Thanks to the unrelenting rise in the stock market since 2009, there’s now a trend on social media to share your 401(k) balance, especially if it’s over a million bucks. Despite the distastefulness of bragging, just the fact that more people are talking about saving for retirement via their 401(k) is a good thing.
Make no doubt about it, being a 401(k) millionaire is very impressive given the maximum contribution limit has never been higher than 2018’s contribution limit of $18,500. When I was first able to contribute to a 401(k) in 1999, the maximum contribution limit was only $10,000. Check out the chart below for details.
Here’s When You’ll Become A 401(k) Millionaire
Given we know the various portfolio returns based on asset allocation in my post, How Much Investment Risk You Should Take In Retirement, one can simply do a little math to figure out roughly when someone will become a 401(k) millionaire if they are starting with $0, max out their 401(k) this year and every year after, and return the average annual return of the portfolio composition since 1926.
100% Equity Allocation (10.2% historical return): 401(k) millionaire in 18 years.
80% Equity / 20% Fixed Income (9.5% historical return): 401(k) millionaire in 19.5 years.
70% Equity / 30% Fixed Income (9.1% historical return): 401(k) millionaire in 19.7 years.
60% Equity / 40% Fixed Income (8.7% historical return): 401(k) millionaire in 20.5 years.
50% Equity / 50% Fixed Income (8.3% historical return): 401(k) millionaire in 21 years.
40% Equity / 60% Fixed Income (7.8% historical return): 401(k) millionaire in 21.5 years.
30% Equity / 70% Fixed Income (7.2% historical return): 401(k) millionaire in 22.2 years.
20% Equity / 80% Fixed Income (6.6% historical return): 401(k) millionaire in 23 years.
100% Fixed Income (5.4% historical return): 401(k) millionaire in 25.5 years.
100% Cash (1% assumed return): 401(k) millionaire in 44 years.
Of course, historical returns cannot guarantee future returns, but after a 10-20 year period of investing in your 401(k), your average annual portfolio return will likely begin to mimic the historical averages. Further, if your company provides a generous 401(k) match or profit sharing plan, then it is likely you will become a 401(k) millionaire sooner.
For those readers with more than $0 in your 401(k), simply find an online compound interest calculator and input your data for your specific results. The good thing is, all the numbers above can be considered the maximum longest amount of time it will take to get to 401(k) millionaire status in a normal market.
Let’s say I’m 40 years old with $500,000 in my 401(k) and will max it out every year. I’ve got a 70% Equity / 30% Fixed Income portfolio and expect to earn 9.1% a year based on historical averages. Using a compound interest calculator, I’ll simply input my current principal, annual addition, interest rate, plus a guess number in the Years to Grow field. When the future value equals roughly $1,000,000, you’ll know about how long it will take for you to achieve 401(k) millionaire status.
The Key To 401(k) Millionaire Status Is Longevity
I worked for 13 years for two employers and got my 401(k) balance up to ~$400,000. But once I left my job in 2012, I rolled over my 401(k) to an IRA. If I worked for seven or eight more years, I probably would achieve a $1,000,000 401(k) balance due to strong returns and great company profit sharing. But alas, I’m not a 401(k) or even a rollover IRA millionaire.
The key to 401(k) millionaire status is being able to work at an employer with a great 401(k) plan for as long as possible. The year before I left my employer, I was receiving ~$20,000 a year in company profit sharing.
Therefore, before you decide to leave your cushy job, please first calculate what you are forgoing in company benefits. The same goes for people who are contemplating leaving higher paying, stable jobs to go work for startups which may have no 401(k) plan or most definitely have no 401(k) matching benefit since most startups are loss making.
Let’s review my 401(k) savings targets by age and see when various age groups of savers may become 401(k) millionaires if they are able to work at a job with a 401(k) plan for several decades.
Click to learn more about the methodology
Based on my 401(k) by age estimates, older age savers (50+) should be able to become 401(k) millionaires around age 60 if they’ve been maxing out their 401(k) and properly investing since the age of 23. If not, then best of luck with Social Security, a paid off house, and hopefully after-tax investment accounts.
Middle age savers (35-50) should be able to become 401(k) millionaires around age 50 if they’ve been maxing out their 401(k) and properly investing since the age of 23. I’m expecting to be a 401(k) millionaire when I turn 50 in 2027 by contributing to a Solo 401(k) plan.
Younger age savers (20-34) should be able to become 401(k) millionaires around age 40 if they’ve been maxing out their 401(k) and properly investing since the age of 23.
Loading ...Treat Your 401(k) As An Insurance Policy
According to Vanguard, the average 401k plan balance was ~$100,000 in 2017 and the median 401k plan balance was ~$27,000. If you get to 401(k) millionaire status, pat yourself on the back.
