I've read in several places that it is a good idea, retirement-wise, to put as much money as possible into one's 401k. One of the (very good) reasons is that apparently some employers match one's contribution.
It sounds fantastic indeed but there's always one thing that I haven't been able to understand. Is it a good idea for early retirement? What happens if you reach your target SWR and want to retire immediately? I guess the plan exists under the assumption that one will only take advantage of it after a certain (old) age, right? So I would assume there are penalties if you for example sell stock from it to pay your expenses. How does this work?
Also, for the knowledgeable non-American crowd, is there something equivalent to this in Europe (with employer matching contributions)?
401k question from a non-American
Re: 401k question from a non-American
In two words.. roth conversion.
Re: 401k question from a non-American
Yes, there is a penalty (10%) for early withdrawals from a 401k or a traditional IRA. Roth conversion is one way to avoid this. But if you're following an ERE lifestyle, you'd still come out ahead even with paying the penalty, since your tax rate while working is high (maybe 30%) and your tax rate while ERE is low (maybe 10%). More details here.
Re: 401k question from a non-American
My plan to use it early:
Roll the 401k into an IRA
Setup a72t against the IRA, this will get me 3% a year at a 15% federal tax rate, no state taxes, no penalty
Convert the IRA to a roth IRA, moving as much money each year as I can while staying in the 15% tax bracket, currently 75k AGI per couple
After 5 years, start withdrawing conversions tax free from the Roth IRA at my SWR
At age 59.5, start taking earnings out of Roth IRA tax free
The number of conversion years will depend to some extent on when/how I can manipulate my adjusted gross income to fall under the ACA health insurance subsidies. I need to do some though, because the 3% IRA withdrawal rate prior to normal retirement age is based on a government formula, using age as an input. I cannot go higher without penalty, but believe my assets support a greater SWR.
Edit - social security and Medicare are taken out before 401k contributions, per the post below. Removed my bad information, thanks for setting me straight.
Roll the 401k into an IRA
Setup a72t against the IRA, this will get me 3% a year at a 15% federal tax rate, no state taxes, no penalty
Convert the IRA to a roth IRA, moving as much money each year as I can while staying in the 15% tax bracket, currently 75k AGI per couple
After 5 years, start withdrawing conversions tax free from the Roth IRA at my SWR
At age 59.5, start taking earnings out of Roth IRA tax free
The number of conversion years will depend to some extent on when/how I can manipulate my adjusted gross income to fall under the ACA health insurance subsidies. I need to do some though, because the 3% IRA withdrawal rate prior to normal retirement age is based on a government formula, using age as an input. I cannot go higher without penalty, but believe my assets support a greater SWR.
Edit - social security and Medicare are taken out before 401k contributions, per the post below. Removed my bad information, thanks for setting me straight.
Last edited by Scott 2 on Fri Nov 25, 2016 11:50 pm, edited 1 time in total.
Re: 401k question from a non-American
You pay social security and medicare taxes on 401k contributions, but not withdrawals.
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Re: 401k question from a non-American
Once you withdraw 401k savings, they’re gone and they can be very difficult to replace. Also as mentioned earlier you will need to pay a 10 percent early withdrawal penalty. You can also go through some alternatives before cashing out 401(k) like you don't necessarily have to leave former company’s retirement plan. Many plans allow former employees to keep their account active even though you can't make any new contributions to the plan. Another option is to roll your old plan into your new employer’s plan. Also review your new plan’s fees, expenses, and investment options and compare them with your old plan and those in an IRA.
Re: 401k question from a non-American
In Europe taxation and pensions are handled by national governments, so there are a lot of different solutions. It's all about understanding your national tax law. They just killed the only deduction you could make here in Sweden($2k a year!). We have a close equivalent to a 401k, but there's not opt-out, you simply choose your mutual funds/annuities.