Financial Strategy for Early Retirement, New Graduate..

[ebisky]

Hello All,

I am in search of advice related to retiring early. I am currently in my last semester of college and have been interested in personal finance for a few years.

I know the key to retirement is starting early, so that is what I want to do. My plan is to retire between the ages of 40-50. I am confused, however, about how to invest my money to get there. Being that a 401k and IRAs have penalties associated with them when withdrawing before the age of 59.5, I am not sure which route to take to invest my money. Is a SEPP even worth it? I was considering investing up to, but not over my(future) companies 401K match, because it just makes sense regardless if I have to pay penalties on the money when I'm out - it's free $$.

Would investing in a 401k and/or IRA be worth it, if in theory I would be retiring between 40-50 years old? Would the penalties be better than not investing in a 401k/IRA at all? What other investment vehicles could I look into?

Owning real estate is an idea, but one I don't feel up to dealing with at this point in my life.

Also, I never really undestood what was the best way to invest money AFTER retirement? I always assumed to get a fixed far-reaching annuity with all your investments? Are there better ways? You have millions of dollars saved up for retirement, what then? Do you move the investments into something much safer and withdraw whenever you want or do you do something like an annuity and get fixed payments for the rest of your life?

All Ideas Welcome!

-EB

 

[justin]

You are in for a pleasant surprise. Google or search on this board for 72(t) or substantially equal periodic payments as it relates to withdrawing IRA's before age 59.5. I plan on retiring probably late 30's or early 40's, and the substantially equal periodic payments will probably end up being a part of my pre-59.5 retirement funding.

 

[maddythebeagle]

You could also have a portion of you investments in "taxable accounts". A lot of folks here collect dividends and interest for income.

 

[justin]

Holding a good bit in "taxable accounts" is good for the very early ER (30's-40's). You can draw on it whenever you want. If your "substantially equal periodic payments" aren't enough to live on, your taxable account is there for you. Or for one time expenses, like new (used) car, new house, unexpected expenses, etc.

 

[HFWR]

Plus, currently, at least, there's a tax advantage to taking income from dividends and capital gains. Income taken from tax-deferred accounts is taxed as regular income.

 

[Texas Proud]

As Justin said.. you can get some money if you do periodic payments.... but be careful, you need to do it from one 'account'... you need to set it up properly...

ALSO, you can invest in a ROTH and take out your investment without penalty.

 

[justin]

Big advantage of substantially equal periodic payments (SEPP) is that you can roll your 401k into an IRA then SEPP it out over years or decades.

 

[ebisky]

So it would be advisable to invest both in a roth IRA and a 401k if retiring early?

How much should I be investing in the ROTH/401k vs a taxable account?

 

[wstu32]

I think getting a definative answer can only be derived from the research you do.  But the participants on this board have terrific insight and ideas!

God Bless and good luck!

 

[MasterBlaster]

How much should I be investing in the ROTH/401k vs a taxable account?

well the rule of thumb is:

Put as much into a 401k as you can to get the company match. If you will be in a lower tax bracket when you retire (like 10 or 15 percent ) then put as much money in the 401k as you can until you either:

A) hit the 401k investment limit ($15k this year, $20k if you are 50 or older)
B) you reduce your income down to the 10 or 15 percent tax brackets.

If you have more money to invest then put it in an after tax investment that won't throw off alot of (taxable) income and capital gains. ETF's and index funds might be good choices for this money

If you are a very successful investor and will be in a higher tax bracket after you retire then skip the non-matched 401k investment.

For the Roth IRA max it out every year

 

[Nords]

So it would be advisable to invest both in a roth IRA and a 401k if retiring early?

Yup. Take advantage of every low-priced tax deferral you can get.

How much should I be investing in the ROTH/401k vs a taxable account?

well the rule of thumb is:

Put as much into a 401k as you can to get the company match. If you will be in a lower tax bracket when you retire (like 10 or 15 percent ) then put as much money in the 401k as you can until you either:

A) hit the 401k investment limit ($15k this year, $20k if you are 50 or older)
B) you reduce your income down to the 10 or 15 percent tax brackets.

If you have more money to invest then put it in an after tax investment that won't throw off alot of (taxable) income and capital gains. ETF's and index funds might be good choices for this money

If you are a very successful investor and will be in a higher tax bracket after you retire then skip the non-matched 401k investment.

For the Roth IRA max it out every year

What he said. To clarify, the conventional wisdom suggests maxing out the 401(k) match first, followed by the IRA, followed by additional 401(k) as per MB's considerations, and THEN followed by taxable investments.

Keep an eye on expenses. If your low income makes it worth investing in the 401(k) past the match and up to the limits, but your only 401(k) option is a loser fund with a 2% ER, then consider the merits of skipping the 401(k) after the match and just putting your money in a low-cost tax-efficient Vanguard fund.

 

[justin]

Keep an eye on expenses. If your low income makes it worth investing in the 401(k) past the match and up to the limits, but your only 401(k) option is a loser fund with a 2% ER, then consider the merits of skipping the 401(k) after the match and just putting your money in a low-cost tax-efficient Vanguard fund.

What Nords said. Keep an eye on expenses. If your 401k happens to be kick-ass (like my wife's) and you have access to institutional shares of Vanguard funds (for example) with 0.03% expense ratios, then load up on those (if it fits your portfolio allocation).

 

[bongo2]

If you plan on retiring in 20 or even 30 years of working, and getting your nest egg through savings and LBYM (as opposed to fabulous stock options, great success in a small business, becoming a real estate mogul, etc), then you are going to be saving a lot of money.  For example you would pull it off by saving 40% of your after tax income every year and making 7% over inflation on your investments for 20 years.  You could also do it by saving 25% of your AT income the first year, making 7% over inflation on your investments, and getting salary increases 5% over inflation 1/2 of which you save.  Or some other combination.  But however you do it you will be saving a lot of money, well over the amount that you can put into qualified plans, and you will ultimately have to have a significant amount of money in regular taxable accounts.  For this reason I wouldn't worry about putting too much in qualified plans right now.  You have an opportuinity every calendar year to put as much as you can in the qualified bucket.  You can always take it out and lose 10%, but you can't make up for not putting it in later.  In a few years when you're making a lot more and trying to save 2-3x the max for qualified plans you'll wish that you could get more money in there.

I agree with what everyone has said so far. If you are in a low tax bracket right now you should probably put money in your 401k up to the match, then max your Roth, then max your 401k (unless the expenses are really bad), then build some taxable savings.  If you are in a high tax bracket favor the 401k over the Roth. To succeed you will probably need to max out both. Others have mentioned the 72t withdrawals, but even if that doesn't work out for you for whatever reason (and who knows what the rules will be in 20-30 years), the tax savings and tax-free compounding will make up for a lot of the 10% penalty.

One last piece of advice -- don't bit off more than you can chew savings-wise right away.  You're just starting out in the world, and it may cost more or less than you think to live the way you want.  Do your best and see how much you're spending before you make any 30 year plans.

 

[kat]

I haven't had access to a 401k, so I can't offer an opinion on that, other than to say I always maxed my retirement contributions, and still do, as a 43 year old mostly retired self-employed person. (Solo 401k's came along when I was winding down.)

But I totally agree with the above opinions about also maxing the "taxable account", as much as you can.

I have enough in my taxable account to make it an enticing game to see if I can hold off accessing my IRA's early.

Don't rule out being semi-retired, not fully retired, for a few years in your 40's. It can be enjoyable.

 

[ebisky]

Great advice everyone!

I will think more on this and reply with any additional questions. Really appreciate the help. Much of my questions were answered.

Thanks!

-E