The funny thing about your 401(k) is that it doesn’t really matter if you have millions in your account. You can’t tap the funds without paying a 10% penalty before age 59.5 or doing a Roth conversion and paying taxes, so it’s more like a retirement insurance policy. Further, a better goal might be to not become a 401(k) millionaire because that probably means you spent 18 years or longer working at a day job. What you should really be doing is building up your after-tax investment account aggressively so that you can retire well before you are 59.5.
As you’ve only got one life to live, you might as well figure out a way to escape the grind sooner, rather than later. Not a day goes by where I’m not thankful for aggressively building a portfolio of non-401(k) investments in my 20s and 30s to have the courage to leave my 401(k) behind.
Recommendation: Run your 401(k) through Personal Capital’s 401(k) Investment Fee Analyzer to see how much you’re wasting in fees. I ran mine through and found out I was paying $1,748.34 a year in fees I had no idea I was paying. After discovering how much I was wasting on actively managed mutually fund fees that didn’t have a perfect track record for beating their respective benchmarks, I switched to low cost index fund ETFs. Their Investment Checkup tool also allows you to analyze your investment risk exposure and make appropriate adjustments.
Sam,
I feel you have missed a few points in your initial analysis and while some where pointed out in comments, not all.
First, I may be an odd duck, but I am on track to have pretax accounts well exceeding my peak ordinary income by retirement. And compound that with your strange use of the commutative property. I think a guiding light should be not income when starting out but years of compounding. Without looking up specifics on a compound calculator….. if you expect to pay in $200k to yield, say, $1m… and even at same tax rate, say 20% to make math easier, that means you pay $20k in taxes on contributions and avoid 200-20k or 180k. This simplifies by not accounting for details, but what you ought to compare is avoided tax.
I fully agree that there is risk … who knows what tax rates will exist in the future, but I expect them to rise due to ineptitude as our debt servicing continues to grow.
You also missed another big risk: the USG siezes ALL private retirement funds. Think it won’t happen? Maybe you will be right, but Congress has been discussing it since before I was born. And it won’t be the first to do so if it does happen. With 50-80% of Americans on the road to self-destruction how else will the USG find money to send them in 30 years?
Hi Sam, I am new to FIRE community. First of all, I wanted to thank you for all of your hard work. You have shape and change so many people future and we are very greatful to you. Here is a little bit about me. I am 30 years old and married. I love my job and my goal is do part time job at 53 until 62 and fully retire. I am doing 2 jobs, 7 days a week with average of 65 hrs per week for almost 2 years. I am planning to do that for the next 11 years than move to just 1 full time job until 53. My wife is 24 years old and she is studying while working and make only 28k per year. Our combine income is average about 135k to 140k per years for the past 2 years. I had 88k of students loan and I just pay it off in 18 months by living with my parents but we are planning to buy a house around 250k to 270k at most. After tax and we have about 105k left. Our plan is to invest 10k to my 403b plan, 8k to Roth 403b plan, 11k for our Roth IRA, 5500 for our HSA and 25k for our taxable account per year and 1950 to my wife roth 401k. Our expense is around 41k per years. We contribute total of 60k per year not including any of employer matching. Our networth is low at the moment. I only have 60k in my 403b plan and 401k plan, 8k in my HSA, 14k in my roth IRA, 14k in my wife roth IRA and 10k in taxable account. I know that we suppose to max out our 403b 18500 and our Roth IRA and 50% after tax to our taxable account. I am just confuse about 50% after tax and I seem don’t understand how to calculate 50% of after tax saving to our saving account. If we make 135k per year, after tax 105k and after expense is around 41k and I contribute total of 60k per year which include our 403b plan, can you please tell me what is my after tax saving rate is? If I want to contribute 50% after tax which not including my 403b and Roth IRA, how much should I saving oer year toward my taxable account per year if I wish to do 50% after tax? By the way, our taxable account will stay with Betterment until I retire. Thanks for your help.
Financial Sam community-
I am VERY new to FIRE. Just this Jan 2018, I changed my 401k contribution to try to get the max which until this moment I thought was $18,000? I didn’t understand the post. What is equity/fixed income ratio and the other bit in parentheses?
In my career, I’ve never had access to a 401K. I hope to become a brokerage account millionaire before I become a Roth IRA millionaire. Or maybe a SEP IRA millionaire if I can get my business more profitable.
As I am an expat I can’t take advantage of a 401K. However, i get to avoid other taxes and that lets me save and invest more.
Granted the number of Americans not saving or investing is scary. The few times it has come up I noticed that a lot of my friends and colleagues have little beyond a savings account.
The biggest issue is probably not the amount of a return but a lack of participation by many.
12 more years! But I have a much bigger non 401k balance. Not revealing that though ;)
I’d be interested in computations and time horizons to becoming a retirement account millionaire–but in today’s money! That seems more relevant.
