Off To a Good Start - Does a 401(k) Make Sense For Early Retirement?

[JayNYC]

First off, "Hi!" To quickly introduce myself, I'm 22, recently married, and live in New York City. My wife and I are big savers (she converted me), and we hope to be financially free within 15-20 years. Briefly, our current stats:

Combined Salary: $135,000 (as of June, when I graduate and start work)
Cash Savings (in a 5% 6 month CD now): $130,000
Taxable Investment Account: $52,000
Roth IRA: $18,000
Wife's 401(k): $10,000
Total Assets: $210,000
Total Liabilities: $0

Expenses currently run about $24,000/year, leaving us with some serious savings. Invested money is almost entirely in index funds with about 15% in a bond fund. I think that we're on the right track for hitting financial freedom pretty early on.

Anyway, my question:

Does it make sense to fully fund our 401(k) accounts, given that we would have to wait until 59 1/2 to access the cash? Remember, we're 22 and will potentially be FIREd by 40.

(Taking "substantially equal periodic payments" doesn't make sense and I don't know if we want to buy real estate. The potential future value of $31k/year after 15 years is $700k - $900k, a substantial chunk of what we would need for early retirement / financial freedom.) *Please explain your reasons if you vote.*

[Dude]

Do you have decent 401(k) investment options?
Why do you say that SEPP doesn't make sense?
I think you would need more than $900k to retire at 40.

[JayNYC]

Originally Posted by Dude

Do you have decent 401(k) investment options?
Why do you say that SEPP doesn't make sense?
I think you would need more than $900k to retire at 40.

In terms of 401(k) investment options, all I care about is having a low expense ratio index fund available. (So the answer is yes.)

I don't think I thought through SEPP enough. It may make sense after all. I wasn't sure if it would provide enough cash, but it looks like it would actually provide around the same 4% withdrawal that I would be making otherwise.

Of course I would need more than $900k to retire at 40. We would be saving substantial amounts in taxable accounts as well.

[CuppaJoe]

How do you find housing in NYC for less than 2K a month? Student housing? Will you have to move when you graduate? Are you in your grandma's rent controlled apt. like in "Friends." Received a Brownstone as a wedding gift?

Congrats on the great start, new life, new career coming up, and marriage. Welcome to you and DW.

[JayNYC]

Originally Posted by CuppaJoe

How do you find housing in NYC for less than 2K a month? Student housing? Will you have to move when you graduate? Are you in your grandma's rent controlled apt. like in "Friends." Received a Brownstone as a wedding gift?

Congrats on the great start, new life, new career coming up, and marriage. Welcome to you and DW.

Easy, we don't live in Manhattan. We have a nice sized one bedroom in the heart of Riverdale, a middle- and upper- class residential neighborhood in the NW Bronx. It's beautiful, suburban-ish, and 15 minutes from Manhattan by car or subway. Granted we got an amazing deal on it, but we're only paying $1175/month.

Thanks for the kind words!

[Maurice]

Sticking just to the 401k question, I say yes it makes sense, especially if you have an employer match (and even if you don't today you may over the span of your career). The advantages outweigh the restrictions.

This coming from a guy who is (most likely) FIREing by 40....

[sunshine]

Growing tax defered is a big advantage, especially when the government can and does change the tax laws often.

[Abreutime]

Originally Posted by sunshine

Growing tax defered is a big advantage, especially when the government can and does change the tax laws often.

I agree. You can be financially free and retire early with a combined nest egg (401K and taxable) sufficient for your needs, even if neither one is big enough stand alone. After retiring, when you start withdrawing funds for living expenses, you draw from your taxable accounts, and leave the 401k to grow tax free. Why wouldn't you want to accept the free tax breaks? As long as you can build up your taxable accounts to bridge the gap from 40 to 59, you should save in the 401k. You high savings rate leads me to believe that you should be maxing the 401k.

[ziggy29]

Yes, I'd put as much as I could into the 401K, but only after I captured all the company match and then threw $10K for the two of you in a Roth IRA.

