Author Topic: To 401k or not to 401k?  (Read 5019 times)

pca

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To 401k or not to 401k?
« on: July 14, 2012, 08:08:04 PM »
Hi all,

My situation is, I'm 31 years old, with a wife 32 and two young children. We are very fortunate to be looking at ER in a five year window. We currently have $925k in non-retirement funds, $110k in a 401k, and $15k in a Roth IRA. Our debt is limited to a $350k mortgage at 2.5%, on a house worth $630k. Our annual income is $300k, but I expect it to drop to $180k over the next few years (vesting options with a low strike price).

My question is, how much I should be contributing to my 401k? Currently I contribute the maximum match amount of 6%.

Putting more towards the 401k is attractive, because our marginal tax rate is 35% AMT + 10% state, and so a 401k contribution would lower it nicely. On the other hand, this seems like cutting off our nose to spite the tax man: it would effectively lock up our money for almost 30 years, which would delay our ER.  I don't want to plan on needing a financial boost three decades into my retirement.

Thanks in advance for your thoughts!

hayhayday

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Re: To 401k or not to 401k?
« Reply #1 on: July 15, 2012, 05:49:12 AM »
Have you looked into using 401k for substantially equal payments during ER?

grantmeaname

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Re: To 401k or not to 401k?
« Reply #2 on: July 15, 2012, 08:26:36 AM »
In addition to the above suggestion, you could convert your 401k to a Roth IRA and then withdraw it after it sat in the Roth IRA for five years (oh, and you'd only be able to withdraw your and your employers' contributions, not any investment earnings). So just convert a tenth of it each of the first ten years you're retired, and you'll be able to access each year's conversion in years 5-15 of retirement. The only problem is that you have to pay income tax on everything you convert each year, so it's best to do it as gradually as you can. (And if your 401k doesn't allow you to partially convert it, you should turn it all into a Traditional IRA, which has no associated tax, and then do the conversion from the traditional IRA each year.

pca

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Re: To 401k or not to 401k?
« Reply #3 on: July 15, 2012, 02:52:29 PM »
Thanks hay and grant.

I'd never heard of that "substantially equal payments" thing, and it looks ideal for my situation.  Barring that, a five year waiting period is much more palatable than waiting until I'm 60.

James

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Re: To 401k or not to 401k?
« Reply #4 on: July 15, 2012, 03:52:00 PM »
I agree you should put the money aside in the 401k, shielding it from your 35% tax rate probably beats all other options.  There are many choices once it's there, just convert it to a rollover IRA after you retire so you aren't limited by your employer at that point.  As others have pointed out the money can be accessed slowly over time, but I also assume you will have money invested in diverse areas over the next 30 years, I would just use this money in areas you can invest in inside a IRA and spend other money first.

sol

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Re: To 401k or not to 401k?
« Reply #5 on: July 15, 2012, 09:40:12 PM »
I think a lot of people in your situation are afraid of contributing to the 401k because they think they will need the money before they are old enough to withdraw it, but unless you plan on dying before traditional retirement age keep in mind that you will need a big chunk of that money AFTER you are old enough to withdraw it without penalty. 

You only need to get back enough to hold you until 59.5.  If you're 31 now and looking to retire at 37, you need 22 years of funds before age 59.5 but if you live to 85 you'll need 25 years of funds after age 59.5.  Unless you've already got at least enough money in the 401k to meet all of your expenses between 59.5 and 85, I'd keep dumping more in.

With that said, you DO need to have five years of living expenses stashed outside of the 401k if you're going to do this 5 year Roth IRA rollover plan.  Any principal you've put into a Roth IRA already can come back out penalty free, and then you need some other stash to make up the 5 year difference.  If you're within 5 years of retiring and don't have 5 years of expenses accessible to tide you over during that 5 year seasoning period, you might have to bite the bullet and take the tax hit up front to build your short term savings cushion.

Alternately, you could HELOC for living expenses and then pay it off when the first 401k to Roth rollover chunk becomes available in 5 years.  You'd have to do the math on the interest rates, but I suspect it's better than 35% loss to taxes.