For example, becoming a retirement account millionaire after 44 years has little value. In 44 years a million will be equivalent to 300-350k in today’s money. Kind of pitiful for a retirement account.
Indeed. That’s what the younger, higher end column on the very right is for. Shoot for $5 million or bust!
How old are you and how much do you have in your 401(k)?
Becoming a 401K millionaire is a given if you start early, remain disciplined and dedicate 15% or more of your earnings to the plan. Something that isn’t discussed as often is to know when to back off on tax deferred savings plans. It’s easy to get into a situation where most of your retirement savings is subject to tax upon withdrawal resulting in less spendable retirement income than one might expect. Losing the beneficial capital gains tax treatment in a 401K plan coupled with potentially large required distributions can flip the tax efficiency math in favor of taxable savings at some point. Of course, you should always contribute enough for the free company match.
Hi Sam,
I have been enjoying the bull market for years but all the sudden it feels like dotcom bubble or global financial crisis.
I can’t help but think I should sell all my stock, take the long term capital gains tax hit on long held (10’plus year) stocks and mutual funds rather than ride this down.
Any thoughts? I appreciate crystal ball stuff is tough
Thanks
Randall
I left my employer a few years ago and then once ignored my 401K. Then suddenly a couple of years I realized it. I now manage it more. Last years’s return is 60% without putting a dollar in it. It made up with all the years that I have missed. Agree treating it as an insurance plan.
I’m a little hesitant to comment on this but if it helps encourage someone else then I guess it is worth it. I should begin by saying I am 60 and my wife is 56. Between my wife and I, we have (2) 401Ks over 1M. We had a third over a million but it pulled back to just under a million with the recent market drop. We have 3 other 401Ks that together total ~400K. We have a few other investments that are pre-tax as well, IRAs, deferred compensation, etc.
Our split of investable assets is 54% pre-tax and 46% after-tax so, nearly as much in after-tax as pre-tax. We also have over 1M in Home Equity and a little less than 7 years on our 15-year fixed rate mortgage at 3.5%, which is our only debt. We started with nothing and have built this up over the past 30+ years. The formula is straightforward. We maxed out our 401K every year and stayed invested in index funds through good times and bad. When we each turned 50, we increased to the fully allowed catch up contributions. A long horizon and the magic of compounding yielded our results. And as mentioned, we also were able to make additional regular investments to our after-tax brokerage accounts.
This sounds easy but we made a lot of sacrifices. We both worked incredibly challenging and time-consuming jobs. We only had one child who is now a Freshman in college. She was a blessing and hardly gave us an ounce of trouble which allowed us to both be involved parents and career oriented at the same time. It did involve some time management and each parent sharing the responsibility and working around our travel schedules but we managed to figure it out. It also meant turning down some good career opportunities in order to maintain a manageable balance.
My wife still works and I have been involved with startups as a second career after retiring from my primary career in 2015. Crazy as it sounds, I still worry about our investments and where we are. At this point, I think my main focus is just leaving a strong legacy and a branch of our family tree that has a chance to feed some of our future generations. I feel like our daughter is level-headed with a good dose of common sense and she will be a good steward of our future net worth in the years to come.
I guess you could say we’ve done OK with the “FI” part of financial planning but failed miserably with “RE.” Honestly, I come from a generation where it just never really dawned on me to think about retiring early. However, I take comfort in knowing that my daughter should have that option and she should also always be able to decide what she “wants to do” in life and not what she “has to do” because of money.
Retired now. I am opposite to Paper Tiger. I was good with real estate from my teens, but only woke up to investing in the stock market on my own about 7 years ago (regrettably let advisors do it for me). With real estate, owning a good house in a good neighbourhood that is certain to appreciate, and is also easy to rent (e.g. near a university) to good quality tenants has been my strategy. Rent a suite in the basement to pay the mortgage, keep working up the ladder every 10 years as your equity increases, don’t worry too much about paying the mortgage off, and never be out of the market. This is tax-free capital gain in Canada so it’s a no brainer. Friends who live in smaller communities have much nicer bigger newer houses but sacrifice liveability (my opinion) and lower COL. Yes, I do find it cheaper and healthier to live in a coastal city. No commute, no need to run expensive vehicles, lower utility costs, lower property taxes, better climate, and better, cheaper food.
Paper Tiger – You’ve done really well.
From what you’ve written, it appears you have several 401Ks from prior companies. It was mentioned to me years ago that a 401K has fewer options upon the passing of its owner. You might consider consolidating the 401Ks of companies you’re no longer working for into an IRA. If anything happens to the holder, it can be converted to a stretch IRA by the beneficiary.
I’ve done this with all my 401Ks and have only one traditional IRA statement to look at instead of multiple 401K accounts.
Just a consideration.
Thanks Jim, I agree and I’m looking at that and other options to simplify and make managing things a bit easier.
