Author Topic: Is there too much in my 401K????  (Read 15357 times)

DenverStache

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Is there too much in my 401K????
« on: December 21, 2012, 04:04:20 PM »
Hello Investors, 

I have a question that will lay the foundation for how I will grow my stache for the next 10 years.  I would appreciate some feedback.

My wife and I are both 31 years old and have ~250K in our retirement accounts (actually 7k in a roth, 56k in a rollover, 145k in a 401k, and ~50k in a 403b).

If I am doing my math correctly, if we do not contribute another cent into these accounts we will have 2.4M when we turn 65.  With a SWR of 4% that gives us ~100k to live on annually, which is more than enough.  Please check my math!  Now of course we will continue to contribute at least to the company match (5% for me and 4% for her), but should we limit it to that and put the remainder in the after tax stache or due to our relativley high incomes (~180K/yr) should we take advantage of the tax deferred growth?  I am concerned about all of my money being locked away until I am 65.  What are your thoughts?  We could also use MMM's pipeline method, does anybody have experience with this?  Are there concerns that laws may change?

For more background, check out my original (and way too long) intro post:
 https://forum.mrmoneymustache.com/ask-a-mustachian/my-case-study-who-wants-to-help-thank-you!/

Thank you!

happy

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Re: Is there too much in my 401K????
« Reply #1 on: December 21, 2012, 06:55:11 PM »
I use this calculator for compounding http://jaw.iinet.net.au/stuff/interest.html
If you have 250k at 7% for 34 years you run out with 2.68mill according to this calculator.
You don't say what interest you used, but you're in the ball park. If you use 5% you get 1.36mill ( yes HALF of 2.68 mill, those 2% make a lot of difference over 34 years of compounding,  I just double checked because I couldn't quite believe it when I saw it).. Don't forget this is in "today's" dollars, i.e. 5% would allow for 2% inflation if you made 7%. Also take into account exit taxes i.e. will you be taxed on capital gains or earnings when you start drawing the money. I'm not from US so I don't know the laws on the various tax sheltered accounts.

Either way, if you are continuing to put money in, at least to get the free money match you should be fine post 65: the calculator will allow you to see the effect of this: Work out the amount using the extra contributions until you think you will retire (ie for 8 years if thats your goal).  When you retire , you  lose those extra contributions,  so you can then take that figure and calculate the compound effect for the remaining years (34-8=26 years) without extra contributions - this will give you the whole amount.. Some people here talk about ways to access some of these accounts prior to 65, so it may be worth investigating a bit more. ( There has been some controversy about this on these boards). Again not my area so I can't help, but hopefully your US citz here will help out on this question.

At the very least it looks to me like you've got over 65 pretty well  all sewn up as much as anyone can, and now need to concentrate on 31-65.

luna

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Re: Is there too much in my 401K????
« Reply #2 on: December 21, 2012, 08:40:06 PM »
Is the $2.4M and thus the $100k/year in today's money or future money? I.e. inflation adjusted or not?

If it is not inflation adjusted then it will probably have the purchase power of around $50k.  Still plenty of money.

I think the withdrawal age from 401k et al without penalty is 59 and not 65, so you should take that into consideration.

hoppy08520

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Re: Is there too much in my 401K????
« Reply #3 on: December 26, 2012, 06:12:12 PM »
At your tax bracket (25%-28% + 4.63% CO), with rates likely to increase for 2013, I'd take as much tax deduction as I can.

See this post for more on how an ER person can tap their 401(k) before age 59, including a link to a MMM blog on your exact question:

https://forum.mrmoneymustache.com/investor-alley/401k-vs-personal-investments

JohnGalt

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Re: Is there too much in my 401K????
« Reply #4 on: December 27, 2012, 09:23:30 AM »
Even if the roth pipeline were to go away - you may still come out ahead even after the penalties, depending on your tax bracket.

Say the dollars you are contributing right now are in the 28% bracket.  You're saving that right now.  If, when you need the money, you withdraw $40,000 / year (in todays dollars).  This would put that money at about a 13% effective tax rate.  Tack on an additional 10% for the penalty and you're still under the 28% effective rate you would have paid today (and you got to enjoy tax free growth in the mean time and will continue to enjoy it on money left in there).  Of course, tax rates could also change - but that's difficult to plan for. 

DenverStache

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Re: Is there too much in my 401K????
« Reply #5 on: January 02, 2013, 12:42:52 PM »
Thank you everyone for the replies.  This is exactly what I was looking for.  I realize that I need to change some things.  For one, I incorrectly assumed that I would not have access until 65 instead of 59.5. This will change my number drastically.  Now I would be looking at ~1.8M (assuming 7%) at 60 years old.  This would give a withdrawl (assuming 4% SWR) of 71K a year.  I have a similar question as luna, is this 71K in today or future dollars? For some reason I thought that the 7% took into consideration inflation, but I could be incorrect and should use 5% as happy points out.  This would leave ~1M for a withdrawl of 41K which I think would be enough in my "old man" years.

