Max Out 401K? How Much into Taxable vs. Non Taxable?

[Gilberto de Piento]

Assuming you cannot both max out your 401k and IRA space and save for FIRE, what do you do? Unless you are near retirement age, you can contribute $17,500 to a 401k and $5,500 to an IRA for a total of $23,000 in tax advantaged space.

As I am a bit of a Boglehead, the party line there is that you must always fill up your tax advantaged space first before investing in taxable space. I've been thinking about this and I'm not sure it fits into the ERE philosophy unless you make enough to fill the tax advantaged and have plenty left over for FIRE.

Using my personal situation as an example, I currently put $400 per month into my 457b (like a 401k) and save about $1500 per month in taxable (up until very recently this was just going into a savings account, now into an index fund). I've also got around $8800 per year going into a pension (whether I like it or not) so I'm not totally dependent on the 457b in retirement.

If I put the $1500 per month that is going into taxable into tax advantaged I would just be able to max out the 457b and an IRA. I would obviously have more saved when I turn 65 because of the tax break. Unfortunately this would mean I'll never retire early because I won't be able to get that money until normal retirement age.

The truly extreme version of this would be to not use the tax advantaged space at all. If I have enough to retire early, why would I need the tax advantaged money to become available at age 65?

Is anyone else dealing with this same issue? What do you do?

[jacob]

First consider that the typical Boglehead tends to live in the high tax brackets, believe in total return over income, have a spending pattern resembling a coupon-clipping consumer, and think that the early in early retirement means age 55-65; hence their advice of maxing out makes sense from their perspective.

Conversely, if you had a lower income, focused on qualified dividends and never planned to sell your holdings; a lower expense level, and a far earlier definition of "early", then you have somewhat more flexibility. In principle you could buy and hold dividend paying stocks in a taxable account and never pay taxes.

That said, there's rule 72(t), there's the consideration that you only need to save enough money in taxable accounts to last you until age 59.5 (not 65), and that you have considerably more flexibility in a broker account than in a given 401k. Also consider that 401k money is slightly more protected against lawsuits than is IRA moeny and both are significantly more protected than taxable money.

Another thing to consider is that you might not have access to the generous limit of a 401/457 forever and could end up with an employer where you'd have to make do with the much lower IRA limit. For that reason alone I would take full advantage of the 401k limits when I have them. In fact, I asked HR to deduct 100% of my paycheck for my 401k (we live off of passive income) until it's maxed out ASAP for the simple reason that if I get fired (at-will) got as much deduction as I possibly could.

Also consider tax brackets... if you're a typical ERE, you will be in the lowest brackets when you retire. This typically means [almost] no taxes. Hence paying income taxes now will makes you less wealthy than if you could channel pre-tax money in instead. If you're a traditional late retiree (e.g. age 50 and up), a roth may make more sense since you're retirement income will be much higher and it might be better to have it tax free in the future.

Finally, consider that having your money in a tax-deferred account makes many kinds of investments much less of a hassle/cost, e.g. commodity ETFS, REITs, bond funds, ... are easier to deal with without the tax consequences.

The best you can do is to lay out a spreadsheet for each year of your potential future and play around with it. This will require you to learn how the tax system works. That's always a good idea!

[pathguy]

I'd fill up the 401k first. You only need 5 years of expenses in a taxable account. You can then use 72t or Roth conversions to get your 401k money early without any penalty.

Assuming you are in the 25% bracket, you'll save 25% on your 401k contributions. When you withdraw, you'll pay much less on the amount withdrawn. A single person withdrawing 50k pays 11.9% federal, or a married couple pays 7.2%. You'd have to withdraw $240,000 to pay 25% effective tax on the amount withdrawn.

[dot_com_vet]

I max out my 401k and HSA, based on the fact my tax bracket will be lower once I ER.

[Gilberto de Piento]

Thanks for your responses! I'm going to continue this discussion with some spreadsheets on my journal page.

@Jacob: Somewhere I saw a continuum of some retirement pages sorted by something like "extremeness". I've gotten a lot of value out of reading Bogleheads but I no longer think their philosophy fits my goals entirely so I'm trying to do some thinking for myself. Here's the continuum:
Least: Bogleheads
Early-Retirement.org
MMM
Most: ERE

[BennKar]

You should read up more on your 457 plan. My understanding is that 457 plans have one advantage that other deferred compensation plans don't have.... there is no penalty for getting the money out of your account once you have left your employer. Your age doesn't matter. With a 457 plan, if you feel you have enough money at 50 years of age, you can retire and take out what you feel like each year. While I don't plan on early retirement (unless you call 60 early), I max out my 457 monies as I know I can start accessing them right away should I ever have to leave this job.

I don't know the reason for this provision, but I believe it was put in due to the ability of goverment employees to retire early. Here is a link that discusses when you can withdraw this money.

http://www.icmarc.org/products-and-serv ... ation.html

[Tyler9000]

Jacob gives great advice.

When you have a passive investment strategy and your required income is ERE low, federal taxes are basically nonexistent for an early retiree if planned properly. Ordinary dividends and interest are offset by the standard deduction & exceptions, and qualified dividends + long term capital gains (for the total return crowd) are currently taxed at 0% up to $72k as a couple. So tax efficiency is yet one more good reason to minimize spending.

FWIW, when the wife and I pull the ERE trigger it looks like we'll have a little more than 60% in taxable accounts. I won't claim that was part of some grand plan as we basically fell into that distribution for most of our careers, but it does seem to strike a decent balance for us. Not too tied up in tax deferred accounts, but enough to have access to tools we may need later.

[chipmunk]

I work at public university and have access to both a 403b and a 457b. I max out the 457b and put enough in the 403b to get my federal tax liability down to zero. The remainder goes into taxable savings and/or gets queued up for next year's Roth IRA contribution.

Keep in mind that 457b accounts carry the label "deferred compensation" and withdrawals can be made at any age after you leave the employer. For these reasons I like to think of it as a stack of paychecks that I haven't cashed yet. I could cash them now (not contribute to the 457b) and pay income taxes. Or, I could save these paychecks (contribute to the 457b) until I'm in a lower tax bracket. Ideally I will pay zero income taxes on this money because I plan on withdrawing it slowly over several years so that wages+457b withdrawals <= standard deduction + exemptions.

Skipping the taxes with no age requirements was simply too good of a deal to pass up.

[Gilberto de Piento]

@BennKar and @chipmunk:

Holy @#$&! I had no idea that a 457b has different rules than a 401k. I thought there was a big penalty for early withdrawal like the 401k as they are described at work as "just like a 401k". This changes everything! Thanks!