Between the 2 of us our 401k represents no more than 25% of our portfolio, as you say it’s mainly an insurance policy which we will start tapping at 59.5 to smooth out the taxable income.
We also spent a large part of our careers working in an overseas division which didn’t offer a 401k but instead a generous pension benefit which a total present is hard to quantify into our net worth.
Retired at 56. My contributions to Canadian equivalent of 401k (RRSP) were also less because I had a defined pension (by choice). Any certain income (pensions) is worth a fortune. See Sam’s post on valuing pensions. An insurance policy that allows you to take more risk in other savings.
My policy has been to maximize any tax-sheltered investments and defer tax as long as possible even if I pay more later — as insurance as Sam says although I never thought of it in those terms. But you do not know what your income or assets will be when you FIRE so in that sense maximizing RRSP is insurance in case other sources of income fail.
Good sh*t, Sam. I feel better having read this. :-) I’ve been pretty diligent about socking away at least a percentage equal to the max match my employer gives. Oh, and I’m glad I’ve stuck with the low cost equity set and avoided the cash option. Man. That’s terrible.
Funny. The single most powerful little tool our community has at its disposal (aside from such great blog posts) is that little compound interest calculator. Can’t tell you how often I’ve visited that thing over the years.
You are so right. The ability to look into the future and project finances — even if only understanding compound interest. There is no guarantee of anything but figuring out the possibilities is very motivating.
In Sam’s chart showing getting to $1M after 18 years (100% equities), may I point out that the $1M will double tax-free in the next 7 years (using rule of 72 — 72/10.2%) without further contributions. That is the amazing thing about compounding — and why starting as early as possible makes a vast difference to the outcome. To most readers and commenters of this blog this is elementary but to others not always.
Another possibility would be to withdraw half the profits to live on every year after year 18, e.g. $51,000. and let the rest compound at 5%. Other cash flows for FIRE could be rental of a basement suite in the house, and eventually pensions/social security. The rental and pension income are sure and stable (increasing slightly over the years), and the investment income could fluctuate.
As someone aiming to retire at 60 (I like to enjoy a nice lifestyle and do not wish to aggressively save post tax target 20%), I’m a bit confused about Sam’s comments above regarding the intent of the post. I plan to have about $2M in 401k at that point, and whatever we have in home equity and after tax investments as well. In all likelihood, 401k will be our largest accounts.
I feel like retiring at 60 will be winning, coming from my background of blue collar folks who never retired at all or were constantly worried about losing everything.
If you are happy with your plan and see high likelihood of the plan succeeding, then you’ve won. Congratulations.
One piece of the pie. All those who are able should be taking advantage of a 401(k) as part of their overall plan. I will keep my balance off social media!
Nice article. My taxable account inflow is much more than 401(k). At some point I need invest more into my 401(k). For now I am quite happy with my distribution of money. For me 1 million is yet another number. More than assets I am worried about cash flow and income. I assume a modest returns of 3-4% for my computations. Better to be cautious and overshoot :-)
I shoot low as well. Given where we are valuation wise at this time, that is a really good idea. That way, anything over 3 or 4% is a bonus. I did take an overweighting to EM equities. The valuations are incredibly low. They have had a run up already so I got a bit lucky but I still think it is early days for that reversion.
Im probably the only anti 401k person here but that is because my w2 job does not match so I dont get “free” money and I just cant see how the other benefits are actually benefits. I get that everyone says oh its great for tax savings, but dont you still have to pay the tax when you eventually take it out when you “retire” at some crazy old age of 60 something?
Whats the difference between paying that tax now then later? Im guessing something to do with compounding the original deposits made right?
The other gripe I have about it why in the world should I get penalized for trying to use my own money before a certain age? That just boggles my mind. Its my money!! LOL Not to mention I plan on retiring way before 60s. Probably late 40s I am thinking.
FYI – i have been able to build some decent wealth from sticking to investment properties. That is my thing but I really need to diversify a bit more.
My current plan is to build enough passive income from rental properties and allow that to get me to the point where I am financially free. So far I am making a bit over $3k per month on just cash flow. Still need a bunch more though. And yes I know its not truly passive, but its enough passive in my opinion to be happy.
Rant over! Someone please enlighten me.
:)
There are 2 still benefits
1. You would presumably be in a lower tax bracket when you retire. So, you would rather have the money coming out when the taxes are Lower and take advantage of the tax break when your bracket is higher.
2. You get complete deferral on taxes from any gains, dividends or interest earned and distributed by the funds in a 401(k). Outside of that, it is all taxable. That alone can decrease your return by a lot.
You MIGHT be in a lower tax bracket when you retire.
However a big fat 401k rolled into a traditional IRA will be subject to RMD at age 70-1/2. The RMD could very well push you into a higher tax bracket. Also, the RMD is treated as regular income, so dividends earned along with capital gains within an IRA don’t get the benefit of reduced tax rates.
