How Much is TOO MUCH in your 401(k)?

For all of its shortcomings, the traditional retire-at-65 system does have a few cushy benefits in the US. You get low-cost health insurance coverage through Medicare, a reasonable pension through Social Security, and you also get to start taking penalty-free withdrawals from your 401(k) plan.

This system was originally designed to accommodate people who would work through their entire adult life, and retire only when they had lost all ability to be productive, presumably to die just a few years later. In fact, the life expectancy of US males only reached age 65 around 1950. (Females reached that longevity in the mid 1940s, and both sexes only a hundred years earlier had expected lifespans of only 40 years!)

Books targeted at today’s Late Retirees (which I define as over 60) speak quite excitedly about the new idea that people get to live for twenty or more years in retirement, and thus the financial planning is much more complicated than it was just a generation ago. So as you can imagine, those of us planning a 50+ year period of retirement need to game the system even more.

This is one of the things about which I get the most email questions. People are asking,

Should I put money into my 401(k) if I’ll be retiring much younger than the standard age? Won’t I be hit with penalties if I try to use the money before then?

Let’s review the basics:

  • Through most jobs, you can contribute to a 401(k) plan – currently $16,500 per year and rising. You might even get a partial or full employer match, depending on how fancy you are.
  • If your employer doesn’t offer this option, you can still contribute up to $5,000 on your own to an IRA account.
  • If you are self-employed, (which I highly recommend!), you can contribute up to $44,000 per year using the SEP-IRA or solo 401k options, and there’s a nice description of their differences here.
  • The government lets you make any of these contributions out of your pre-tax income, so you pay no income tax on that cash, or any of its investment gains over the years. This gives you a big savings boost, which is the whole reason 401(k)s and IRAs are useful.
  • You’ll still have to pay income tax on this money when you eventually withdraw it, but the idea is that you’ll be in a lower tax bracket then.. because you will have quit your job and your only taxable income will be your 401(k) withdrawals.
  • If you try to withdraw the money earlier than age 59.5, you’ll pay the income tax mentioned above, PLUS a 10% penalty on top of it.

Assuming we want to avoid the 10% penalty, we early retirees have a few options.

Strategy 1: Treat the 401(k) as your “Old Man/Old Woman Money”

The idea with this strategy is to throw enough money into the fund, such that it becomes enough to live on for a good 30 years, from age 60 through 90. As a really quick calculation, say that you can live on $30,000 per year in today’s dollars. And assume that you can safely withdraw about 5% per year from your fund from a combination of its investment returns/dividends and a bit of its principal. You would then need $600,000 of today’s dollars, scaled up for inflation to whatever year you reach age 60, to meet that goal.

Let’s say you are 30 now, and you’ve made the maximum contribution each year since graduating at age 21, and thus you have about $144,000 in the account. Let’s also assume your investments can grow at 5% after inflation. What will it be worth by the time you reach 60?

The answer is of course 144,000 x 1.05 to the power of 30 (years).  This is about $622,000 inflation-adjusted dollars (i.e.,  in the year 2041, it will buy you just as much as $622k does today). Since this is more than the $600k we calculated above, it could be said that this person already has TOO MUCH in his 401k, and now he just needs some dough to get him between whenever he retires, and age 60.

This is a simple strategy, and it’s the one I took myself. Mrs. Money Mustache and I both let the 401k contributions run on autopilot when we were working, then promptly ignored them after we quit, where they have since continued automatically generating dividends which are reinvested in more shares every quarter. Besides the 401k contributions, we raked up some additional savings that went towards investments that provide for our current living expenses. Technically, this is sort of double-saving for retirement, but I like to think of it as a nice safety margin that allows you to loosen some of your other assumptions (like using a 5% withdrawal rate above instead of the 4% rule that serves as a general rule for sizing your retirement nest egg.

Strategy 2: Use the Roth IRA Escape Hatch Loophole

Don’t go google searching that term, because I just made it up. But here’s a trick I learned only recently from a fellow blogger named No Debt MBA:

  • Build up your 401k and any other savings, then quit your job to begin retirement – hooray!
  • You are now in a low tax bracket – you can actually roll over a chunk of your 401k into a Roth IRA account and pay income taxes on it at this point.
  • Then you let it sit in the Roth IRA for a minimum of 5 years
  • At this point, you can withdraw all of the principal (but not the gains yet, no big deal), penalty-free!

To be extra fancy, you could just roll over enough to cover your annual spending (say, $30,000) once per year into the Roth account, and pay the minimal income taxes. This would build a 5-year pipeline so that you would be able to withdraw an equal amount from the Roth account each year once you got the pipeline filled out. Of course, you also have to set aside money (or do some part-time work, or pay some 401k early withdrawal penalties) to get you through the first five years while you are waiting for the first batch to finish “fermenting”. But it is still a definite loophole that can help you spring out your 401k money penalty-free.

Strategy 3: Use the Section 72(t) Early Retirement Grocery Money Loophole

The government provides yet another complicated-but-still-useful way to draw a little penalty-free income from your 401(k). You can set up a stream of payments to yourself, called “Substantially Equal Periodic Payments (SEPP)”. The only hitch is that once you start them, you cannot stop them until you reach 59.5 years of age. To determine how much you can get, the government prescribes something called a “reasonable interest rate”, which right now happens to be 1.43%.

The 1.43% number then gets mixed and mashed with some other complicated stuff about principal withdrawals vs. life expectancy. But the bottom line is, for each hundred grand you have in your 401k, your SEPP payment will be about $2900 per year, according to this popular calculator on the subject: http://www.dinkytown.net/java/Retire72T.html. That’s some nice grocery money, but not a full lifestyle amount for most of us.

