Author Topic: Don't understand maxing out 401k  (Read 3923 times)

Longwell

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Don't understand maxing out 401k
« on: February 08, 2017, 11:20:34 AM »
So I read everywhere that you should be maxing out your 401k ($18k a year) and then if you have anything left over then put it in a taxable account like Betterment. It makes sense since it is tax free but this brings up an issue for me. I am familiar with the Roth Ladder (or whatever its called) where when you retire you can take the money out tax free as long as you wait 5 years after converting it to a roth. If I wanted to go FIRE at 40 and the majority of your savings (50%+) was in a 401k, is the idea that the money that you have stashed in your taxable accounts will be enough to live off until you can access the money in the 401k in 5 years? This seems super shady to me since you don't have an income anymore and your 401k stash (which is a substantial portion of your savings) is untouchable for 5 years.

In my head it seems like the split should be something like 60% of your savings should be in taxable accounts and 40% in 401k's so that you can have access to enough money to live for those first 5 years before the ladder kicks in.

What am I missing?

neo von retorch

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Re: Don't understand maxing out 401k
« Reply #1 on: February 08, 2017, 11:25:20 AM »
In your example, you are 40 years old. Let's just make super basic assumptions:

* You only need income from 40 to 60 (at 60 all of your 401k/IRA will be available)
* Your total stash is 25x one year's expenses
* 5 years from now, 1 year of expenses will be available from your 401k via a Roth conversion
* This will repeat until you're 60.

So how much do you need to cover? 5 years or 5x one year's expenses. That's only 20%!

You only need 20% of your total stash in taxable accounts, liquid (aka cash/CD) or Roth IRAs at the moment of FIRE.

Longwell

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Re: Don't understand maxing out 401k
« Reply #2 on: February 08, 2017, 12:11:16 PM »
So the idea is that you only need 20% in taxable accounts, and that at the end of those 5 years you will have used most of that money and then live off of 401k returns through the roth ladder until 60 when I can access all of it. It makes sense when you put it like that.

Side note, your in doylestown? I'm in Aston! Local mustachian!

teen persuasion

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Re: Don't understand maxing out 401k
« Reply #3 on: February 08, 2017, 06:02:58 PM »
What about maxing a Roth IRA after maxing your 401k?

We've been funding 2 Roth IRAs and DH's 401k (none available to me), and have roughly 1/3 Roth to 2/3 traditional split.

Eric

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Re: Don't understand maxing out 401k
« Reply #4 on: February 08, 2017, 06:57:41 PM »
In my head it seems like the split should be something like 60% of your savings should be in taxable accounts and 40% in 401k's so that you can have access to enough money to live for those first 5 years before the ladder kicks in.

What am I missing?

If 60% of your investments is only enough to last you 5 years, then you don't have enough money to retire.  You need 25x your projected annual expenses as a general guidline.

Also realize that nothing is "untouchable".  At most, if you have to withdrawal some of it, you'd pay a 10% penalty.  You most definitely saved more than 10% on your taxes by contributing to the pre-tax 401k, so you're still coming out ahead.

Check out the Mad Fientist's results:

http://www.madfientist.com/how-to-access-retirement-funds-early/

steevven1

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Re: Don't understand maxing out 401k
« Reply #5 on: February 08, 2017, 07:28:36 PM »
Also realize that nothing is "untouchable".  At most, if you have to withdrawal some of it, you'd pay a 10% penalty.  You most definitely saved more than 10% on your taxes by contributing to the pre-tax 401k, so you're still coming out ahead.

Woah, be careful. You get assessed a 10% penalty PLUS regular income taxes, so you're not coming out ahead. If you came out ahead by withdrawing from a tax-deferred retirement account early, everyone would shovel all their money into these accounts regardless of their financial situation, then just take it right back out whenever needed, without thought.