Uncle Sam (the government one) will love it when I’m 70-1/2 and pay taxes on my RMD.
You also have significant protections on your 401k/IRA in the case of bankruptcy or lawsuits etc.
~T~
One of the best financial moves I have made in my entire life is contributing the maximum possible to my 401k plan. Although in the beginning of my employment I was contributing only 3%, once we were able to satisfy our emergency fund needs, we (wife and I) went ahead and start to max out our contributions. We’ve been very happy with our decision. After I quit my job a few years ago, rolled it over to an IRA account and have been managing it ever since. Wife still works and still doing the maximum contribution.
The strangest things get trendy on social media. At least it’s good to raise awareness on retirement savings because a lot of people really should be saving more!
I completely agree with Sam on this. Take full advantage of a 401(k) especially the match portion but also focus on non-401(k) assets. Up until 2009, we had all of our money tied up in my 401(k), spouses IRA Rollover, her 401(k) and $10,000 in a savings account. I realized the risk of that and vowed to increase my non-retirement assets. I was fortunate because the next 7 years were my highest earning years ever and I took full advantage of that and diversified by adding to taxable assets. Now, my taxable assets represent 31% of my overall portfolio. In 09, it was less than .05%. Both pies grew which was good news.
Still, I find it odd and disconcerting that people are bragging on-line about how much money they have. Yet another contrarian indicator.
Thanks Sam. I will never be a 401K millionaire since my current balance is only about $9000, I will not be contributing the max, my employer only contributes about $800 each year and I only have 4 years until retirement at 48. Even if I include my Roth IRA I will most likely end up with a total of around $400,000 by age 59.5. I haven’t contributed to my Roth in about 6 years and that’s okay because I am ahead of my retirement goals.
About a year ago I decided to estimate what has happened to the first $500 I invested in my IRA in 1997. From 1997 to 2008 not much happened, but it was during this time that I consistently contributed over $2000/yr, so that worked out well. My average return from 1997 until the end of 2016 was 7.2% (pretty convenient – rule of 72). My first $500 was worth about $1874 last year and is now worth about $2226.
Right now I am aggressively paying off my mortgage since that is an important cog in my retirement machine.
I am far from being a 401k millionaire since I left the workforce in my 30s, right before the financial crisis. It’s just as well since I can’t access that money anyway. Many have mentioned the Roth conversion ladder, but if you are going to early retire, hopefully you have built up your passive income to the point where you can’t do the Roth conversion tax free. There hasn’t been a year that I have been able to use the Roth conversion.
Sam,
Perfect timing. Since I have 20 more months to be eligible to retire at 55, it has been a real drag at work to pass the time. So, I need to play mental games to create milestones to distract myself to pass the time.
On the first day of the new year 2018, I actually created a spreadsheet to calculate exactly when I will reach 1M in my 401K just for fun since I was so close. I am such a spreadsheet geek. It will be in Aug 2018 at age 54. Yippee! I have been waiting for this milestone since age 30. Since Jane was laid off, she will reach 1M at the end of 2020 at age 55 if the fixed investments are 4% or greater each year.
We are 500K less than your spreadsheet for age 55 because we started 4 years late and we only invested in 100% fixed interest investments. Also, because of HCE (Highly Compensated Employees), we were never able to max out the 401K until the recent 2-4 years because our salaries were lower. We were subjected to 10% max. We still have no regrets.
Thanks for the charts which are great so that people can see what amt they will expect by investing early.
Adam
I don’t think that it’s necessarily fair to treat it as an ‘insurance’ policy when it’s such a large percentage of people’s portfolio typically. Unless you’re a high income earner, it’s tough to max out tax-advantaged accounts and build a substantial after-tax portfolio. I’m not sure I’d recommend forgoing the tax advantages when there are ways to access that money early.
That being said, if that’s what it takes to motivate you to make more money so you can build up your taxable investments, then good for you. I just don’t know that it’s realistic to expect that to be the case for many, even the financially savvy folks who read your blog :)
I am hoping to be a 401(k) millionaire in my 40’s. We’re well on our way there, and will be maxing from now on so unless the market is terrible it is basically inevitable.
Agreed. I love Sam’s advice and it is a great article, but I simply do not make enough to max out my 401(k) plus save an extra $15K/year in a taxable account.
I just started maxing out my 401(k) two years ago and feel great! I opened a small Roth a few years ago also. Beginning this year, I finally opened a taxable brokerage account and I am excited, but will invest gradually.
Everyone should find a balance and enjoy life, but these are great ideas.
I like your breakdown of how many years to expect millionaire status. It’s interesting that so many personal finance sites tell people to have high fixed income percentages. They are really doing a disservice because they are only focused on risk. Sure your portfolio will be more stable but it will not have the gains possible by mostly equities. It really comes down to how much risk you can tolerate.
