Planning Phase: 401k vs Taxable Balances

[EvrClrx311]

I wanted to pose a question, in an attempt to calibrate my mind towards an appropriate understand of what works best...

Assuming the goal is to FIRE around the age of 50...
Is there an ideal ratio of 401k vs taxable account values?

I've always had a mindset of getting the 401k as high as I possibly could, but does there come a point where it's better to have invested money other places. I'm not really talking about emergency funds, or cash, but the equity (growth) piece.


I'm currently 35, and have a bit of a unique situation with my job in that they set aside $34,000 a year towards my 401k. I've been putting in $18,000 myself. A total of $52,000 a year. By my math my 401k should get to the $1M mark sometime around age 42, and ideally in the $2M range when I'm 50.

I haven't bothered much in the taxable savings department to date, and was wondering if I should start ramping that up? Obviously, the more invested, the better in the long run... but specifically I wanted to know if it might be better to allocate some or all of that $18,000 away from 401k and into something else? I'd get the $34,000 contribution from work regardless of what I put in. Are there any benefits to having invested wealth outside of the 401k if my goal is to FIRE around 50? More specifically, does the 401k trap you in a way? I only vaguely understand the rules about planning scheduled early withdrawals from 401k... I guess I'd be using that if all my eggs were in the 401k basket and I wanted to Retire at 50.

Appreciate any thoughts or insights people have.

 

[MichaelB]

This will probably get more views and responses in the FIRE and Money forum.

 

[pb4uski]

AFAIK there is no optimal ratio... however since you want to RE at ~50, you need to think through where the money from 50-59 1/2 will come from. One source would be rolling some 401k money into an IRA and doing a 72t SEPP withdrawal plan... you could probably get as much as $85k a year out of that without penalty assuming $2 million at age 50. If you need more than that, or prefer not to do a 72t, then you'll need to have taxable account money or Roth money set up for that period of time.

 

[RunningBum]

I don't think ratio is a valid measure. Too many variables, such as how many years until you can pull from IRA/401Ks, whether you have pensions coming later, how much SS will be, what your expenses are, whether your expenses are evenly distributed over the years, life expectancy, etc. Also some can tap their 401Ks early. With all that I just don't see how it's possible to come up with any kind of X:Y ratio that works for all people.

I would look at how many years you have before you can tap your tax deferred, and what your expected expenses are. Probably need to fudge some for inflation, which is partially offset by investment returns but those will dwindle as you withdraw from your account. Not sure exactly how to do that. If I was going to do it I'd put the numbers in a spreadsheet with a conservative investment return and reasonable inflation rate and play with them to get them to work. Also want to leave some buffer.

If you do some conversions to Roth, after 5 years you'll be able to pull the conversion amounts back out, so that's another way to bridge the gap.

 

[Cobra9777]

I'm not sure there's an "ideal" ratio. Although I think having some tax-related diversity in the nest egg adds draw-down flexibility in early retirement, which seems to be a good thing. I retired at 52 with a 45/55 mix of taxable to tax-deferred. Now 56, we live on taxable, a couple small pensions, and some rental income. I do Roth conversions to the top of the 15% bracket, so taxes are the lowest I've seen since my college days. Depending on when we take SS, we might wait on tax-deferred until 70. If things work out, I'd like to have a balanced mix of taxable, tax-deferred, and tax-free by the time RMDs start.

In our case, except for an emergency fund, we were 100% tax-deferred until our early 40s. At that time, earnings were peaking, kids were moving out, and our capacity to save easily exceeded the contribution limit for two 401Ks. So the taxable account grew very fast, helped in large part by options and RSUs. When I was your age (35), I was also concerned about hitting 50 with nothing but tax-deferred. We just continued to max-out contributions, kept our lifestyle in check, and watched taxable grow at a very nice pace.

 

[jazz4cash]

That's a fantastic match. It's the IRS max for employer contribution. As others stated you need enough to get through to 59.5 and/or use a 72t plan.

