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Early Retirement Extreme Forums » Money Questions

1. 

   m741
   

   Master
   Joined: Jan '11
   Posts: 733

   What is the ERE position on 401ks, and what percent of salary should go into one vs an investment account? Right now I'm in my early 20s and assuming no changes in my employment status or other major life events, I believe I will be in a position to retire by the time I'm 30.

   As I understand it, you cannot withdraw until you are 55 without paying a 10% penalty, which is a long time for me. I currently put 10% of my salary into my 401k, which is more than my company matches.

   It seems sensible to me to put the money in an account that will be more liquid, unless there's an option to take funds from your 401k without paying a penalty.

   Posted 2 years ago #
2. 

   Chris
   

   Journeyman
   Joined: Jul '10
   Posts: 195

   It depends on your plan, and may be worth it if the benefits outweigh the negatives. If you get a company match, it can be appealing. But if your plan's choice of investments is poor (or expensive) there may not be any real benefit.

   My plan overs a good match, immediate vesting, and very low-cost funds. I see my 401k as an "emergency net" if my ERE money misses projections later in life.

   Posted 2 years ago #
3. 

   M
   

   Journeyman
   Joined: Sep '10
   Posts: 164

   In addition to what Chris said above, sometimes having a 401k has other benefits as well. For example, with my 401k I can borrow money against it and pay back the interest to myself. I've never actually used this feature, nor do I think any ERE type of people would find the need for it, but it's nice knowing that it's there.

   I generally just see my 401k as an additional safety net in case my projections are off later on in life. I invest enough to get the company match and that's all. It's kind of like social security - the only difference is that my 401k might still be here in 40 years or so...

   Posted 2 years ago #
4. 

   akratic
   

   Master
   Joined: Jul '10
   Posts: 480

   If you're alright at math and good at planning, the 72(t) rule allows you to access your 401k money at any age with no penalty at all. For this reason I'd max your 401k contributions, but not everyone agrees on this point.

   Posted 2 years ago #
5. 

   MossySF
   

   Apprentice
   Joined: Nov '10
   Posts: 44

   401K decreases your AGI down where you might qualify for all sorts of tax goodies. You should download a free tax program and test out a few numbers to see what happens.

   Posted 2 years ago #
6. 

   KevinW
   

   Master
   Joined: Aug '10
   Posts: 577

   I second akratic's statement, including the bit about how not everyone agrees.

   Posted 2 years ago #
7. 

   Mo
   

   Master
   Joined: Jul '10
   Posts: 442

   I think the 401k is a great part of an ERE plan, for some individuals. Probably a big determinant of the utility of a 401k vs other options is your income. I don't think too many folks have taken the stance that you shouldn't contribute enough to get the employer match- beyond that is where the decision seems to depend on personal factors.

   Posted 2 years ago #
8. 

   Maus
   

   Master
   Joined: Jul '10
   Posts: 504

   All the posts have highlighted the positives of the 401(k): the employer match, a reduced AGI for tax purposes, and a forced savings vehicle for later life. And while the 72(t) provisions allow for early access, the annual required distribution is fairly small for those who are in their twenties or thirties because it is pegged to your life expectancy. Some plans do not permit loans, or restrict the purposes for one. And the loan has to be paid back within five years.

   So the real issue is whether you will have sufficient funds outside the 401(k) to fund the years of ERE prior to 59.5 years of age, when the 401(k) can be tapped without restrictions or penalties.

   I use both a 401(k) and a taxable account. I have also discounted (using the 10YR T-note rate) the anticipated cash flow of my small pension that begins at 55 and social security beginnning at 62. I plan to spend down the taxable account in the years prior to 60, then rely on a SWR of 3% thereafter on the 401(k) balance.

   Posted 2 years ago #
9. 

   m741
   

   Master
   Joined: Jan '11
   Posts: 733

   Thanks everyone for the suggestions. Seems as though, right now, the middle path I've chosen (full company match + a little more, but not maxed out) is the best option for me, with an eye towards the 72(t) rule.

   One concern there is that it appears the minimum age to take advantage of 72(t) is 35.

   Posted 2 years ago #
10. 

    BennKar
    

    Journeyman
    Joined: Dec '10
    Posts: 144

    If you're concerned about getting to your money earlier than normal from your retirement accounts, perhaps you should split your money between the 401(k) and a Roth IRA. Roth IRA allows for withdrawals of the principle investments (not the growth) without penalty. I have read where you can withdraw the money any time, and other places say you must wait 5 years. In either case, that would be more than soon enough for you. Using the Roth would allow you to add years until you need to get money from the 401(k) monies. The Roth doesn't give you the tax beneift up front, but it does give flexibility, so look into it.

    Posted 2 years ago #
11. 

    F
    

    Novice
    Joined: Jul '10
    Posts: 5

    One concern there is that it appears the minimum age to take advantage of 72(t) is 35.

    There is no minimum age for taking 72(t) distributions, though some online calculators erroneously appear to enforce one. Here's one that allows any age: http://www.72t.net/Sepp/Irc72tCalculator.aspx

    Posted 2 years ago #
12. 

    F
    

    Novice
    Joined: Jul '10
    Posts: 5

    I have read where you can withdraw the money any time, and other places say you must wait 5 years

    Contributions made directly to a Roth IRA can be withdrawn at any time. The 5-year rule here is likely the Roth IRA conversion rule: after a regular-to-Roth IRA conversion, you must wait 5 years to withdraw that money penalty free.

