:57 PM »
I'm not planning to immediately cut off all income streams the day I hit my FI number either. $750k would be my "lean FI" number, meaning I could support myself indefinitely on $30k a year.
Could you retire on half that?  If you're 28 y/o now and retire at 65, that's 37 years of inflation.  At 2%/year that cuts your future dollars in half, so $30k/year at age 65 is like having $15k/year now.  And that 2%/year is historical, ignoring current demographics that point to higher inflation (possibly mitigated by technology).  Maybe your 7%/year compounding was intended to factor this in, but thought it worth mentioning.

Valley of Plenty

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Re: Asset Allocation: Am I putting too much into my 401k?
« Reply #11 on: June 02, 2023, 10:38:40 PM »
I'm not planning to immediately cut off all income streams the day I hit my FI number either. $750k would be my "lean FI" number, meaning I could support myself indefinitely on $30k a year.
Could you retire on half that?  If you're 28 y/o now and retire at 65, that's 37 years of inflation.  At 2%/year that cuts your future dollars in half, so $30k/year at age 65 is like having $15k/year now.  And that 2%/year is historical, ignoring current demographics that point to higher inflation (possibly mitigated by technology).  Maybe your 7%/year compounding was intended to factor this in, but thought it worth mentioning.

It has always been my understanding that the 4% rule accounts for inflation. Maybe I'm mistaken though?

VanillaGorilla

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Re: Asset Allocation: Am I putting too much into my 401k?
« Reply #12 on: June 02, 2023, 10:50:14 PM »
I'm not planning to immediately cut off all income streams the day I hit my FI number either. $750k would be my "lean FI" number, meaning I could support myself indefinitely on $30k a year.
Could you retire on half that?  If you're 28 y/o now and retire at 65, that's 37 years of inflation.  At 2%/year that cuts your future dollars in half, so $30k/year at age 65 is like having $15k/year now.  And that 2%/year is historical, ignoring current demographics that point to higher inflation (possibly mitigated by technology).  Maybe your 7%/year compounding was intended to factor this in, but thought it worth mentioning.

It has always been my understanding that the 4% rule accounts for inflation. Maybe I'm mistaken though?
Of course it does.

OP you're doing great. $750k is a fine LeanFI goal. Max out your 401k unless you need that money soon. There are ways to access your 401k early, as stated earlier.

Keep a big emergency fund/sinking fund/taxable account for short term needs.

Valley of Plenty

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Re: Asset Allocation: Am I putting too much into my 401k?
« Reply #13 on: June 03, 2023, 01:12:33 AM »

OP you're doing great. $750k is a fine LeanFI goal. Max out your 401k unless you need that money soon. There are ways to access your 401k early, as stated earlier.

Keep a big emergency fund/sinking fund/taxable account for short term needs.

I keep about $15,000 in my checking account, which is 6-12 months of expenses depending on how hard I flex my frugality muscles. Then I also have my Roth IRA that I could pull contributions from if that ever were to become necessary. Overall I'm in a great position financially, I just want to make sure I'm putting my dollars to work in the most efficient way possible.