Author Topic: When to STOP Maxing Out 401k?  (Read 7362 times)

thelamb

  • 5 O'Clock Shadow
  • *
  • Posts: 95
  • Age: 39
  • Location: Columbus, OH
When to STOP Maxing Out 401k?
« on: October 08, 2013, 06:16:59 AM »
Hi, first post here.  The question is when is it wise to cut back or altogether stop contributing to your 401k (or other traditional, post-60 retirement fund)?  And by when I mean at what percentage of the total you expect to need to retire do you start to shift focus to savings that can be utilized, without penalty, at an earlier age? 

There are a lot variables here--amount you spend per year, your current age, amount being contributed to "other" savings already, etc--so not sure if there's a specific formula, but I'd like to hear ideas on this one. 

Ok, I'm going to modify this post and elaborate to make slightly more interesting and personal... 

My current financial situation is a tad complicated:  I'm currently embroiled in a lawsuit against a former employer that I've won and now my lawyer is just leaning on the courts to force payment.  This ties up some of my cash flow, paying for said lawyer.  The payout is set between $40-50k.  The likelihood is 50/50.  I expect a windfall of $90-120k in next year, likelihood very very high.  I am paying off a big chunk of debt, largely due to a remodel that, based on the market and visitor reactions, will pan out.  For all of this, I plan for the worst, but for the sake of this post, I'm going to be super optimistic and jump into the future one year. 

In one year, I hope my situation is as follows:

Mid-30's, Income between $130-150k, $180k in retirement (equal parts Roth/IRA/401K), $30k in taxable investments, $90-120k in company stock, $150-200k in home equity.  Ultimately hope to sell home and downgrade and pay cash, so considering all, looking at, conservatively $300k of investments with a goal of $700k to reach financial independence. 

So back to original question, would you stop contributing to long-term retirement at mix of 200/500 retirement to taxable?  300/400?  Or just go all in until the magic number is hit? 

Thanks!
« Last Edit: October 08, 2013, 06:58:33 AM by adunfee »

matchewed

  • Magnum Stache
  • ******
  • Posts: 4301
  • Location: CT
Re: When to STOP Maxing Out 401k?
« Reply #1 on: October 08, 2013, 08:20:26 AM »
If I was at your income level I would stop maxing out my 401k when I stop working. There are several ways to access the money in that account, if you are truly saving it for your traditional retirement age I would still max it until I quit. It is one of the largest sources of immediate tax deferral assuming your expenses will be low in the future.

Cyrano

  • Stubble
  • **
  • Posts: 123
Re: When to STOP Maxing Out 401k?
« Reply #2 on: October 08, 2013, 08:23:01 AM »
See whether either of (a) a SEPP plan for withdrawing part if the IRA, or (b) a program of converting IRA to Roth and then withdrawing the converted funds after 5 years, can work for you. You can probably get access to retirement funds without sacrificing the tax efficiency of your savings today.

KingCoin

  • Pencil Stache
  • ****
  • Posts: 783
  • Location: Manhattan
  • Achieved FI @ 30
Re: When to STOP Maxing Out 401k?
« Reply #3 on: October 08, 2013, 11:50:38 AM »
Another variable is employer matching contributions.  An employer match will usually make even a 10% early withdrawal penalty look like chump change, and makes investing a no-brainer.

Kira

  • Stubble
  • **
  • Posts: 168
  • Age: 35
  • Location: Columbus, OH
Re: When to STOP Maxing Out 401k?
« Reply #4 on: October 09, 2013, 12:31:09 PM »
If you are single, I would say continue maxing out your 401k until the bitter end. Depending on what you expect your post-retirement income needs to be, you are in such a high tax bracket that it is possible that if you had to withdraw earlier than retirement age, even with the 10% early withdrawal penalty you'd still end up saving money on taxes.

Moving money from traditional IRA to Roth slowly is a great idea - http://www.madfientist.com/traditional_ira_vs_roth_ira/

But it sounds like what will work best for you is using an SEPP or substantially equal period payments as mentioned by Cyrano. Setting up an SEPP plan with your IRA means that you get a check once a month, quarter, or year, the amount of which is based on how much you have in the account and how long the government expects you to live, such that if you got the checks for the rest of your life you'd drain the account. You can start this plan at any time, and you won't be charged the 10% early withdrawal penalty (though you will have to pay income tax.)

A few important things to note:

1 - you do not have to take SEPP payments from all of your IRAs, just one - so you could figure out how much you want to live on, and how much of that is going to come from taxable accounts or any side work you might choose to keep doing after hitting FI. Then put enough in one of the IRAs to fill in the gap and start taking SEPP payments on it.