On the positive side, because you’ll be drawing the money out at such a low rate, the odds are it will grow faster than you use it, leaving you a larger amount to tap more freely once you reach 59.5.

Overall, any of these strategies will work, but the issue remains the same for early retirees – because of contribution limits, your 401k will probably not be large enough to retire on until you’ve made at least 20 years of maximum contributions and seen some investment gains as well. So while I still advise maxing out any tax-deferred savings accounts like the 401k, you’ll also need to invest elsewhere simultaneously. My own strategy was in Vanguard index funds, a paid-off house, and some rental properties, but you will surely find other places depending on your own interests.

Since I’m still over 22 years from 401k eligibility myself, I must admit that I haven’t done a huge amount of research into even more advanced strategies involving tax-deferred accounts. Some of you are masters of this subject, so if you see any errors or omissions, let me know in the comments, and I’ll continually integrate them into the article, so over time we will have a rather kickass “401k for early retirement” article.


  • Matthew November 11, 2011, 7:27 am

    This is an interesting topic. I’m personally not planning on retiring too early (my personal goal is 55). So in the meantime, including employer match, I’m saving around 19% of my gross income in my 401k (which is a Roth option) and maxing out a Roth IRA.

    I’ve been considering lately to reduce the amount I’m personally setting aside since of the 19% being put into the 401k 10 is from me and 9 is from my employer. The idea would be to start long-term investing for home or an even earlier retirement.

    But I do really think that for “super savers” this is a good question. Is ≈ 30% of your income being set aside for retirement too much at the age of 30? Should a larger percentage of that be diverted to non-retirement investing?

    • Free Money Minute February 24, 2014, 11:20 am

      I would say the most you can contribute while still maintaining a reasonable lifestyle. A lot of that depends on your income and how much you are willing/able to sacrifice in order to keep your lifestyle in check. If you make $100k and can live on $30k, go ahead and save 70% as early as you can. You only activate your compound interest machine that much earlier.

      • theFIREstarter February 28, 2014, 6:31 am

        I think the question is more of how much to invest in a 401k and how much to invest outside in taxable accounts (or other forms of investment, property… etc…)

        There will be some sort of theoretical perfect tipping point where you can get exactly the right amount in the 401K when you are 60 to last you for the rest of your life, just as you run out of money in your taxable account, meaning you retired at the perfect and earliest point possible.

        However due to market fluctuations and life circumstances changing, this will never happen exactly how you might plan it, so building in some safety margin into your numbers is clearly advised (not too much though!)

  • Heather November 11, 2011, 8:03 am

    Do you think there’s a reasonable probability that tax rates will rise enough by the time I want to retire, that I’d actually have been better off just paying tax on the money up front? Given government debt problems, it seems that something has to change radically. I am of course, still contributing to my RRSPs personally. Just musing.

    • Mr. Frugal Toque November 11, 2011, 9:04 am

      The top income tax brackets here in Canada are somewhere in the 40 – 45% range.

      Come retirement, Mustachians will find themselves in the $30k income range, where taxes are much lower.

      We’ll still have basic exemptions of (inflation adjusted) $10k or so, which will protect half to a third of your necessary withdrawals from your RRSP (twice that if you’re making sure that half your RRSPs are in a spouse’s name).

      Unless the tax rate on the remaining income, in the lowest bracket, goes to 80% or so, we should all come out ahead.

      • MMM November 11, 2011, 9:37 am

        Thanks Mr. Toque! I fully agree with your analysis.

        Heather’s point is a great one for the traditional idea of a big-spending retiree, like the people who plan a retirement budget of $120,000 per year. In this case, their retirement income might be just as high as their working income. I do believe that the tax rates on higher income brackets are probably going to rise in the coming decades. And maybe somewhat on the middle and even lower income brackets too.

        Another interesting point, however, is that you are both in Canada, which has less than half of the US level of government debt, both on a debt-to-GDP ratio and a debt-per-person basis.

        Part of Canada’s success and the US failure has been caused by rising oil prices and the fact that Canada is a massive net oil exporter while the US is a net importer. If these things continue (which I also expect to happen), Canada’s government will continue to have lots of income and the US will continue to have a disadvantage in the oil-based revenue department.

        Which means you lucky people will take less of a tax hit, because your social programs will be paid for by the polar bears and the ice caps instead of the taxpayers ;-)

        • Megan March 19, 2014, 11:33 am

          I know this article was written a few years ago, but i just spoke with a financial adviser about retiring early (i’m a #2 – will pay off my mortgage in 4 months, no other debts, saving like crazy!) and he mentioned filling a work-offered 457B after doing the minimum of the 401 and 403 to get the matching benefits from my employer (already do!). The 457b is similar to a traditional ira in that it’s tax deferred, but that i can access it penalty free once i quit work. You cannot access it while employed, so part time won’t give you access. You have to terminate employment. But you can get at it right away and you can invest up to $16,500/yr in it too.

          • David August 23, 2015, 4:18 am

            457B is only for government employees.

            • Darin November 28, 2015, 7:57 pm

              Actually, although a 457b is most commonly a government agency program usually referred to as deferred income, there are quite a few non government employers that have 457b programs. But your point is correct – I don’t believe you can request that program from your employer. They either offer it, or don’t. I’m greatful mine does!

      • Vik February 9, 2015, 10:16 am

        Older post, but I thought I would add to the Canadian content.

        I put $$ into my RRSP at 22% – 29% Federal Tax rate [I’ll ignore the Provincial Tax rates as I contributed in 3 Provinces so it gets messy].

        At 60 I’ll be getting ~$8400 CPP [2015$] and 67 I’ll get a total of ~$15,100 [2015$] CPP + OAS.

        Currently the lowest Federal Tax bracket is 15% at $44.7K and below.