[bongo2]

You want to be tax diversified. If you are going to be saving ~$75k a year, then $10k Roth, and $30k 401k still leaves a lot of after-tax savings. When you ER you will likely be in a position to take out much of the 401k at very low rates. Even if you decide to pay the 10% you may still come out ahead.

[Texas Proud]

Not sure where it it.... but if I was in the 15% bracket I would not be funding a 401(k) past the matching...

Since I am in the 28%... I do...

[DblDoc]

I'd max out the 401k and let it grow tax free and compounding for as long as possible.

DD

[jIMOh]

You should be setting aside 20% of income (or more) if you expect to FIR that young. So max out the 401k and the Roth and also open a taxable account too. You'll want all 3 account types set up so you can plan appropriately.

[JayNYC]

Originally Posted by jIMOh

You should be setting aside 20% of income (or more) if you expect to FIR that young. So max out the 401k and the Roth and also open a taxable account too. You'll want all 3 account types set up so you can plan appropriately.

We're saving around 80% of income :-)

[theHundt]

I'm almost in the exact same situation, albeit I'm about 10 years older. My company matches 100% up to 6% and adds an additional 2% for free. I also have a Roth 401k option as of this year. Right now I'm putting 8% into the Roth 401k, company matches 8% into the standard 401k, I'm maxing out my Roth IRA and trying to put 1000 or so a month into a taxable account. I don't see this changing much in the near future other than putting more into the taxable account. My long term goal is to have my roth balance (401k + IRA) about equal to my standard 401k balance, with a taxable account of 25% of that size or so. As I see it, the taxable account need only provide income to bridge the gap to the other accounts and need not survive beyond that so instead of 4% withdrawal rate, I plan to spend it all. I don't think there is really a right or wrong answer here, but at your age I would look for maximum flexibility and have a 401k, Roth, and taxable accounts with a weight towards the tax advantaged accounts. Evaluate your plan yearly and make changes where it makes sense.

[papadad111]

"As long as you can build up your taxable accounts to bridge the gap from 40 to 59, you should save in the 401k."

In general, I agree. But do not ignore funding SOME money into a regular taxable account that you can get to without penalty. In general, given your savings, you'd max out the 401K offered by employer...all the way up to the maximum $15500/year per person especially easy to do now given your income levels, to reduce taxable income and put you in a lower tax bracket.

You could also contribute to Roth IRA and Traditional IRA for some additional pre-tax growth..just watch out as your income grows on the IRS phase-out of those.

But what the finanicial books and advisors dont tell you -- I have seen many folks retire in their late 40's assuming they had enough to bridge the gap to 59 1/2 only to have medical expenses, kids education, etc cause them to not have enough bridge and have to dip into retirement accounts early. That's 20 years. That's a long time. And if your taxable accounts take a dip, say, a 10 year period of stock market malaise and inflation, you might be better off having a bigger available war-chest that does not penalize 10% for early withdraws.

[segfault]

I think you should max out the 401(k) now. You are young and your salaries are likely to increase. Once this begins to happen, you will have money to put into taxable accounts, above and beyond the 401(k) maximum. You can't contribute more than the maximum each year to the 401(k) later, so it makes sense to take advantage of it now.

[Salaryman]

Jay, congrats on the marriage and your economic achievements.
I agree that maxing 401k contributions is a must. At a later point, you can dial down the retirement contributions if you decide that you have too much in the 401k.

I had similar thoughts on FIRE as yourself & have maxed my 401k plan for as long as I can remember.
Fast forward 16 years & 3 kids later, I've come to realize we're gonna need more socked away to do this right.

Good luck.

[CyclingInvestor]

I do not see the problem with SEPPs. I retired in 2006 at 48 with most of my net worth in my IRAs
(99+% rolled-over 401ks). I immediately started the 'simple-to-calculate' method of SEPPing. The 100%
stock allocation there provides more than enough dividends to fund the SEPP (about 3%/year at my age),
which more than replaces my old paycheck (adjusting for health insurance and mortgage payoff). The
$$$ in my after-tax account is for over-runs (surprise car replacement, dog surgery, etc).

Given your after-tax savings rate, you should have no trouble meeting your goals.