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Max Out 401(k) or focus on After tax savings?

Started by nolesrun23, March 20, 2019, 05:26:21 AM

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nolesrun23

Here is my dilemma... I'm 32 years old and I've been making out my 401(k) for the past few years. My goal is financial freedom at a young age. If I can't afford to max out 401(k) and sufficiently fund my after tax savings, which should I focus on? I'm starting to feel that putting so much money away for use at age 59.5 is no longer as important as saving after tax money to invest in passive income generating assets now to reach financial freedom sooner. Thoughts?

RageCage

The compounding value of that money growing tax free cannot be understated.  Continue to max out 401k.  You can always figure out another way to exist on funds and work within a budget until 59.5 comes around.  Your future self will thank you when you are a multi-millionaire...

chrismoneystir

#2
I would max out your 401k. That is what we are going to do. When your income increases, then focus on after-tax investment accounts, including a Roth IRA (if you quality).

You do have the option of going with a 72t to access 401k funds, if that does become a problem. But it sounds complex and hard to setup.

https://www.financialsamurai.com/rule-72t-to-withdraw-money-penalty-free-from-ira-for-early-retirement/

FS post for the FS Forum  ;)

VikingAccounting

I am about the same age facing the same questions these days, but have come up with a slightly different approach than what some of the other samurais seems to be presenting. Let me try to summarize what I am doing and why:

1. Take advantage of your 401(K) match - this one is obvious... free money! My 401(K) account is a traditional not a roth

2. HSA - my employer only offers HDPs so the HSA is a must! More and more employers are moving away from PPOs (sadly but for cost reasons) so having an HSA is a must in my opinion for anyone shoe-horned into an HDP, especially since the spend is truly tax free not even tax deferred. Plus... my employer contributes $1K per year so Im only out $6K every year for the family.

3. Roth IRA contributions - until this point in my career Ive only put money into our (wife and I) traditional IRA accounts, however this year I will take advantage of the Roth (I will cover why below)

4. Investing in non-qualified accounts - when I did a review of my finances earlier this year this is where I identified the largest gap... for me personally at least.

The reason why I think maxing out the 401(K) is a bad idea without leveraging some of the other tools such as Roth accounts and non-qualified accounts are for some of the following reasons:

- Assuming you dont want to work till you're 60, you need income from either non-qualified accounts or other passive sources (real estate, side hustle, blog etc.) to bridge the gap from early retirement till 59 1/2. How much you need obviously depends on your spending needs and wants and the gap you need to bridge to 59 1/2.

- If you happen to have found the dream job and want to keep working till you're 70 your $19K annual contributions (and increasing) in your 401(K) account is going to kick off some really hefty RMDs by that time... given that's all taxed as ordinary income Uncle Sam is going to take a pretty hefty chunk of that.

So I guess in summary, having a combination of roth and non-qualified accounts in addition to your 401(K) can give you some more flexibility in terms of timing your retirement as well as taking advantage of the more forgiving long-term capital gains tax rates (LTCG) and of course having some qualified roth accounts. I would strictly advise against putting all your savings in traditional 401(K) account if you're unable to invest some of your savings in the other two types of investment accounts. These are by no means novel ideas... just my perspective on some of the things I've picked up on doing my own research and evaluating my own situation. The Wealthy Accountant has great write-ups and podcast episodes on this specific topic, especially as it relates to the RMD "issue".

To Financial Independence and Beyond!

Sam

It's definitely a hard dilemma. But the best thing I did was max out my 401(k) for 10 years. I was astounded how much I was able to accumulate in this timeframe thanks to performance and company matching.

Once you have this large chunk of change, you will rest and breathe easier knowing you have this cushion in place. As a result, you'll probably be able to try new things at work or work for different companies in different locations. It's really the peace of mind that counts the most.

Nobody really starts working once they achieve FIRE.
Regards,

Sam

VikingAccounting

Thanks for chiming in Sam!

Do you think the timing of when you max out your 401(k) makes a difference? For example, first 10 years of your career or the "second decade" of your career?  The reason why I ask is... if you happen to ignore any non-qualified or after tax accounts ore towards the middle of your career dont you run the risk of being forced to work closer till you turn 60?

I could see maxing out your 401(K) during your first 10 years (assuming you can) makes total sense, and you've really kick-started your retirements savings however personally I dont seem 100% comfortable sticking most if not all of my savings in the 401(K) approaching 10 years in work... am I thinking of this the wrong way?

And taking the the peace of mind into consideration - would you apply that same logic to a traditional vs. roth IRA? All of these pre-tax accounts will really accumulate when you have another 30 years until you can touch it... i know, good problem to have! :)

chrismoneystir

VikingAccounting: That is an interesting perspective that I didn't think about.