        At 71 I’ll have to convert the RRSP to a RRIF at take out ~7% minimum which grows to ~16% over time. If my RRSP is too large I’ll end up being bumped up to a higher marginal rate tax bracket and potentially get some OAS benefits clawed back increasing my effective tax rate two ways.

        It would be most advantageous to keep total income below ~$44.7K to get the biggest tax deferral benefit. At 71 that means $44.7K – $15.1 = $29.6K would be the maximum mandatory withdrawal. That corresponds to a RSSP worth $422K at 2015 $. Although keep in mind each year after 71 I’ll have to take out more $$ and that extra $$ will get taxed at the higher marginal tax rate. So it would be preferable to have shifted to even less RRSP income by this point and more TFSA or non-registered income.

        My RRSP is already projected to exceed that adjusted for inflation so contributing more now will provide a much smaller deferred tax benefit than it did earlier in the program. If I am earning some unexpected income in my older years and/or tax rates go up I could quite possibly pay more tax then I would have if I had simply used the same $ for a non-registered investment.

        There are a couple ways to deal with this:

        1. analyze your income needs over time factoring in all sources of income. Identify any opportunities to harvest deferred tax benefits as you go along and withdraw from your RRSP at that time.

        2. Stop RRSP contributions and max out TFSA accounts and then invest in non-registered accounts.

        For example any year where my taxable income is less than $44.7K it makes sense to withdraw the difference from my RRSP and invest it in my TFSA or non-registered accounts. Say when I am 40 I have one year I travel a lot and only earn $15K from my consulting business [after deductions] I would take $29.7K out of my RRSP that year and see it taxed at 15% which is much lower than the 22%-29% I would have paid when I put the $$ in the RRSP and when I get to 71 I’ll have less $$ in the RRSP and reach a lower mandatory withdrawal rate.

        If my projections for the later years of retirement indicate that mandatory RRSP withdrawals will be in a higher rate than what when I put them even if I jumped up to the 22% marginal rate bracket which is triggered between $44.7K and $89.4K. I might start withdrawing more from my RRSP earlier to optimize the actual taxes I pay.

        Some important RRSP/TFSA tax facts

        – RRSP is a tax deferral account it works best if you are making less $$ when you take the money out vs. when you put it in. If you are in a low tax bracket when you are saving you might be better off to max out your TFSA or invest in a non-registered account paying the tax owed now at the low rate and enjoying tax free income later in life.

        – your RRSP only really works if you put the principal amount [say $1K] AND the tax credit [say $300] into the account. You are going to have to pay that tax later so if you spend the credit now you don’t get the full benefit of the plan.

        – RRSP withdrawals become mandatory ay 71 so check the current rates and model your unavoidable income $$ in the later years to see what will happen.

        – There is no penalty for early withdrawal from a RRSP. There is a witholding tax, but that is just a payment of tax owing to the Gov’t. When you file your return you will use that as tax already paid against the year’s burden. If you take your year’s RRSP withdrawal out in Dec and then file that year’s tax return as quickly as possible the next year you can minimize the amount of time the Gov’t has your money and you do not.

        – you accrue TFSA contribution room every year regardless of income so you can [today 2015] put $5.5K/yr of any RRSP withdrawals into your TFSA to shelter its growth. This money is never taxed again and does not impact any income tested old age benefits.

        – you will pay capital gains tax on income generated from non-registered accounts, but this is at a lower rate than the same gains inside a RRSP get taxed when you take them out [assuming you are earning the same base income at both times.

        Sorry for the long comment, but it’s a topic worth thinking about.

        My summary is:

        – evaluate the income needs for your whole retirement [including CPP + OAS]

        – project your RRSP value throughout your retirement and calculate the mandatory withdrawal income combined with CPP + OAS

        – assess the likely input tax rate vs. output tax rate and use this to identify when it makes sense to put $$ in your RRSP and when to take it out.

        – don’t miss out on opportunities to withdraw from your RRSP early at low tax rates if you have low income year.

        – when you start using your investments to fund your lifestyle consider using RRSP $$ first until your RRSP is projected to provide a tax favourable income stream in your later years combined with CPP + OAS.

        – don’t forget to max out your TFSA account every year to shelter your capital gains

        – Canada has some pretty great retirement savings plans, but they take some analysis of your specific situation to get the most out of them.

        — Vik

        • Lori March 21, 2015, 8:54 am

          Just remember that when you withdraw from an RRSP you don’t get that contribution room back, so you are permanently reducing your contribution limit.

  • Carl November 11, 2011, 8:27 am

    You might want to touch on (or maybe you already have elsewhere) the fact that employee matching in a 401(k) is FREE MONEY! We always like that.

    I work here in Longmont (at an unnamed Turkey plant) and the plan they offer isn’t great, but if you put in a minimum of 5% of your salary, they will contribute a maximum of 4%. So by putting in the 5% I will get a 9% total into my 401(k).

    If I contribute 10%, I would have a total of 14%, and my 10% is pre-tax, so I effectively LOWER my taxable income by that much. This may not mean much to most people, but if that’s enough to drop you into a lower tax bracket, you get a double benefit! Or is it triple?

    1, Lower effective income
    2, Lower tax bracket
    3, Free money (the company match)

    In common urban vernacular: I lurvs me some free monies!

    • Andre (SF) Nader November 11, 2011, 9:43 am

      I also echo the sentiment of encouraging people to at least make contributions up to the match.

      This is stache territory though, I think he assumes we will be doing this already. In fact he actively encourages us to be “maxing out any tax-deferred savings accounts like the 401k”. So I think his bases are covered there.