 

[bingybear]

It depends. And you need to know Roth/TIRA/after tax. And I agree that there likely is not a magic ratio. It depends what you want to do.
I RE @53 with a mix. I live off of after tax and do Roth Conversions while paying tax for the conversion out of after tax $. How much really depends on spending, conversion plan, health planning, and so on.
you really need some kind of plan not just for pre SS stage, but all the way through RMD time. This is where you do some RE income plan that sets you up for RMDs and beyond

 

[Dash man]

We ended up with about double taxable vs tax deferred. It wasn’t a plan but has worked out nicely. For example we are in the process of buying a home on the Jersey Shore for both rental and personal use. We’re able to pay cash for it without any concern for cash flow. We get rent from one other year round rental and a small pension. Dividends and interest in taxable accounts round out our taxable income. We plan to start some Roth conversions next year, but will likely be in a 25% - 28% bracket. But we need to do something before RMDs start in nine years.
The reason for our large taxable accounts are primarily stock options that did well for us. Some good stock picks helped too.

 

[meierlde]

One of the issues one needs to read the crystal ball about is what is the future of tax rates? The traditional 401k operates on the principal of lower rates after retirement, which was valid in the 80s when the 401k was set up. (max rate was 70% then). There is at least a possibility that long term tax rates could go back up (20+ years) and if that is the case the Roth is the better deal.

 

[JackJester]

2 words: Health Care. Do you have this covered from 50 to 65 (a long time)? This is the biggest unknown. Sure you need both 401K and After Tax to get you to 59.5. And ratio is not what you need to worry about. Its all about making a plan. Use spreadsheets and do lots of FIRE Calc to figure things out. Also, do you have a plan for AA and how that will change over time? Visit portfoliocharts.com. Good luck. I am on track for 4 yrs 2 months to RE at age 55, but I revisit my plan weekly. Planning for RE is a commitment.

 

[bw5972]

I FIRE'd last year at 57. I had built to 25% taxable and 75% 401k. My target was more driven by an amount to have enough taxable to last until I start SS. Hopefully between 62 and 65 depending on the market gods.

 

[bobandsherry]

I retired at 54, coming up on end of my 2nd year. My mix was 33/66 (taxable/non-taxable) balances. However it's more than just the ratio, you have to also have enough savings to cover your expected spend.

 

[NgineER]

I FIRE'd last year at 57. I had built to 25% taxable and 75% 401k. My target was more driven by an amount to have enough taxable to last until I start SS. Hopefully between 62 and 65 depending on the market gods.

Why don’t you start spending down tax-deferred as soon as you can withdraw it. That has no preferential tax treatment in retirement whereas the taxable has advantages.

 

[scrabbler1]

For me, when I retired 9 years ago today at age 45, it wasn't so much a ratio but $x I wanted to have in taxable to get me through to age ~59.5 when the first of my "reinforcements" would become available, unfettered access to my rollover IRA. After that, I would have a frozen company pension and SS available in my 60s. And I would still have my taxable portfolio contributing to my expenses.


The ratio of taxable to tax-deferred on the last day of my employment was 1:2. But I had a one-time chance to move a lot of money from tax-deferred to taxable at low tax rates by cashing out company stock using NUA. This single move, planned well beforehand as part of my ER plan, reversed the ratio from 1:2 to 2:1.

 

[Sunset]

OP- you will need 9.5 years worth of spending in non-taxable accounts like regular brokerage account and ROTH.
The issue for you is that in 15 years you cannot be guaranteed the 72t rule will still apply, and even if it does, it is not convenient.
Besides, having some of your money not in a 401K means less of a tax torpedo at age 70 when RMD's kick in.

 

[BeachOrCity]

Think buckets not ratios.
If you know your expenses think of a taxable bucket of savings until 59.5

After that you should think of tax planning. How can you keep magi low for aca benefits before 65. What about keeping income low so ss is not heavily taxed? Use roth and taxable for that as well as for rmd planning.

 

[ace8]

Sounds like you should be looking at backdoor Roths. You did not mention if your tax differed is all 401K or you have tIRA also. Assuming no tIRA and an ability to fund the cash flow implications, backdoor Roths could be a great option for you.

A couple of big advantages with Roths. Growth is tax free. In a large brokerage account even if equity invested, it will generate ~1.5% in divs per year creating additional tax. In a Roth, withdrawals under age 59 is allowed for contributions. Thus funding your gap years.

 

[Hermit]

I retired at 63 with zero after tax. Any withdrawals are taxed at 25 percent in my case. I don't recommend getting in this situation even after SS starts.

 

[RunningBum]

Sounds like you should be looking at backdoor Roths. You did not mention if your tax differed is all 401K or you have tIRA also. Assuming no tIRA and an ability to fund the cash flow implications, backdoor Roths could be a great option for you.