JohnGalt, that is the type of analysis I am trying to do.  With my income, I definitely see the value of tax deferred growth and if I can take advantage of the pipeline or just take the penalty this may be the correct way to get to early retirement.  I just have not seen/read much on either of these strategies and MMM himself chose to split the investments into "old man" and "young man" money. 

Additional thoughts/suggestions are welcome because I would like to open a new brokerage account today or increase my 401k contributions to the 17K number.

DoubleDown

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Re: Is there too much in my 401K????
« Reply #6 on: January 02, 2013, 01:05:31 PM »
I'm in the same boat and I think you've got it down right. Maximize your 401k and IRA contributions to take advantage of the tax deductions now. Also contribute into non-tax sheltered investments (stocks, real estate, etc.) so that you'll have a decent amount of money you can draw on during your "young man" years until you can start withdrawing your 401k/IRAs/Social Security/etc.

Also, you can withdraw from IRA's completely penalty-free before age 59.5 by doing "72(t)" withdrawals (substantially equal and non-stop payments until you reach age 59.5). Depending on how the assets look as I get near age 59.5, I might decide to tap in a couple of years early so that I don't have a ridiculous amount of money built up in the tax-advantaged accounts while having less to live on during the younger years. As an obvious example, if your 401k is doing really well and looking like it will be up to $2 million by age 55 or something, why not start withdrawing on it a few years early rather than waiting until you're nearly 60 when it will likely be more than you could even want to spend?

I second or third the motion to use 5% growth in your planning to account for inflation (assuming you are investing healthily in stocks to achieve that kind of inflation-adjusted growth in the long run).

DoubleDown

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Re: Is there too much in my 401K????
« Reply #7 on: January 02, 2013, 01:12:48 PM »
For some reason I thought that the 7% took into consideration inflation, but I could be incorrect and should use 5% as happy points out.  This would leave ~1M for a withdrawl of 41K which I think would be enough in my "old man" years.


If it's not already clear, the 7% growth (non-inflation-adjusted) that leads to $1.8 million would be the actual value in dollars when you are 60. By lowering your growth to 4% or 5%, you are accounting for an average 2% or 3% annual inflation. Thus, your $1.8 million will have the same "purchasing power" as $1 million today. It just depends on how you want to look at it. I prefer to think in today's dollars (using the lower growth rate to adjust for inflation) rather than trying to imagine what a loaf of bread will cost in 2040. If I can live on $1 million now, then I can live on $1 million in 2040 (or $1.8 million Year 2040 dollars).

DenverStache

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Re: Is there too much in my 401K????
« Reply #8 on: January 03, 2013, 09:01:25 AM »
Thank you DoubleDown, that is very helpful.  I will use 5% from here on out and will do some additional research into the 72(t) withdrawls. 

If I max out the 401k contribution that will obviously decrease the amount I am able to contribute to non tax sheltered accounts (young man money).  If I want to retire/semi-retire in 10 years I will not have enough money in these non tax sheltered accounts for the SWR.

Do you think I should max out my 401k in order to build a larger nest egg for 60+ retirement or just plan on taking a penalty?  Or once I "retire" (aka leave my job) do you suggest I roll my 401k over to an IRA and will be able to use these 72(t) withdrawls to live off of between 40-60?

Thank you for all of your help, you seem very knowledgeable and I really appreciate the help I am getting on these message boards.

 

bo_knows

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Re: Is there too much in my 401K????
« Reply #9 on: January 03, 2013, 10:56:28 AM »

If I max out the 401k contribution that will obviously decrease the amount I am able to contribute to non tax sheltered accounts (young man money).  If I want to retire/semi-retire in 10 years I will not have enough money in these non tax sheltered accounts for the SWR.


Can you clarify this statement a little? Are you saying that if you max your 401k, in order to reach your "old man money" goal, that you won't have enough "young man money"? If so, you're retirement age is technically too soon.  Also keep in mind that your "young man money" SWR is meant to completely deplete it in the years from retirement to age 60. So, it's like to be much higher than 4%.

DoubleDown

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Re: Is there too much in my 401K????
« Reply #10 on: January 03, 2013, 01:20:55 PM »

Also keep in mind that your "young man money" SWR is meant to completely deplete it in the years from retirement to age 60. So, it's like to be much higher than 4%.


Yes! Bo does know!