    • Liz October 17, 2012, 10:39 pm

      That contribution doesn’t drop you into a lower tax bracket because tax rates are marginal meaning the first 15,000 is at 0% the next 10,000 is at 15% and so on (don’t know the exact rates). It doesn’t matter what the tax rate on what you put into your 401k would have been because it’s 0% now. It could help you in the way of not phasing out of certain tax credits though if you keep your taxable income low enough. That’s about it.

      • Bill June 10, 2016, 3:28 pm

        Not sure what you have posted is correct Liz. Between state (California) and Federal, my tax rate for earning an additional $1 (and my top-end dollars) is about 33.4%. So, any dollars I can take off the top save me 33.4% on taxes and may *also* prevent certain credits from being phased out. So, if I max my 401k ($18,000) and contribute $5500 to my wife’s IRA, I save 1/3 of $23,500 or nearly $8000 per year on taxes. It would be hard to safely and consistently earn 33.4% in the stock market (even harder if you have a company match) so I intend to keep this up for quite a while. Only when my pre-tax 401k + IRA savings (i.e. projected balance at retirement after growth) start to hit higher tax rates for minimum withdrawals (a good problem to have), would I consider giving up the pre-tax benefits and switching to a Roth 401k for example.

        Just this year, I realized that I can probably max my pre-tax 401k, yet still contribute $5500 of after-tax dollars to a Roth IRA to start building a tax-free withdrawal ‘stache as well. I had always assumed that it was either / or for 401k vs IRA. However, it is only the deductibility of those savings that is either /or. I could contribute $5500 in after-tax dollars to a traditional IRA, but that would be sub-optimal if I can instead contribute to a Roth IRA. Actually, even if I couldn’t contribute to a Roth IRA (if my income rises beyond the Roth IRA limits), I could just open a separate traditional IRA for after-tax dollars (never commingle pre-tax and after-tax dollars in the same IRA account) and later opt to roll it over to a Roth IRA.

  • akratic November 11, 2011, 9:00 am

    Great article! But you’ve got the maximum withdrawal per year from the 72(t) wrong.

    Use the java calculator in the source you linked to. With a 1.43% reasonable interest rate and $100k in the 401k and an age of 35, you can withdraw up to $2,873/yr (2.87%) if you choose the fixed amortization calculation method.

    Here’s a screenshot I took of the calculator results: http://akratic.com/ERE/72t.png

    • MMM November 11, 2011, 10:11 am

      Isn’t that what I said? “About $3000 per year”? .. or is my figure not precise enough for you? ;-)

      Either way, I am glad you are trying out the calculator since that’s the goal here – to get people to poke around on the Internet and figure out the details of these potential strategies if they are interested.

      • akratic November 11, 2011, 10:21 am

        My bad. Reading comprehension failure. I saw the 1.43% in your post and assumed that was the withdrawal rate, which is actually closer to ~3% right now, as you correctly pointed out.

  • Mike November 11, 2011, 9:39 am

    Vanguard Index Funds are great. Vanguard ETFs may be even better. These are ETF versions of your favorite Vanguard mutual funds, only cheaper. They carry lower fees and if you have your brokerage at Vanguard, you can buy / sell them for $0 in commission. So if you’re into the dollar-cost averaging thing then you can now execute an extreme version of that strategy at Vanguard, buying just a couple of shares every month commission-free. This sounds like a GREAT way for a new investor to start building assets.

    You might also think about rolling any 401k assets into a rollover IRA at Vanguard and investing that into Vanguard ETFs as well. You may be paying unreasonably high account fees in your 401k (these fees seem to be, shall we say, less than transparent), and for passive strategies a few basis points worth of fees every year for 30 years can add up to real money.

    • MMM November 11, 2011, 9:47 am

      Yeah, I have recently switched to buying ETFs for all future purchases as well. Because Vanguard’s regular funds have an annoying habit of delaying your purchase to the end of the trading day, or even the end of the following day. They say they do this to discourage market-timers, but in today’s volatile stock market, I AM somewhat of a market timer. When there is a huge drop like the one on October 3rd, I wake up and make a big transfer out of any cash I have around and into stocks. During my earlier investing years from 1997-2008, drops like this and the subsequent recovery seemed much less common.

      For automatic payroll deductions, you don’t care about this advantage. But even so, if the management expense ratio is even lower with ETFs, I don’t see any disadvantages.

      • Mr. D October 23, 2013, 9:33 am

        To be fair to Vanguard, it’s not like they specifically choose to do it this way. Mutual funds always do all of their transactions are market close; by the security’s structure, you are supposed to receive your shares’-worth of NAV, and NAV is calculated when the market closes. ETFs, by contrast, are priced by bid-ask spreads, which are constantly moving around based on investors’ speculation. In theory, the price of the ETF might actually be lower or higher than NAV, perhaps by a lot. For this reason, while I generally prefer Vanguard’s ETFs compared to their Investor shares for cost, I usually try to use their Admiral shares over ETFs if the cost difference is negligible. I’d rather be guaranteed NAV at the end of the day than roll the dice mid-day and see if I got above/below NAV.

  • Richard November 11, 2011, 9:41 am

    This is a good topic especially for folks that are aggressively saving for retirement. The strategy is different depending on your goals, job, benefits, etc. I think Carl’s point about always taking the 401k match is a good one. Even if you pay the taxes and take the 10% withdrawal hit down the road you will still be in the black because you doubled (or nearly doubled) your money when you made the contribution.

    Also, for those now planning to use money from an IRA before retirement age right now is a good time to convert some of your money to a Roth IRA. First, you can split the amount converted between two years so you aren’t hit quite so hard on the taxes. For instance, if you convert $50,000 you can pay taxes on $25,000 in 2011 and $25,000 in 2012. Remember that this amount is added to your taxable income so plan accordingly. Here is an article on that: http://articles.moneycentral.msn.com/RetirementandWills/InvestForRetirement/best-time-to-convert-to-a-roth-ira.aspx.