My 401(k) balance currently stands at $513K. I started contributing at the age of 25 in 2002, about a couple of years out of college. I’ve been maxing out my contribution for many years, and get a modest company match. At this rate, I expect I would hit $1M by the age of 50, which would put me in the mid-end range of your chart.
Hopefully I’ll be FIRE’d by the age of 45, which means I may not reach that milestone in the expected amount of time.
I actually have an excel sheet on the side that I track my contributions, present, and future with estimated market returns of 6% and 7%. It’s fun to predict when this will happen and motivates you to keep on track! We are losing a bit of money in my wife’s 401k account due to fees and I have to go in and see what I can do to alleviate that.
A reminder, you can tough those funds before 59 1/2 under certain circumstances:
You separate from service at 55 or after
Sep 72t periodic payments
Roth conversions
My 401k + rollover IRA have about $650,000 in them. I’m 44 so it looks like I’m a bit behind on your mid range chart. It took me a few years before I maxed out when I first started working. I think I also stopped contributing for a year or two in the middle. Anyway, I hope to break a million before I’m 55.
I’m not worried about the 10% early withdrawal penalty. We could rollover to Roth whenever our income is low.
“The funny thing about your 401(k) is that it doesn’t really matter if you have millions in your account. You can’t tap the funds without paying a 10% penalty before age 59.5 anyway, so it’s more like a retirement insurance policy.”
That is not true. You could easily, and many do, IRA Ladder it to get access the money well before 59.5. I plan to do this as well from 45-50ish until 59.5. Just need to plan ahead (5 years for each year you would want a distribution before 59.5. I’m sure you’re aware of this, Sam? If not, roll 401k to traditional IRA > roll 1 year of expenses to roth IRA (pay taxes) > withdrawal in 5 years penalty free.
Otherwise good post, Sam! I’m on track for 1mil at 44 (11 years from now).
I really hope people take my message to heart and get out of the mindset of depending on their 401(k) for financial freedom.
Treat your 401(k) like an insurance policy. Know that is there but do not depend on it. Build your after-tax investment account much greater than your 401(k). In 11 years, you’ll be very happy you did.
Related: https://www.financialsamurai.com/disadvantages-of-the-roth-ira-not-all-is-what-it-seems/
I completely agree with you, and am working on that very thing. I just maxed my 401k and working on this next step of building up to saving 20% of after tax income. Would you suggest maxing a roth IRA first and then the brokerage account? Or just straight to the after-tax investment account?
Ideally i’d love to not touch my 401k until 60+ and only take distributions, never principal out.
Would you stop maxing out a 401k once you reach a point where the growth alone will get you to where you need to be for a reasonable retirement? Is it then time to live more in the moment? Or do you remain on autopilot since you’re in a high tax bracket, even if it means you take one less great vacation every year?
My 401k plan has a max of 25% of my gross pay. So, the first 2-3 years, I maxed out at 25% without maxing out the IRS dollar amount limit. So, that limits my contributions a little.
Also, it shows I already took your poll, but my answer changed. I wonder if there is a way to let people update their answers as their 401k balance increases.
“You can’t tap the funds without paying a 10% penalty before age 59.5 anyway“
This is not exactly true. You can roll your 401(k) into an IRA and then do a Roth conversion. That will let you access the converted amounts in 5 years after the rollover.
Sure, there are still flexibility benefits for saving outside of retirement plans. Still, you may not want to pass on the tax benefits of a 401(k) just because you think you can’t access the money until you are 59.5.
Great article, Sam. I’m like yourself in that I have a significant net worth but have not hit 401K millionaire status. However, this has been by design–much like you. I chose to leave formal employment in 2016 and have pumped most of my cash into post-tax investments. I did want to point out that you have a great article about how/when to tap into 401k. I think it’s appropriate to reference in this article as additional insight per comment above.
Best,
Brian
Exactly right. The only reason I’m making out my retirement savings account is because I know the Roth conversion ladder exists.
another option: you can tap your 401k at your employer when you turn 55 if you leave or are let go
Substantially Equal Periodic Payments (SEPP)
The rules for 72(t)/(q) distributions require you to receive Substantially Equal Periodic Payments (SEPP) based on your life expectancy to avoid a 10% premature distribution penalty on any amounts you withdraw. Payments must last for five years (the five-year period does not end until the fifth anniversary of the first distribution received) or until you are 59-1/2, whichever is longer. Further, the SEPP amount must be calculated using one of the IRS approved methods which include:
Required minimum distribution method: This is the simplest method for calculating your SEPP, but it also typically produces the lowest payment. It simply takes your current balance and divides it by your single life expectancy or joint life expectancy. Your payment is then recalculated each year with your account balance as of December 31st of the preceding year and your current life expectancy. This is the only method that allows for a payment that will change as your account value changes. Even though this may provide the lowest payment, it may be the best distribution method if you expect wide fluctuations in the value of your account.