Paul der Krake

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Re: Don't understand maxing out 401k
« Reply #6 on: February 08, 2017, 07:41:19 PM »
Also realize that nothing is "untouchable".  At most, if you have to withdrawal some of it, you'd pay a 10% penalty.  You most definitely saved more than 10% on your taxes by contributing to the pre-tax 401k, so you're still coming out ahead.

Woah, be careful. You get assessed a 10% penalty PLUS regular income taxes, so you're not coming out ahead. If you came out ahead by withdrawing from a tax-deferred retirement account early, everyone would shovel all their money into these accounts regardless of their financial situation, then just take it right back out whenever needed, without thought.
Regular income taxes which are likely non-existent or very reasonable if you're a Mustachian.

Eric

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Re: Don't understand maxing out 401k
« Reply #7 on: February 08, 2017, 07:45:21 PM »
Also realize that nothing is "untouchable".  At most, if you have to withdrawal some of it, you'd pay a 10% penalty.  You most definitely saved more than 10% on your taxes by contributing to the pre-tax 401k, so you're still coming out ahead.

Woah, be careful. You get assessed a 10% penalty PLUS regular income taxes, so you're not coming out ahead.

You have to pay the taxes either way.  I thought that was a given. 

If you came out ahead by withdrawing from a tax-deferred retirement account early, everyone would shovel all their money into these accounts regardless of their financial situation, then just take it right back out whenever needed, without thought.

But yes, you ARE coming out ahead, with the assumption that when you're retired, you're no longer earning income, and are therefore in a lower tax bracket.  So yes, shovel as much money into it as you can (there are limits, you know) and feel free to take it back out when you're at a lower tax bracket whenever needed, without much thought.

You should read that Mad FIentist post where he proves this with math.

ReP

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Re: Don't understand maxing out 401k
« Reply #8 on: February 10, 2017, 11:32:26 AM »
Quote
But yes, you ARE coming out ahead, with the assumption that when you're retired, you're no longer earning income, and are therefore in a lower tax bracket.  So yes, shovel as much money into it as you can (there are limits, you know) and feel free to take it back out when you're at a lower tax bracket whenever needed, without much thought.

You don't know how relieving this is to hear. We've been beating our heads against a wall reading tons of forum and blog posts about tax shelters, diversification etc because my partner and I do have some awesome options available to us. All I need to know is WHERE DOES THE MONEY GO.

VoteCthulu

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Re: Don't understand maxing out 401k
« Reply #9 on: February 10, 2017, 03:12:48 PM »
All I need to know is WHERE DOES THE MONEY GO.
1) Employer plan up to match
2) Max HSA if available.
3) Max employer plan
4) Max tIRA or Roth IRA if income is low enough
5) (Optional) After tax contributions for backdoor Roth
6) Taxable savings, favoring whatever investments are best in your tax situation (qualified dividends, foreign tax credits, etc.)

Eric

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Re: Don't understand maxing out 401k
« Reply #10 on: February 10, 2017, 04:19:27 PM »
All I need to know is WHERE DOES THE MONEY GO.

Check the stickied thread at the top of this forum "Investment Order"

http://forum.mrmoneymustache.com/investor-alley/investment-order-65299/

ReP

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Re: Don't understand maxing out 401k
« Reply #11 on: February 10, 2017, 04:21:07 PM »
All I need to know is WHERE DOES THE MONEY GO.

Check the stickied thread at the top of this forum "Investment Order"

http://forum.mrmoneymustache.com/investor-alley/investment-order-65299/


I found it thank you!!

MoonLiteNite

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Re: Don't understand maxing out 401k
« Reply #12 on: February 11, 2017, 02:47:32 AM »
I divide my 401k up, 75% T, and 25% R.
That way when i pull my 401k money out, the ROTH side can go straight into a rIRA and i can live off that until i can start up my ladder.

At least from my understanding that is a do-able way.


Another way is to start funding a rIRA now, and save up enough to live on that for 5 years until your ladder kicks in.