    To Heather’s point about paying the taxes upfront instead of when you withdraw it I really think it depends on how much the person is earning now versus how much they plan to earn/withdraw during retirement. If they are earning a high salary now and plan to withdraw small amounts during retirement it would probably be better to pay the taxes later. However, who knows what the tax situation will be in 20 or 30 years. Personally, I contribute to both tax deferred (401k) and taxable accounts (Roth IRA) which equals to a pay some now and pay some later situation.

  • Mike November 11, 2011, 9:46 am

    Timely post!

    I’m going through my numbers, trying to figure out if I’ve amassed enough in my Qualified accounts to stop contributing and focus on my young person retirement plan (though I might keep putting some into my 401k to get the employer match, like Carl mentioned above).

    The current parameters on my spreadsheet are:
    1. 7% return until 60, then dropping to 6%
    2. 1.5-2% inflation of my current expenses (taking into account major changes in the future, eg home paid off in 15yr and no more daycare in ~4 yrs)

    I’m not sure how to deal with the tax changes at this point, so they are included in my current expense figure. But they’d likely go down as we’d be bringing in much less income by then.

    Am I missing anything else?

  • Des November 11, 2011, 10:02 am

    We are maxing out our 401ks as part of our FI plan. Part of the reason for that is taxes – we are making much more now than we plan to spend in retirement. But the other important part of that decision is the protections that retirement accounts have – no one can take that money even if we get sued and even if we go bankrupt. We don’t plan on getting sued or going bankrupt, but those things happen and it is an additional layer of security and piece of mind that I wouldn’t have if I put the money into taxable accounts.

    • Des November 11, 2011, 10:04 am

      Oops, I meant PEACE of mind, not piece of mind ;)

  • B November 11, 2011, 10:03 am

    I think if you have maxed out your other savings and don’t qualify (income to high) for a tax deductible IRA than a Roth is a great place to save. Then once you quit working you can pull out the principal if you want.

    Also worth noting another vehicle you can use to save is and HSA.

    Good point made by Carl above. For every 1k I can shelter I can save $300 in taxes. That’s a pretty good chunk of savings.

    • Gypsy Geek November 11, 2011, 10:22 am

      Yes, an HSA is another neat place to sock money away. For a family, you can put up to $6250/year tax free AND social security AND medicare free. Unlike 401ks and IRAs where you have to pay social security/medicare upfront before putting money away, HSAs allow you to save tax free, SS free, medicare free.

      The trick is to save enough (and no more) to cover for medical expenses you think you’ll have from retirement until age 59.5. You can take the money out before age 59.5 for medical expenses, and then at age 59.5, it becomes just like a 401k/ira.

      Also, if in true mustachian fashion, you choose to get your healthcare across the border, I *believe* you can take money out of your HSA to pay for transportation to that country. Assuming it’s a legitimate medical expense, and it’s going to be at most what you’d reasonably pay in the US. Tax free vacation!

      I’m not 100% sure, but I read the entire IRS rules on HSA last year, and the section on travel was vague enough to allow for travel to medical care– even in another country. Especially, if it’ll be cumulatively cheaper than having the procedure done locally.

      • MMM November 11, 2011, 10:38 am

        WOW!! Those are all things I did not know about the Health Savings Account. I will have to incorporate your wisdom into the article too, Gypsy.

        While we are on a roll here, are there any limitations on how we can invest our savings in the HSA? Can I buy Tobacco and Whiskey company stocks? (haha).

        • Gypsy Geek November 11, 2011, 11:06 am

          The investment variety in an HSA plan lie solely in the plan administrator’s options. For example, my plan does not allow any investment other than money market/CDs until I save at least $10,000. I suppose it’s a way to keep stupid people from investing all their HSA into volatile funds.

          Then after 10,000, you can choose amongst a variety of index mutual funds or bond funds. Although you should probably keep at least your year’s deductible (or max out-of-pocket amount) in a highly liquid format (money market?).

          It depends on the plan. Ideally you want a plan with lots of options.

          It would be interesting to know if HSA plans can be transferred to another provider. I know that after I quit my job, I would like someone like Vanguard to administer it. BTW, I don’t know if Vanguard actually administers HSA’s.

          • Gypsy Geek November 11, 2011, 11:21 am

            OK, I have double checked. In my plan with Chase, you need at least $2000 before you are eligible to invest in anything non-cash, so it’s not too bad.

            There are of course fees, so buyer beware. My Chase HSA charges $2.50/month fo INVESTMENT balances less than $10,000. There is no such fee for keeping the money in cash. You have to do the math and see if it’s cheaper to take the $2.50/month hit if you’re getting more than that in investment returns…until your balance grows to more than $10,000. In my case, I’m stuck with stupid fees, but after the 2nd year I should have $12,000 which should be enough to bypass the $2.50/month fee.

            Assuming mine is a typical HSA, here are typical HSA investment options:

            JPMorgan Prime Money Market Fund – Morgan Shares
            Federated Government Ultrashort Duration Fund
            American Century Diversified Bond Fund
            Russell LIfePoints Conservative Strategy Fund
            Russell LIfePoints Moderate Strategy Fund
            Russell LIfePoints Growth Strategy Fund
            JPMorgan Equity Index Fund
            Royce Premier Fund – Investment Shares
            BlackRock Small Cap Growth Equity Fund
            BlackRock Capital Appreciation Fund
            DWS Global Thematic Fund
            Thornburg International Value Fund

            Unfortunately, most employers do not have options as to who administers your HSA. As you can see, my options suck. Perhaps the equity index fund is the best option.