Denver, hopefully Bo's advice helps clear things up. You might think of it as planning two retirements, as you've already noted. For the first retirement during your "young man years", you can essentially completely blow through all of your non-IRA stash, until you can safely start withdrawing from your 401k/IRA, when you're 59.5. During those years, your SWR is the amount of cash you have saved divided by the number of years between retirement and age 59.5. You could probably safely assume you'll also earn 5% on that money during those years, but remember it will be a shrinking asset over the years. And of course you can also always earn extra income during those years if you want.

For the second retirement when you can start withdrawing on 401k/IRAs, then you can adopt the 4% SWR (or 3% SWR if you're really conservative). You've already used up all the non-IRA money, and now you're switching to living off that saved-up money. The 4% or 3% rate should leave your 401k/IRA principal pretty much untouched, allowing it to go on forever for all purposes. Of course, make sure you have enough planned in your 401k balance when you will be 60 so that it's enough to live on during that second "old man" retirement. Assuming you maintain a decently frugal lifestyle, $1.8 million should definitely be enough.

I'm not advocating starting 72(t) withdrawals at age 40 -- I was saying that as those 401k accounts continue to grow after you retire early, you might find that they've built up enough such that you could start taking them out a little early, but not 20 years early. I'm saying that for me, I want to spread things out enough to have a relatively stable amount of income forever. I wouldn't want to have to really cut corners between age 40 and 60, only to "hit the jackpot" at age 60 with a really huge 401k balance. In that case, I might start taking 72(t) withdrawals whenever that account had grown large enough to support me forever at my chosen lifestyle. Hope this makes sense!

DenverStache

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Re: Is there too much in my 401K????
« Reply #11 on: January 03, 2013, 05:11:06 PM »
I loved Bo Jackson growing up, but that is for another topic. 

Thank you and DoubleDown for working through this with me.  I appreciate it and I promise I am not as thick-headed as I seem on the forum. 

Perhaps some actual numbers may clear up the situation.  As I look at my finances right now (me contributing ~17K to 401K and wife contributing ~7K to 401k) we probably will have approximately 3k to stache away each month if we are good.  That is 36K a year and will grow to ~450K in ten years (5% assumption).  Here is what the two periods of time look like (check my math please):

40-60:  450K to live from (could probably make it work but may be tough, what is a good way to plan for this time?)
60+: 1.7M (5% growth to account for inflation, this should be plenty)


However, I could increase my wifes contributions to 17K as well to maximize the tax advantage in our high earning years as you suggest.  It is difficult to determine what that would do to our take home pay.  But if we assume we need an extra 10K/yr = 833/mo and I know that this is pre-tax so lets assume it decreases our stache contribution by only 500 instead of the full 833.  Here is what it would look like:

40-60:  377K to live from (this seems very difficult and I do not think I would be close to FI at this point, I think I would have to work a few more years)
60+: 2M (5% growth, this is way more than we need, why do this?)

The third scenario that I am considering, but am concerned because of the way I have always been told to max out my retirement accounts is to decrease both 401k contributions.  So we would be looking at ~7K for wife and ~10K for me.  This would obviously not give us all of that money to put into the stache due to taxes but I would be contributing 7K less so lets assume that only gives me 5K/yr or 416/mo meaning now we could contribute 3416 to our stache.  Here is what I think it would look like:

40-60:  515K (that seems a little better or more comfortable)
60+:  1.5M (this seems manageable as well and does not include employer contributions)

So the fundamental question is why max out my 401k when my old man money seems that it is already in a "good spot"; particularly at the detriment of my young man stache?

I am concerned that my calculations/assumptions are flawed, but I do not want to work for several years longer because I can not access my money.

On the side:  What SWR should I use for my young man stache, assuming a 15 year timeline?

Thank you again for your help.

sherr

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Re: Is there too much in my 401K????
« Reply #12 on: January 04, 2013, 08:24:01 AM »
Just a side note here, it is possible to take money out of your 401k before you reach retirement age without taking the penalty. Substantially Equal Periodic Payments allow you to take money out of your 401k without penalty, providing you continue to take out the same amount every year until you reach retirement age. You are somewhat at the mercy of the government / economy as to how much they'll let you take out this way though.

Even if you just pay the 10% penalty and take money out of your 401k early that might not be the end of the world, depending on what tax bracket you're in when you retire. If you're paying an average tax rate of 15% in retirement plus the 10% early withdrawal penalty, that's still only 25%. If you're in a 25% marginal tax rate now then it's just as good or possibly better to continue maxing out the 401k instead of investing in a non-tax-advantaged account. So until you hit max this may well be the best source of "young man" investing available to you. (I just noticed that JohnGalt has already said this bit. I agree with him.)