A couple of big advantages with Roths. Growth is tax free. In a large brokerage account even if equity invested, it will generate ~1.5% in divs per year creating additional tax. In a Roth, withdrawals under age 59 is allowed for contributions. Thus funding your gap years.

A backdoor Roth is a conversion, not a contribution. There is a 5 year wait on getting to conversions in a Roth, as I mentioned in post 4. Still a good option, but don't ignore the difference in rules for withdrawing conversions vs. contributions.

 

[USGrant1962]

I'm not sure there's an "ideal" ratio. Although I think having some tax-related diversity in the nest egg adds draw-down flexibility in early retirement, which seems to be a good thing.

This.

I just retired at 55 with only about 20% in taxable accounts an am finding tax planning to be difficult. For example, it looks like my biggest tax consideration next year will be ACA premium tax credits to the tune of $20K. If I would have to draw most of my spend from tIRA/401(k), I would drive over the cliff.

At the same time, I want to use the next few years to convert to Roth, again being careful not to cost myself $20K in health care premiums. Of course any and all of the current tax structures could change so tax-related diversity is key.

Some posters above have mentioned 33% or 1:2, which feels right to me for ER in your early 50s.

Another consideration is home ownership and/or mortgage. If you think you will pay off a mortgage prior to retirement (to increase your cash flow and take risk off the table) you'll want that money on the taxable side. My 20% taxable would be more like 25% if I didn't pay off the mortgage, but I would have $30K/yr more mandatory withdrawals if I was still paying it.

 

[bobandsherry]

This.

I just retired at 55 with only about 20% in taxable accounts an am finding tax planning to be difficult. For example, it looks like my biggest tax consideration next year will be ACA premium tax credits to the tune of $20K. If I would have to draw most of my spend from tIRA/401(k), I would drive over the cliff.

Yep, that's why I had focused more towards the later part of my career before retirement getting money to taxable. I'm sitting pretty comfortable currently with being able to manage MAGI for subsidy by having after tax money to draw from.

 

[karen1972]

Personally, I split my money into two buckets.

How much did I need from 60+ and get to 100% in FireCalc and put that into my 401k, then how much did I need to get to 60 (in my case 15 years) and put that in taxable.

I'm assuming your in a very high tax bracket currently, so your not likely to be doing any ROTH conversions until you quit work, so you'd need at least 5 years of taxable before you could pull those ROTH conversions out without penalty.

Funding an HSA to me would be a priority if its an option, since you can take that out tax free anytime for medical purposes. I suggest funding it, but not using it while working.

The biggest thing to me was taxes and outlining how each would be taxed and how to get those taxes minimized at every stage. That includes what you invest that taxable money in, since you don't want to be adding to your tax bill while working either via large dividends/cap gains.

 

[RunningBum]

Another consideration is home ownership and/or mortgage. If you think you will pay off a mortgage prior to retirement (to increase your cash flow and take risk off the table) you'll want that money on the taxable side. My 20% taxable would be more like 25% if I didn't pay off the mortgage, but I would have $30K/yr more mandatory withdrawals if I was still paying it.

I look at this totally differently. The OP appears to be looking at being cash poor from 50 to 59.5, then very cash rich. I wouldn't want to use up any more cash then necessary in my 50s, so ideally you'd have as much of your home as you can leveraged with a loan. People can talk all they want about sleeping better with a house paid off, but how about sleeping better knowing you've got your needs met to 59.5, after which you can tap the huge retirement accounts?

 

[RunningBum]

Nobody has asked yet what the OPs current tax rate is, and whether it might be higher in retirement with so much deferred. It might be that not deferring any more than the match is best. We've all been assuming since the deferral amount is so high, the taxable income must be really high, but that's not necessarily true.

 

[whatnot]

To Karen1972 - What do you mean by this statement?
"The biggest thing to me was taxes and outlining how each would be taxed and how to get those taxes minimized at every stage. That includes what you invest that taxable money in, since you don't want to be adding to your tax bill while working either via large dividends/cap gains."
We are in a high tax bracket and have been adding more $$ to after tax accounts. We do max out our 401ks and the cash outside of this is currently sitting in CD's.
I know this is not the best place. So curious how you are trying to minimize your taxes on your after tax accounts. Thanks!