401k vs. taxable account allocation for FIRE

[ekrim]

Hi all,

First post here, looking forward to absorbing this community's wisdom. I'm 30 and my spouse is 33. Our FIRE goal is 2032. We have a current NW of $400k with a goal of at least $1.5MM for FIRE.

I'm having trouble figuring out allocations to/withdrawals from 401k vs. my taxable Vanguard funds. Right now I'm not maxing out 401k contributions/employer match because I'll need the money well before I can withdraw from the 401k penalty- free. Instead I'm allocating primarily to Vanguard. I figure that with Vanguard and 401k combined, I'll have enough to hit our 2032 FIRE goal. However, I'll need enough in the taxable account to hold us over for about 15 years until we can withdraw penalty-free from the 401k. I'm debating whether I should contribute anything to the 401k at all at this point so I can max out the Vanguard fund and just let the existing 401k balance grow until then.

Does this approach make sense? Is there an argument for maxing out the 401k and somehow being able to leverage for FIRE withdrawals? I hate missing out on free money with the 401k employer match, but I don't see how I can achieve our FIRE goal when a significant portion of our net worth would be tied up for at least 15 years after we want to retire.

 

[JoeWras]

We may be seeing more of this kind of question with the new tax rates...

Welcome to the board. You are the second youngster with a similar question recently. You'll find a lot of good advice here. Keep participating!

Anyhow, don't ignore the power of compounding. For the next 15 years, that little bonus from your company match can really compound. Do you really want to give that up? Free money!

I do understand your desire to have that 12 or 14 year cushion to not have to deal with the penalty of early withdrawal. For ER planning, it is wise to think about that, especially for 40-something ERs.

How about this? Is there any expense you have right now you can cut or lower that allows you to do both? (401k and your taxable VG account) What about debt? Don't tell me you have credit card balances. Stop right here if you do and get rid of them. Etc.

Finally, I'll give you a hint you can keep in your back pocket. It is called the 72t rule. There are a few board members here executing this strategy. Should you find yourself in 2032 needing access to that 401k, you can roll it to an IRA and execute a 72t plan. You do get boxed into a very strict distribution. But it is possible to distribute penalty free!

 

[DrRoy]

Determine how much you need for the bridge, and shift your deposits over time to the taxable account so that you can benefit from as much tax free compounding as you possible. You are able to withdraw from a 401K at 55 if you are retired, or at least you used to be able to.

 

[JoeWras]

Determine how much you need for the bridge, and shift your deposits over time to the taxable account so that you can benefit from as much tax free compounding as you possible. You are able to withdraw from a 401K at 55 if you are retired, or at least you used to be able to.

Most plans allow this only if you separate from the company at 55 or beyond. The OP is talking about leaving in their 40s.

 

[NgineER]

Welcome to the forum! You'll find plenty of good advice here.

The following sentence might seem harsh, but I want you to take it to heart.
Do NOT stop the 401(k) contributions! (At least up to the match) If you have a dollar for dollar match, you are losing out on an immediate 100% return on investment, why would you ever want to do that?!
You will have plenty of time hopefully to increase salary and build up after tax contributions as you go along.
Ideally you get a good tax break putting money away into a tax deferred 401(k), since you are targeting retirement on a relatively small nest egg in your mid forties, you will have many years to roll over your tax deferred money into a Roth IRA at very low tax rates.

I would propose that you keep maxing out your tax deferred options now to get the match and tax break.
Investigate whether you can do after tax 401(k) contributions, these can be rolled over to a Roth IRA immediately if your plan allows for it. Contributions can be withdrawn tax free at any time.
Consider building up enough Roth IRA or taxable money to last you five years upon retirement and set up a roth rollover ladder when you retire.

 

[teejayevans]

If I were you I’d try to somewhat balance you funds amounf 401K, Roth, and taxable. This gives you ultimate flexibility to control your income level and taxes. Because you don’t pay taxes on 401K it usually ends up being larger even if putting in equal amounts, but you want some money in the other accounts. So if you retire before 55, you have options...

 

[cusetownusa]

I wouldn't give up tax advantage space because you are worried about accessing the funds. Accessing the funds for an early retirement should be a non-issue.

https://www.madfientist.com/how-to-access-retirement-funds-early/

The tax-advantage space is way to valuable to not max out in-lieu of contributing to a taxable account.

 

[JoeWras]

The following sentence might seem harsh, but I want you to take it to heart.
Do NOT stop the 401(k) contributions! (At least up to the match) If you have a dollar for dollar match, you are losing out on an immediate 100% return on investment, why would you ever want to do that?!

I just took a look at my 401k statement for my current Megacorp, about 19 years or so of contributions.

My company match + growth of that match money is worth $160k. That would be a hell of a lot to ignore. So, yeah, the company match is something one really needs to take advantage of. And my Megacorp only has a middling match. Some matches are outrageously advantageous.

 

[HMMY]

If you can, always max out your 401k and ROTH. If you can't, fund, in order, (1) 401k up to match, (2) ROTH, if eligible (3) balance of 401k, (4) taxable. When you stop working, you can convert your 401k to Roth IRAs annually while you are in very low tax brackets.

 

[ekrim]

Thanks all for the guidance, clearly a consensus on maxing out 401k! (JoeWras - the $160k you threw out definitely helped put this into perspective). I never thought of the concept of funding the "bridge" and the annual Roth rollovers. I'll do some more reading and scenario modeling but in the meantime, I'll re-up on the 401k I've thought a lot about how to save enough and I'm realizing now I've given almost no thought to how you actually withdraw all those savings.

 

[Scuba]

Thanks all for the guidance, clearly a consensus on maxing out 401k! (JoeWras - the $160k you threw out definitely helped put this into perspective). I never thought of the concept of funding the "bridge" and the annual Roth rollovers. I'll do some more reading and scenario modeling but in the meantime, I'll re-up on the 401k I've thought a lot about how to save enough and I'm realizing now I've given almost no thought to how you actually withdraw all those savings.

Great that you’re asking these questions early! I have a slightly different perspective. I do agree that you should at minimum fund your 401K up to the company match at minimum. Never turn down free money. After that, I recommend a balance between taxable and tax deferred. When we ER’d in our mid 50’s, we had about 60% in taxable assets, 15% in employer tax deferred programs that are not IRA’s (mostly deferred compensation), with the remainder in 401K’s and tIRA’s as we weren’t eligible for Roth’s. In addition to having plenty as assets to draw on before age 59.5, this strategy has also resulted in our not having to worry as much about RMD’s (required minimum distributions) as we would have to had we emphasized tax deferred at the expense of taxable. Tax diversification is good!

 

[pb4uski]

What is your tax bracket now? What do you expect it to be in retirement based on your income?

Obviously you want to contribute to your 401k to the extent of any employer match. Beyond that though, it only makes sense if your tax rate in retirement will be lower than your current marginal tax rate... if your income/tax rate will be then same then the tax deferral advantage of the 401k doesn't help you at all.

For those in the new 12% tax bracket a taxable account can be better than a 401k or even better than a Roth... qualified dividends and LTCG are tax free, foreign taxes paid result in a credit, and there are no withdrawals restrictions.

I would fund the 401k to get the match and perhaps to bring you down to the next lower tax bracket if you expect your tax rate in retirement to be lower than your current tax rate.