            • MMM November 11, 2011, 11:45 am

              OK, so it sounds like it is partially controlled by your employer? When I look it up on Vanguard, I see that they do have HSA eligible accounts: https://personal.vanguard.com/us/whatweoffer/overview/healthsavings — but do I understand correctly that not just anyone in any job can open one independently?

            • Jason December 21, 2012, 1:22 pm

              Year late after the fact response… :) I’m just anyone in any job and I opened an HSA. I don’t have health coverage through work so I signed up for a HDHP on my own and set up an HSA.

              I think of it as a retirement savings account that also happens to allow early withdrawals if I have medical needs.

              Since it is not through my employer I only get to deduct for Federal/State Income Taxes, not FICA/Medicare as it is not really pretax, it’s an above the line 1040 deduction

              What I really like is using http://www.hsaadministrators.info/ as mentioned on the Vanguard page as well. They allow investment in Vanguard funds and the fees have been reasonable (not that there is competition since I can’t find anywhere else that offers Vanguard fund investments for an HSA). I just put everything into the total market stock market index, get my tax deduction and stay healthy. Rinse and repeat yearly

            • Mike Racine January 16, 2019, 9:36 am

              Hey MMM—
              My wife and I sold our business, (I’m 49 and enjoying my new-found freedom) and needed someplace to put our HSA accounts. There’s a place we found called livelyme.com that offers a great FDIC insured rate, as well as an investment option through TDAmeritrade. Check it out.

          • Gypsy Geek November 11, 2011, 11:53 am

            That is my understanding, but I’m also new to HSA’s. This is our first year.

            Your employer must provide a high-deductible plan. My employer provides either a high-deductible plan or a traditional plan. Most employers will sweeten the pot by throwing additional money your way to motivate you to switch to the cheaper high-deductible plan. If you are relatively healthy, this make sense: let’s say $20/month instead of $100/month, and the employer throws $800/year into your HSA.

            So yeah, I *think* the HSA provider is completely controller by your employer. It would be interesting to find out if you can transfer it to Vanguard when you retire. I don’t see why not.

            • David February 29, 2016, 8:04 pm

              Comments still going years later…neat.

              Re: Gypsy Geek and Jason above, it’s common for an employer to sponsor both an HDHP and an HSA. Nothing keeps you from setting up either (or both) on your own though, like Jason did.

              If you have the employer option, advantages of using it include:
              -Payroll deduction for automatic contributions.
              -Automatic adjustment to income tax withholding (i.e. less lending to Uncle Sam for 0% interest until tax time, though you can usually request an adjustment to withholding separately)
              -Possible employer contribution to insurance premiums and/or your HSA balance.

              If you change employers (or just find a better HSA plan), you can do a trustee-to-trustee transfer of your HSA balance, similar to moving an IRA.

              Some HSA’s have minimum balances to avoid fees or access investment options (beyond a basic savings account paying almost nothing). So it’s worth comparing what an employer offers to other options out there.

        • BowJoe July 14, 2015, 5:20 am

          Quite a few years after the original post, but another strategy worth mentioning to essentially double your HSA savings. My wife and I contribute the maximum to our HSA every year. (the difference between a HDHP and a comprehensive plan more than makes up for this contribution)

          When paying for qualified medical expenses we use NON-HSA funds and file our receipts. This continues on and on and we have yet to actually need our HSA funds. If we are ever in need of cash (say, early retirement) we can withdraw funds from our HSA at anytime with the receipts as backup for the “reimbursement”. The account stays maxed out and continues to grow. The reimbursements come out tax free.

      • Kurt April 19, 2014, 8:36 am

        For an HSA the is age 65, (not 59.5) before it is converted to “IRA-like” withdrawal process.

  • Gypsy Geek November 11, 2011, 10:11 am

    First, the maximum contribution limit for a solo-401k or SEP-IRA is now 49k, not 44k.

    Second, another benefit to keeping as much as is reasonably possible in your 401k is lawsuit protection. 401k’s are protected from bankruptcy and lawsuits in all states. The money you roll over to a ROTH-IRA has no such protection. If you plan on doing part-time work in retirement in a field that has high liabilities, keeping the money in your traditional 401k may make sense. Yet another reason not to own a car– less chance of getting sued in an accident!

    Third, for folks in high tax brackets (33% and 35%), it may make sense to put the maximum money in 401ks, regardless of if you have enough in it already. If you are in a 33% bracket during your work years, but will drop to the 10% bracket in retirement (*), even with a 10% early withdrawal penalty, you can withdraw money at 10% bracket + 10% = 20%. Twenty per cent is a lot better than 33%!

    This all assumes no state income taxes (there are 7 states that have none). Adjust accordingly for your state.

    I’d love to hear any other tricks. This is all I can think of off the top of my head. Anyone, feel free to correct me if I got the details wrong.

    (*) It is very reasonable to drop to the lowest bracket (10%) in retirement for married couples, because the standard deduction/exemption for couples is about $19,000, and the top of the 10% bracket is $16,700 for a total of $35,700/year. And even junior mustachians can live on $35,700 a year!

    • greatgarlic February 26, 2014, 11:06 am

      I believe there is another option for early withdrawal from a 401K. If you are 55 or older at the time you quit/retired/was fired, you can make early withdrawals from the 401K with that company. So that may be a case to roll over other past employer 401K’s into your retire-from employer 401K, so you have a larger pool of funds for early withdrawal. Here is an excerpt from another site : http://www.401khelpcenter.com/401k_education/Early_Dist_Options.html#.Uw4r84U03IU

      There is an exception to that rule, however, which allows an employee who retire, quit or are fired at age 55 to withdraw without penalty from their 401k (the “rule of 55”).