2 - An SEPP plan only has to be active for five years. (wrote this a while back: http://www.moneycrashers.com/substantially-equal-periodic-payments-sepp-72t-rule/) So you could start the SEPP whenever you want, and then after five years, or whenever you can normally get to the money, you could stop it or change the amount. There are three different methods of calculating the amount you have to take out, and you could start with the one that gives you the biggest payment and then switch to a method that gives you a lower payment several years later.

3 - On the flip side, if you go back to work or start earning money again, you have to keep doing the SEPP plan for a minimum of five years.

kyleaaa

  • Bristles
  • ***
  • Posts: 327
    • Kyle Bumpus
Re: When to STOP Maxing Out 401k?
« Reply #5 on: October 09, 2013, 03:18:30 PM »
Never stop maxing out your 401k. The benefits far outweigh the drawbacks. Besides, you CAN access money in your 401k without penalty before retirement age.

secondcor521

  • Handlebar Stache
  • *****
  • Posts: 1945
  • Age: 49
  • Location: Boise, Idaho
  • Big cattle, no hat.
    • Age of Eon - Overwatch player videos
Re: When to STOP Maxing Out 401k?
« Reply #6 on: October 09, 2013, 06:11:45 PM »
2 - An SEPP plan only has to be active for five years. (wrote this a while back: http://www.moneycrashers.com/substantially-equal-periodic-payments-sepp-72t-rule/) So you could start the SEPP whenever you want, and then after five years, or whenever you can normally get to the money, you could stop it or change the amount. <snipped some stuff>

3 - On the flip side, if you go back to work or start earning money again, you have to keep doing the SEPP plan for a minimum of five years.

This (that the OP, who is in their 30's, could stop an SEPP after five years) is factually incorrect and contradicted by your own article that you link to where you say:

"An SEPP plan must be in place for at least five years or until you turn 59 1/2, whichever is longer. If you start an SEPP plan when you’re 58, you’ll have to continue it until you’re 63, even though you’ll have already reached retirement age."

Kira

  • Stubble
  • **
  • Posts: 168
  • Age: 35
  • Location: Columbus, OH
Re: When to STOP Maxing Out 401k?
« Reply #7 on: October 09, 2013, 07:44:42 PM »
2 - An SEPP plan only has to be active for five years. (wrote this a while back: http://www.moneycrashers.com/substantially-equal-periodic-payments-sepp-72t-rule/) So you could start the SEPP whenever you want, and then after five years, or whenever you can normally get to the money, you could stop it or change the amount. <snipped some stuff>

3 - On the flip side, if you go back to work or start earning money again, you have to keep doing the SEPP plan for a minimum of five years.

This (that the OP, who is in their 30's, could stop an SEPP after five years) is factually incorrect and contradicted by your own article that you link to where you say:

"An SEPP plan must be in place for at least five years or until you turn 59 1/2, whichever is longer. If you start an SEPP plan when you’re 58, you’ll have to continue it until you’re 63, even though you’ll have already reached retirement age."

Sorry for not being specific enough, but I assumed he would be doing this long before 59 1/2.

thelamb

  • 5 O'Clock Shadow
  • *
  • Posts: 95
  • Age: 39
  • Location: Columbus, OH
Re: When to STOP Maxing Out 401k?
« Reply #8 on: October 09, 2013, 08:11:46 PM »
Thanks for all the advice, everyone.  Bottom line, the message is don't take the foot off the 401k gas or even think about it anytime soon.  I get confused on all the early withdrawal stuff, but that's future me's problem. 

secondcor521

  • Handlebar Stache
  • *****
  • Posts: 1945
  • Age: 49
  • Location: Boise, Idaho
  • Big cattle, no hat.
    • Age of Eon - Overwatch player videos
Re: When to STOP Maxing Out 401k?
« Reply #9 on: October 09, 2013, 09:25:46 PM »
@OP, sorry if this is a threadjack.

@Kira, maybe I'm misunderstanding something, but if someone starts an SEPP when they are 40 for example, they would be required by law to continue it until age 59 1/2.  Your original statement seemed to imply that they could stop at age 45 in this example.  That isn't the case.

Kira

  • Stubble
  • **
  • Posts: 168
  • Age: 35
  • Location: Columbus, OH
Re: When to STOP Maxing Out 401k?
« Reply #10 on: October 10, 2013, 07:42:24 AM »
Oops reading comprehension fail.. went back and checked the IRS documentation and yes it is until 59.5 or five years, whichever is longer. Still something to keep in mind though!

thelamb

  • 5 O'Clock Shadow
  • *
  • Posts: 95
  • Age: 39
  • Location: Columbus, OH
Re: When to STOP Maxing Out 401k?
« Reply #11 on: October 10, 2013, 09:45:50 AM »
I have to admit the whole SEPP thing confuses me.  Need to beef up on it, but one reading actually left me thinking it was something that you could do within 5 years of retirement, meaning in the 54-59 age range, as a bridge to when you have full access to those retirement funds.  I'm probably woefully mistaken, but if not, then that's not really an option for someone looking to start accessing funds some 20 years before. 