    (There is also another 5-year rule relating to Roth IRAs. You can't withdraw earnings until they've aged for 5 years. See here for a description of both 5-year rules: http://www.money-zine.com/Financial-Planning/Retirement/Roth-IRA-5-Year-Rule/)

    Neither of the 5-year rules should affect you.

    Posted 2 years ago #
13. 

    dragoncar
    

    Expert
    Joined: Oct '10
    Posts: 1,287

    Roth withdrawals are complicated, but here's a summary as I understand it (see http://www.irs.gov/publications/p590/ch02.html):

    Withdrawals are automatically ordered as:

    1) Regular contributions - you can withdraw any amount you have contributed (for which you have already paid tax) at any time, tax and penalty free.

    2) Rollover contributions - you can withdraw any amount rolled over (for which you have already paid tax)

    3) Gains - generally, this will be TAXABLE until you are 59 1/2. However, the penalty for early withdrawal (an extra 10%) is waived for 72(t)-type distributions. Generally, the 5-year waiting periods only come into play when you are over 59 1/2 and want tax-free withdrawals.

    I think in general, if you are touching the taxable (gains) portion of your Roth before 59 1/2, you haven't saved enough for ERE.

    I don't qualify for deductible IRA contributions, so Roth IRA (via rollover loophole) is a no-brainer.

    Edit: Was writing this while Flicken posted. If you look at the interaction between form 8606 and 5329, it appears you only have to pay the penalty on rollover contributions *that are taxable*. Since you've already paid taxes on the rollover (say, 1 year ago), your basis is equal to the contribution, so you won't pay tax again. Note that the rollover contribution would be taxable if it was withdrawn the same year (and you had therefore not paid taxes)... the penalty would apply in this case. I'm not quite sure why they chose 5 years instead of 1.

    Posted 2 years ago #
14. 

    F
    

    Novice
    Joined: Jul '10
    Posts: 5

    If you look at the interaction between form 8606 and 5329, it appears you only have to pay the penalty on rollover contributions *that are taxable*. Since you've already paid taxes on the rollover (say, 1 year ago), your basis is equal to the contribution, so you won't pay tax again. Note that the rollover contribution would be taxable if it was withdrawn the same year (and you had therefore not paid taxes)... the penalty would apply in this case. I'm not quite sure why they chose 5 years instead of 1.

    Hmmm...I wasn't clear on this myself, so I tried to find out. Still not completely sure, but I think you have to pay a 10% penalty on withdrawals from a rollover account within 5 years. This looks like the proper IRS example to look at:

    Example. In April of 2010, John, age 50, rolls over $20,000 from his traditional IRA to a Roth IRA. This is John's first contribution or rollover to a Roth IRA. There is no basis* in the $20,000 rollover. In August of 2010, John withdraws $10,000 from the Roth IRA. When John completes Form 8606 for 2010, he enters $20,000 on lines 16 and 18 of Form 8606, and $10,000 on line 20a and $10,000 on line 20b. Since the $10,000 distribution John received from the Roth IRA is nonqualified, he completes Part IV of Form 8606 and has a taxable distribution of $10,000 on line 36.

    This $10,000 nonqualified distribution is an early distribution subject to the 10% additional tax. When John figures the amount to enter on Form 5329, line 1, he will enter $10,000, the amount from Form 8606, line 36. John does not include on line 1, the $10,000 allocated to Form 8606, line 18.

    If you receive a distribution that is not a qualified distribution, you may have to pay the 10% additional tax on early distributions as explained in the following paragraphs.

    -- http://www.irs.gov/publications/p590/ch02.html#en_US_2010_publink1000256060

    * Wait, what the basis of a traditional IRA account anyway? Oh, here it is:

    Basis. Your basis in traditional IRAs is the total of all your nondeductible contributions and nontaxable amounts included in rollovers made to traditional IRAs minus the total of all your nontaxable distributions, adjusted if necessary (see the instructions for line 2 on page 5).

    -- http://www.irs.gov/instructions/i8606/ch01.html#d0e281

    Hope that helps.

    Posted 2 years ago #
15. 

    dragoncar
    

    Expert
    Joined: Oct '10
    Posts: 1,287

    In that example, he is withdrawing the same year he did the rollover. He hasn't paid taxes on the rollover so he has no basis. Thus, the withdrawal is attributable to income and he pays the penalty.

    If he has waited until the next year, he would have paid the taxes on the rollover already. Then his basis would be 20k (*). If he withdrew the 20k, none would be attributable to income, since it is equal to his basis. The penalty only applies to withdrawals attributable to income.

    Please feel free to disagree... I'd like to be sure this is correct before I rely on it (plus the IRS could always change the forms, right?)

    * edit: see http://www.irs.gov/pub/irs-pdf/i8606.pdf page 10.

    Posted 2 years ago #
16. 

    MossySF
    

    Apprentice
    Joined: Nov '10
    Posts: 44

    Here's a possible plan.

    100% in a 401K. 5 years before your ERE, switch to a new employer. That then let's you rollover your 401K to a IRA where you can start converting to a Roth IRA. That would give you penalty-free Roth IRA money available for withdrawal at ERE.

    After ERE, you rollover your last employer's 401K to an IRA and continually convert every year. And if you are in ERE earning no income, you'd be able to convert a nice sum at 0%. In effect, you've paid no taxes going in and no taxes going out.

    Posted 2 years ago #

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