Fixed amortization method: With this method, the amount to be distributed annually is determined by amortizing your account balance over your single life expectancy, the uniform life expectancy table or joint life expectancy with your oldest named beneficiary.
Fixed annuitization method: This method uses an annuity factor to calculate your SEPP. This is one of the most complex methods. The IRS explains it as taking the taxpayer’s account balance divided by an annuity factor equal to the present value of an annuity of $1 per month beginning at the taxpayer’s age attained in the first distribution year and continuing for the life of the taxpayer. For example, if the annuity factor for a $1 per year annuity for an individual who is 50 years old is 19.087 (assuming an interest rate of 3.8% percent), an individual with a $100,000 account balance would receive an annual distribution of $5,239 ($100,000/19.087 = $5,239). This calculator uses the mortality table published in IRS Revenue Ruling 2002-62, which is a non-sex based mortality table. Please note that your annuitized SEPP is based on your life expectancy only, and is not based on the age of your beneficiary.
In addition, on July 3rd, 2002, the IRS ruled that you could change your distribution type one-time without penalty from the Annuitized or Amortized methods to the Required Minimum Distribution method. This would allow account holders the option to move from a fixed payment type to a payment that fluctuates annually with the value of their account. The primary reason for this exception is to allow individuals who have suffered large losses, the option to reduce their distribution to prevent their retirement account from being prematurely depleted. For more information on this important exception please see Revenue Ruling 2002-62 on http://www.treasury.gov.
If payments are changed for any reason other than death or disability before the required distribution period ends, the distributions may be subject to a retroactive application of the Premature Distribution penalty. It is 10% (plus interest) for all years beginning the year such payments commenced and ending the year of the modification. It is important to remember that while 72(t) distributions are not subject to the 10% penalty for early withdrawal, all applicable taxes on the distributions must still be paid. Further, taking any early distributions from a retirement account reduces the amount of money available later during your retirement. Please contact a qualified professional for more information.
~T~
My husband didn’t contribute fully to his 401k until he was almost 27. He made great money…he just didn’t contribute and fought me every step of the way. I think we’re a bit behind. But now we’re turbo charging for the time missed although we all know how powerful that time could be, there’s no looking back now. This year, I think we’re going to pile in $60k not including my own solo 401k.
The original article on 401k millionaires was a bit funny. They gave someone sharing a screenshot of becoming a 401k millionaire on Reddit and called it bragging / looming bubble. The subreddit was r/financial independence…like…they do that all the time on that subreddit, that’s what that sub is all about.
Hello,
My wife and I both went to graduate school and we therefore got a late start on tax deferred retirement savings. Once we started the process, I set a goal of
$10,000 by age 30,
$100,000 by age 40, and
$1,000,000 by age 50.
I’m now between 40 and 50 and will meet the goal but there is risk based on future market returns. The next goal could be $10M by 60, but I can’t figure out reasonable plan to get there.
Wow! $45,575 contribution limit from 1978 to 1981…quickly guessing, that’s probably well over ~ +$200k equivalent today? Time to go google…
On your questions and related points, I like the idea of viewing retirement accounts as insurance vs. seeing them as only a pot of gold toward the end of a long journey.
That said, our 2018 focus areas and beyond for the foreseeable future:
– Taxable Accounts – increase passive income derived from taxable investments vs. non-taxable assets.
– Schedule and Frequency of Distributions – consider obtaining appropriate assets that payout during lower contributing months (NOT: March, June, September, and December).
– Liquidity – continue to be mindful of the massive disproportion of passive income from investment vs. banking/savings accounts.
– Type of Income and Diversification – look for new sources of passive income beyond traditional “portfolio” income.
Thanks for the post. – Mike
Sam, thanks for another great article.
Your table on contribution limits mentions 55k as the limit for 2018 (including company match) but I think this can also include after-tax 401k contributions by the employee. It looks like more companies are offering this option.
I am curious how you think the employee after tax contribution should rank in terms of savings priorities. Does it make more sense to put this money in a taxable account or in a 401k. Seems like a tossup to me and interested in hearing from people here
Thanks again
You asked Sam, but my take on pre-tax (traditional) contributions vs. post-tax (Roth) contributions are:
1) If you’re already maxing at the traditional and want to contribute more, then max into the Roth instead. It’s the same amount of money going in, but Roth being post-tax is like being able to contribute more (by paying the tax on it now instead of later). Also, contributing the same amount in Roth takes more from your paycheck (because you don’t get the tax break during contributions) — so it is very much like putting in beyond the max in a traditional. But the overall value in your 401K has more real value in that it doesn’t have to be taxed when you withdraw.