      There are three key points early retirees need to know. First, this exception applies if you leave your job at any time during the calendar year in which you turn 55, or later, according to IRS Publication 575.

      Second, if you still have money in the plan of a former employer and assuming you weren’t at least age 55 when you left that employer, you’ll have to wait until age 59 1/2 to start taking withdrawals without penalty. Better yet, get any old 401k’s rolled into your current 401k before you retire from your current job so that you will have access to these funds penalty free.

      Third, this exception only applies to funds withdrawn from a 401k. IRAs operate until different rules, so if you retire and roll money into an IRA from your 401k before age 59 1/2, you will lose this exception on those dollars.

    • reader in the rockies July 21, 2014, 10:16 pm

      A 401k, an ERISA account protected from lawsuits, is also protected if you roll over into a rollover IRA. In other words, if the source money was protected from lawsuits, it remains protected if it is rolled over into another retirement account.

      • CapeCoddess April 4, 2016, 10:33 am

        Is this only true if you roll over into a rollover IRA, or does it hold true for funds rolled over into an established trad IRA or ROTH IRA?

  • No Name Guy November 11, 2011, 10:35 am

    Google “IRS Substantially equal periodic payment”

    First link from the results.

    3rd question in the FAQ for the 3 methods. 5th question in the FAQ for the tables. Question 7 for how the payments are determined under the 3 methods.

    MMM: There is also the “required minimum distribution” method that does not require the use of an interest rate. It’s based solely on the account value and your age.

    An example: If the 401k is worth 100k and you’re 35, your life expectancy is 61.4 years. Divide 100k balance by 61.4 = $1,629 required min distribution. Of course, you can take more. For the same 100k for someone who is 55, the life expectancy is 41.6, so the RMD = 100k / 41.6 = $2,404. You use both the current account balance and the current life expectancy each year for the calculation. For the frugal FI / ERE / MMM types, this one (the RMD method) might prove to be the better way to do things – calculate it out for all 3 methods and cherry pick the one that matches your needs / wants / goals the best.

    Also – heck yeah to 401k – my current wage payer matches 75% for the first 8% – which, since I max out, is 6% of the gross pay. Wuhoo! “Free” money (although in reality, it’s simply part of the total compensation package).

  • Gerard November 11, 2011, 10:43 am

    I understand not touching the principal on post-tax investments during retirement (because we’re all so bad-ass that we’ll live to 100-plus), but is it the same for tax-deferred investments? I know in Canada, if you die with money still in your RRIF/RRSP, your estate gets taxed on that money all at once… almost certainly at a higher rate than when you contributed. This is why the Shark people (http://www.milliondollarjourney.com/book-review-why-swim-with-the-sharks.htm) recommend you plan to die broke… mustachians, of course, will also have another reliable income source carrying them through.

    In this case, you’d want an annuity or something to winkle the money out of that account in a reasonable manner… or pick a year or two early into retirement where you earn very little elsewhere, and you pull out a crapload of the principal, just under the amount that pushes you into a higher tax bracket.

    • MMM November 11, 2011, 11:54 am

      I like the idea of dying broke in principle – just because I’m not a big proponent of leaving a large estate to your children and denying them of the pleasure of having to make their own way in life. But on the other hand, there’s no shame in not having spent all your money either. Even if your estate gets taxed, that money is still (mostly) going to support your own society, so it’s just another form of giving your money away to help your fellow citizens.

      • Gerard November 11, 2011, 12:40 pm

        I was gonna say, “Well then, why not just save outside the tax-deferred instrument in the first place, and pay taxes now?” But I think I get your point — this way we make sure we have enough loot to carry ourselves through, and then contribute to society when we don’t need the money any more (due to the whole “being dead” thing).

        • MMM November 11, 2011, 2:29 pm

          Right! .. and to complicate the picture with even more options, I ALSO like the idea of using one’s estate to go directly to the most effective causes, if you happen to be smarter than your own government. For example, about 20% my taxes in the US get wasted on things like unnecessary fighter jet contracts and Iraq. I like my taxes to be spent on education and environmental protection. So I can get a tax deduction for creating a foundation which only gives scholarships and grants to schools, and does something about pollution. Then I can accomplish more social good with the same amount of money. But I also want the government itself to get smarter, so I try to do my part by voting, paying taxes, and maybe even writing this blog, if it helps to influence the votes of other people ;-)

      • JZ December 14, 2011, 12:50 am

        The issue I have with dying broke is that I don’t know how long i’m going to live. My grandmother planned that she would finish her biography, take care of one or two last things, and kick off. She finished her book, took care of that last one or two things, and proceeded to live for ten more years.

        Where would I be if I did all my retirement planning based around burning through the last of my retirement by 90, then managed to live to be 108? In a bit of a pickle, that’s for sure.

        I’d rather just have my principal lined up to go to the causes I believe in, and be ready in case they come up with a miracle longevity treatment while i’m in my old age.

  • Geek November 11, 2011, 10:50 am

    I need to get more Mustachian badassity going on in my life, so I can contribute this 401k money to the early retirement fund. Sigh.

    What are your thoughts on medical expenses (which increase as you age)?

  • TLV November 11, 2011, 11:40 am

    I’m on the fence about this. In the long run it definitely makes sense for me to contribute the max to 401k while I’m working and in the 25% bracket. However, at the same time I’m trying to build assets for short term (<10 year) goals – eg buying a house. 16k in the 401k means 12k less for the house down payment each year, which means waiting a lot longer to buy.

    • Geek November 11, 2011, 1:57 pm

      If I were a paragon of badassity, I’d say you should be saving double your 401k!