Depending on when you start investing, and when you are shooting to retire, could definitely change the plan of attack. My general goal is to have our 401k get as large as possible while we work, with the idea that it most likely will cover the cost of our retirement from 59.5 and beyond, which in our case would be most of our retirement years. The earliest we would retire would be 45-50 years old, which means we would need to cover 10-15 years either from our Roth IRA contributions or after-tax accounts to get us to 59.5.

I don't really know what the correct answer is in our situation, but since I'm starting in my mid-30's, I want to reduce the amount of our taxable income as much as possible right now (which is in the midrange of 100-200k). The tax benefits during this time I think are worth it, even if it means we have to do some kind of 72t or Roth IRA latter to help cover the time before 59.5.

My gut is that nolesrun23 should take full advantage of the tax benefits in maxing out their 401k and do what they can to increase their income to max out their Roth IRA and then after-tax investment accounts. This should increase the chances that they are able to cover 100% of their retirement years, and they get some tax benefits now. Just my 2cents.

Sam

Quote from: VikingAccounting on May 13, 2019, 12:03:45 PM
Thanks for chiming in Sam!

Do you think the timing of when you max out your 401(k) makes a difference? For example, first 10 years of your career or the "second decade" of your career?  The reason why I ask is... if you happen to ignore any non-qualified or after tax accounts ore towards the middle of your career dont you run the risk of being forced to work closer till you turn 60?

I could see maxing out your 401(K) during your first 10 years (assuming you can) makes total sense, and you've really kick-started your retirements savings however personally I dont seem 100% comfortable sticking most if not all of my savings in the 401(K) approaching 10 years in work... am I thinking of this the wrong way?

And taking the the peace of mind into consideration - would you apply that same logic to a traditional vs. roth IRA? All of these pre-tax accounts will really accumulate when you have another 30 years until you can touch it... i know, good problem to have! :)

Maxing out during a bull market makes the biggest difference. The goal is to get accustomed to living with less b/c you max out your 401k each month/year. Eventually, it's just automatic and you will feel nothing. Then you will optimize your remaining funds for your goals.
Regards,

Sam

VikingAccounting

Quote from: chrismoneystir on May 14, 2019, 05:12:32 AM
VikingAccounting: That is an interesting perspective that I didn't think about.

Depending on when you start investing, and when you are shooting to retire, could definitely change the plan of attack. My general goal is to have our 401k get as large as possible while we work, with the idea that it most likely will cover the cost of our retirement from 59.5 and beyond, which in our case would be most of our retirement years. The earliest we would retire would be 45-50 years old, which means we would need to cover 10-15 years either from our Roth IRA contributions or after-tax accounts to get us to 59.5.

I don't really know what the correct answer is in our situation, but since I'm starting in my mid-30's, I want to reduce the amount of our taxable income as much as possible right now (which is in the midrange of 100-200k). The tax benefits during this time I think are worth it, even if it means we have to do some kind of 72t or Roth IRA latter to help cover the time before 59.5.

My gut is that nolesrun23 should take full advantage of the tax benefits in maxing out their 401k and do what they can to increase their income to max out their Roth IRA and then after-tax investment accounts. This should increase the chances that they are able to cover 100% of their retirement years, and they get some tax benefits now. Just my 2cents.

You're absolutely right... maxing out your 401(K) will certainly provide you the best opportunity to "secure" your years after 59 1/2, I just like to point out that those that are interested in "retiring" prior to that age needs to consider the gap period and how to finance it.

From what I hear other people discuss that have reached FI, very few fully retire, rather than change jobs to a lower hours, find a side hustle, real estate etc. that covers some of your living expenses so it's not all financed through investment portfolios. I am not the best one to answer that question as I havent reached FI yet... working on it though! :)

VikingAccounting

Quote from: Sam on May 14, 2019, 08:01:51 AM
Quote from: VikingAccounting on May 13, 2019, 12:03:45 PM
Thanks for chiming in Sam!

Do you think the timing of when you max out your 401(k) makes a difference? For example, first 10 years of your career or the "second decade" of your career?  The reason why I ask is... if you happen to ignore any non-qualified or after tax accounts ore towards the middle of your career dont you run the risk of being forced to work closer till you turn 60?

I could see maxing out your 401(K) during your first 10 years (assuming you can) makes total sense, and you've really kick-started your retirements savings however personally I dont seem 100% comfortable sticking most if not all of my savings in the 401(K) approaching 10 years in work... am I thinking of this the wrong way?

And taking the the peace of mind into consideration - would you apply that same logic to a traditional vs. roth IRA? All of these pre-tax accounts will really accumulate when you have another 30 years until you can touch it... i know, good problem to have! :)

Maxing out during a bull market makes the biggest difference. The goal is to get accustomed to living with less b/c you max out your 401k each month/year. Eventually, it's just automatic and you will feel nothing. Then you will optimize your remaining funds for your goals.

Good point... timing is key! Unfortunately a decent amount of luck is involved in that piece.

Sam

The longer you contribute, the luckier you'll get.
Regards,

Sam