2) Roth is better if you believe your tax rates will be higher during withdrawal than they are now. Example, if you’re just starting out in your career & you’re in a relatively low tax bracket. If you plan to make so much more later in your career that your 401K will build up enough that your annual withdrawals in retirement will be much higher than your current income, you’d rather pay the taxes now on contributions (Roth) than later when you’re in a higher tax bracket (traditional).
3) Traditional is better if you believe you’re at a high point in your career salary-wise and that you’re income will drop some later when you’re in retirement. But if you think you’re in this situation, to be an apples to apples comparison of Roth vs. traditional you must do the math on the tax break for traditional and increase your contribution accordingly. I.e. — $5,000 annual contribution into traditional is never as good for retirement as $5,000 contribution into Roth. But if you’re in the 22% tax bracket, $5,000 into Roth equals $6,410 into traditional in the long run assuming everything else in your life remains the same (your tax rates won’t change in retirement from what they are now). Only after you make that adjustment to contributions do you get to sit back and compare the two to see which better handles the future changes you expect (i.e. different tax rates in withdrawal from what you pay now).
Roth can be better even if you believe you are at a high point in your tax life if the period of time you are gaining interest is long enough because of the tax free withdraw on the gains.
If you are at the 32% tax bracket and you drop down in the future withdraw period to 22% tax bracket your break even point due to gains:
2.5% gain = 18 years
5% gain = 9 years
7.5% gain = 4.5 years
10% gain = 2.25 years
Those are not taking into account compounding which would drop the timelines further, but I didn’t decide to do the math (probably cuts the longer ones in half).
Also if you FIRE before 59 1/2 and don’t want to mess with 72t withdraws you can get to the principal without penalty on withdraws.
~T~
Sam did a piece on it as well
https://www.financialsamurai.com/?s=72
~T~
Agreed on the pre-59.5 withdrawals from Roth (as long as it’s contribution $). But I believe that’s Roth IRA’s, not Roth 401K’s. I believe Roth 401K’s have the same withdrawal rules as traditional 401K’s (withdraw penalty free after 59.5, withdraw after 55 if it’s the 401K of the last place you worked and you quit after age 55). Maybe I’m wrong.
As far as gains in Roth 401Ks vs. traditional 401Ks goes, I agree with you on an equal dollar basis. But disagree if more was put into traditional 401k because of the tax break on contributions. If the extra in contributions to traditional is of the same proportion as the tax bracket you’re in, then it’s a wash only because the gains are taxed too.
My point about Roth 401Ks being better is that most people don’t go through that math anyway and contribute more to traditional 401K. For instance, I’m a programmer who works among many programmers (all of us math nerds). When I worked among younger programmers many of them asked for advice on things like investing and I was surprised at how few of even my fellow math nerds realized that traditional is only comparable if you increase the contributions to offset the tax break.
Yes, but you have to calculate the tax savings on the regular side and assume you invest that also in a 401k, a NQDC plan or a non-tax sheltered account.
For example, if you are in the 34% marginal bracket now (ignoring state), you can put in $7,575 into a traditional 401k or NQDC plan (or public employee equivs) for the same cost of a Roth 401k. So you have to run the $7,575 for 30 years of gains – expected tax at withdraw time or whatever time vs the $5,000 for a roth. You should never, ever be comparing traditional $5k to roth $5k because that ignores the tax savings on the traditional and its value grown for the same amount of time.
Good article and podcast!
In my opinion, I think most people should skip the after-tax contribution altogether. The main reason is liquidity – you can withdraw the money at any time without paying the 10% penalty on top of whatever taxes you will owe if you use a regular brokerage account. While you could technically withdraw your after-tax contributions tax-free and penalty free, the issue that people will likely run into is their original principal having earned a decent amount money by the time they need to make the withdrawal. If say, when you go to take out the after-tax funds, that the ratio of after tax contributions to the amount that money has earned is 4:1, where the growth represents 25% of the total value, you would be required to pay the penalty on 25% of the money you withdraw. If you’re pretty close to retirement, then I’d say maybe go for it? I guess you could roll it into a tax advantaged Roth when you retire, I’m just too far away from that point in life.
Most companies let you roll After-Tax 401(k) into a Roth 401(k) while you are there (commonly called the “Mega Backdoor Roth”).
I do this twice a year, and it nullifies a lot of the points made above in this thread.
I actually wasn’t aware there was such a thing. That said it does look like it could be a very good reason to make after-tax contributions. It looks like if you need to access your funds before 59.5, and you haven’t had the funds in that account for 5+ years, you’d have to pay a 10% penalty though. Assuming that you wouldn’t have to pay taxes on any capital gains after the rollover (I’m sure this is the case), the 10% penalty is likely more than offset by the tax savings on those capital gains.