All that to say your 401k is not necessarily just "old man" money, it can be "young man" money too if you need it to be. We contribute max to our 401k and IRAs and don't worry about it too much for a combination of those reasons. We also invest extra money in other ways that can be used as "young man" money (currently: paying down the mortgage of our rental property). That is my (possibly naive) take on the situation.

sherr

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Re: Is there too much in my 401K????
« Reply #13 on: January 04, 2013, 08:40:14 AM »
Just a side note here, it is possible to take money out of your 401k before you reach retirement age without taking the penalty. Substantially Equal Periodic Payments allow you to take money out of your 401k without penalty, providing you continue to take out the same amount every year until you reach retirement age. You are somewhat at the mercy of the government / economy as to how much they'll let you take out this way though.

Actually I just found out that I'm wrong about this. SEPP withdrawals are only allowed out of IRAs, not 401ks. The just-the-same-and-maybe-better argument about tax rates still applies though.

DoubleDown

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Re: Is there too much in my 401K????
« Reply #14 on: January 04, 2013, 10:01:51 AM »
Denver, I think you've thought it all out very well and have several great plans/options to choose from. You don't come off as thick-headed at all, there's just a lot of complexity in all the rules, tax considerations, and built-in ambiguity in not being able to predict the future with any certainty. I've been over it myself many times in the same way trying to figure out how to balance the "two retirements."

Honestly, I don't think you can go wrong with any of your scenarios, which is a great place to be in! They can all work with various pros/cons that you're already noted.

Personally, I would continue to max out the 401k/IRA and Roth IRA contributions to take advantage of the tax deductions at least for the next couple of years. The net effect is you'll be saving up even more, courtesy of the government's tax policy. You could always ramp it down after a few more years. But you could absolutely and reasonably decide not to do that and instead focus on saving up more free-and-clear money for age 40 - 60.

I'm not particularly bothered by having a bunch of my 'stache tied up in 401k/IRA because I'm comfortable with the various methods for withdrawing early at no penalty. But it does take some extra effort, so it could make sense not to do that if you're not so inclined.

I will add one thing: I don't know your real estate market, but I'm very bullish in general on owning at least one rental/investment property if your market is favorable. Owning real estate offers several big advantages -- it positions you for a nice income stream, generally appreciates in the long run (YMMV), gives substantial tax benefits, and is a great hedge against inflation. So if you're up for it, I would direct some of that investing towards an investment property following some of the excellent advice of users on this forum (Arebelspy and Another Reader immediately pop up in my mind). In 10+ years of owning a rental property, you could be looking at a very nice cash-producing asset for your retirement that also provides you with leverage and a built-in place to live should you ever want/need it in your later years.

While most prudent real estate investors don't rely on appreciation, many find that it ends up significantly boosting their net worth in a good market, in a way that surpasses anything you could ever do in the stock market or elsewhere. Leverage is amazing, and in many places there has never been a better time to buy. As an example, if you invest $50,000 into a $250,000 property that appreciates, on average, 4% over the next 10 years, you will get huge gains (value of $370,000 after 10 years, or a net increase of $120,000). It is not your $50,000 that is growing at 4% per year, but $250,000 growing at 4% per year. And at the same time, you get an income stream, increased equity by paying principal, rents that go up with inflation, plus tax write-offs.

Another Reader

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Re: Is there too much in my 401K????
« Reply #15 on: January 04, 2013, 10:26:55 AM »
+1 for DoubleDown's comments (and thanks for the props).  Real estate is the bulk of my net worth and all the advantages DoubleDown lists worked for me.  I did max out most years in my retirement options, and I expect that money to kick in around the time Social Security does. 

It's hard to forecast your financial future from a spreadsheet.  I found it really helpful to talk to a lot of successful folks much older than I was at the time in making financial decisions over the years.  Seeing exactly what they did and what did or did not work for them was more enlightening than any spreadsheet (or HP 12-C calculator and back of the envelope in the pre Lotus 123 days).

DenverStache

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Re: Is there too much in my 401K????
« Reply #16 on: January 04, 2013, 12:55:07 PM »
I can not thank you all enough for all of your feedback.  I have been doing more research on the 72(t) withdraw as well as the 5 year pipeline and the consideration of the tax benefits offsetting any 10% penalty.  There is also the advantage of the money coming out of your paycheck and you never really noticing it was there.  It is a guaranteed 35k in savings that is also appealing and I will still have money to stache away even if it is less.  Honestly, I think I will find at 40 that if we practice the mustachian way diligently that our expenses will be low enough and we will want to work enough that I will not be required to touch the stache anyway.

As for real estate, I do have 2 rentals that have been marginally profitable but I have already noticed the benefits of appreciation and now have a little cash flow going.  I will not dive into the details here to keep this thread focused, but you two better be just as helpful when I start asking about those investments as well :)

Thank you again