To my original question, I had the idea in my head that retirement funds would be accessed during normal retirement years and the bridge would be handled with other investments and handled by the fact that one wouldn't actually retire but just be financially independent and able to pursue other lines of work that gave them more personal satisfaction.  So my concern was having enough of the pre-retirement good stuff to live off of in exploratory times or to double down with personal, entrepreneurial adventures, while leaving the true retirement to continue growing over those years. 

Kira

  • Stubble
  • **
  • Posts: 168
  • Age: 35
  • Location: Columbus, OH
Re: When to STOP Maxing Out 401k?
« Reply #12 on: October 10, 2013, 02:30:11 PM »
I have to admit the whole SEPP thing confuses me.  Need to beef up on it, but one reading actually left me thinking it was something that you could do within 5 years of retirement, meaning in the 54-59 age range, as a bridge to when you have full access to those retirement funds.  I'm probably woefully mistaken, but if not, then that's not really an option for someone looking to start accessing funds some 20 years before. 

After my re-reading I can fairly confidently say that no, you can do it at any time. Here is another article that has some extra info: http://retireearlyhomepage.com/wdraw59.html

If you're retiring really, really early, it might not be very helpful since you have to calculate the payments based on the assumption that you will get them every year for the rest of your life. So if you are 30, that could mean taking 2% or less out of the IRA a year which might not be very much money. But if you retire from your regular job at, say, 30, and shift to a different type of incoming producing activity, you could theoretically wait until you are older and downshift again to start the SEPP.

Another tidbit is that if you are still working, and you don't end up needing all that money, you can actually put it back into a different IRA account.


To my original question, I had the idea in my head that retirement funds would be accessed during normal retirement years and the bridge would be handled with other investments and handled by the fact that one wouldn't actually retire but just be financially independent and able to pursue other lines of work that gave them more personal satisfaction.  So my concern was having enough of the pre-retirement good stuff to live off of in exploratory times or to double down with personal, entrepreneurial adventures, while leaving the true retirement to continue growing over those years.

Well, the real answer is that it depends how long you think you will still be making enough money to live off. If you're living a pretty inexpensive lifestyle, have the house paid off, etc, and you think you'll be making enough to live on when pursuing whatever it is you want to do during FI that brings in money, then you are better off putting as much as you can in the tax-advantaged accounts now. Right now you are paying a TON in income taxes, as a young, presumably single guy. You have a house that nets you some tax deductions but no other dependents, so you are paying a very high rate.

But on the other hand, if you want to stop doing anything money-earning when you hit FI, and do not want to go the SEPP route, I would put more in taxable accounts to avoid the 10% withdrawal penalty.

You might find that a combo strategy works better - save enough in your 401k or IRA now so that you can get a bare-minimum monthly check via SEPP, and then put money into taxable accounts to access if you need it. You're basically making a non-guaranteed annuity out of your IRA.

Using this calculator - http://www.bankrate.com/calculators/retirement/72-t-distribution-calculator.aspx - and a rate of 1.46% return (about the highest the IRS will let you use to calculate your return right now) - you would need about $400k in the IRA in order to get about $1,000 a month as a 40 year old.

So as you are asking our advice, that's what I would do if I were in your shoes - focus on putting all my available funds into the IRA right now to get an SEPP amount I could live on, and then reassess how I feel about working when I get to that number.

J

  • 5 O'Clock Shadow
  • *
  • Posts: 21
Re: When to STOP Maxing Out 401k?
« Reply #13 on: October 13, 2013, 03:51:51 PM »
My employer doesn't match 401k contributions; they simply invest a fixed amount based on my income whether I do or not, and they invest it in a specific fund no matter where I put mine.  Thus, I don't put anything in my 401k, because I want the option of retiring long before I'd be eligible to touch it.  I'm just investing everything directly with Vanguard in funds that don't incur significant tax liabilities.

Khan

  • Pencil Stache
  • ****
  • Posts: 616
Re: When to STOP Maxing Out 401k?
« Reply #14 on: October 13, 2013, 07:26:13 PM »
I don't plan on ever -not- maxing 401k, unless life/circumstances make that harder than it currently is. For one thing, you can take advantage of the ROTH pipeline, and you -need- some form of earned income to deposit into ROTH in the first place. For another, taxes on low income, what almost all mustachians expect, are super low, so why not have -income-(pre-tax 401k balance) post-career?

Also, it makes my net worth go up faster =)