      As I’m not, I’ll just say that we’ve been saving for a few years… and in the meantime, we have someone else to fix things in the apartment we live in, so we can concentrate on saving in other areas. We’re looking at a house in another few years perhaps…

      • MMM November 11, 2011, 2:38 pm

        TLV, I actually had the same dilemma in 1999. I really wanted to buy my first house, and the prices were appreciating in my area so I felt like I wanted to lock in before they rose further. So I paused contributions to my 401K until I got the 20% downpayment raked together.

        Looking back, it paid off, because I DID get the house relatively cheap, and later sold it after capturing lots of early-2000s appreciation. Plus, I avoided buying into the 1999-2000 dot-com market peak just before the crash.

        In today’s environment, houses are again really cheap, and will probably start appreciating again after a few more years of the foreclosure hangover. And the stock market is relatively expensive right now as well, meaning you’re not getting a particular bargain with extra 401k investments at the moment.

        Depending on your rent vs. price ratio, the house could actually be a good choice right now. Especially if you lean towards do-it-yourself maintenance instead of expensive outsourcing. Fixing up your own house is actually a second source income, if you eventually sell it and get the profits and repeat the process.

        • Kelly August 4, 2014, 9:44 am

          Would you ever use your 401k to pay off your house? We would have 300k left in our 401k after paying off our 300k house loan? The other option is to pay extra on our house, about 1k per month and just pay the house off early and not touch the 401k.

          • Steve August 21, 2014, 3:12 pm

            Remember, you’ll be hit with a penalty if you withdraw your 401k early. As long as your interest rate is not exorbitant, you’d probably be better off to just pay extra and hold off on the 401k. (Unless you get a match)

            • Nigel April 12, 2016, 1:14 am

              Some plans offer the ability to loan against your 401k that you can use for a first time home purchase. I am allowed to take out a loan of up to 50k or 50% of my total 401k balance (whichever is the lesser), and pay it back over 15 years with 4.25% interest which I pay back to myself into my 401k. The only fees are a $35 origination fee and $15 a year. In a worst case if I quit my job and can’t pay it back within 30 days, I have to take a 10% penalty only on the outstanding principal.

              I also get a match of 50% on up to 15% of my income invested in my 401k, so this seems like a no brainer.

  • Stashette November 11, 2011, 12:36 pm

    Thanks for the great ideas. So far, I’ve been maxing out my Roth and 401k, but I’ve been at a loss for where to put money for early retirement.

    I just recently started maxing out my HSA, which I’m sure will be helpful. I also have a Roth 401k through work, since I’d rather pay the taxes now than during retirement. Of course, the risk is that the tax rate I’m paying now will be higher than during retirement, but then again, taxes will likely go up, too. With a Roth IRA rollover, I can still withdraw these contributions tax free.

    I’d love to get started in rental properties, but the process is a litle intimidating to me. Maybe a few more of your articles will give me courage to jump in.

  • m741 November 11, 2011, 5:49 pm

    I’m happy to see someone else prefers to think about 401ks as “set it and forget it.”

    I contribute 10% of my salary annually. This is enough to get my full employer match and then some, but not to max out my contributions. I then forget about the 401k except to calculate my net worth. I don’t include it in my income, savings rate, etc for monthly statistics.

    Furthermore I don’t even want to think about it until I’m 60 years old. So I ignore it when examining theoretical dividend income, my “early retirement savings” and so forth. My expenses should be sustainable, indefinitely, without dipping into this fund.

    For me, it is purely a ‘safety factor’ for old age – particularly since I don’t know what my health will be like at that point. 60 years old is so far away, and there are so many variables it’s difficult to calculate what I’ll require. But knowing there’s a few hundred thousand hidden away somewhere will make me feel more comfortable.

  • Co November 11, 2011, 10:18 pm

    Your first line indicates you get free healthcare. But in the US, Medicare is not free healthcare. You pay a premium for the coverage, and it is basically a 80/20 plan. If you have any medical conditions this could really add up.


    check it out to see what the monthly premiums are. Not free.

    • MMM November 12, 2011, 12:02 pm

      Thanks, I appreciate the correction.

      It looks like part A, which is the hospital insurance, is “free” because of the premiums you paid throughout your working career. Part B is $99.90 per month and it covers 80% of standard doctor bills and 100% of some other things. So it’s not as good as the Canadian healthcare system, and you are right that of course the costs for an extended medical condition could add up. It’s one of the reasons I advocate a nice safety margin in your retirement savings, and also a reason I recommend staying skinny and healthy through your whole life, to drastically cut down on the risk and cost of health problems later in life.

      • Co November 12, 2011, 8:22 pm

        thank you. Your blog is widely read and everyone should carefully check for themselves what medicare covers, what you would owe if you were hospitalized or had a medical condition before they reach age 65. Even those who take meticulous care of themselves can have an accident or be diagnosed with cancer so it is imperative to make informed decisions.

      • boognish December 6, 2013, 1:23 am

        Two years later but worth noting I think:

        Original Medicare (Parts A & B) do have a 20% coinsurance for many services. However, beneficiaries may enroll in a Medicare Advantage plan, replacing their Original Medicare. MA plans offer far superior benefits (many have no premiums and $0 copays for some services, plus drug coverage) but you are typically limited to an HMO network. The limitations of an HMO network are fine for many Medicare beneficiaries as many are unwilling to travel out-of-network anyways. Find a medical group you like and enroll in a contracted MA plan.

        You’d have to continue paying your Part B premium, but I think it is important to note that Medicare coverage should be far less expensive than 20% copays if you know the system.

  • steveinFL November 12, 2011, 6:28 am

    I might be the only one here not contributing to their 401K. In the late 90s, I contributed to my 401K so I could get an employee match. I think I socked away about 15K in a few years. Unfortunately I also led a very high spending lifestyle which was greater than my income. When the shit hit the fan in 2002, I had to cash out my 401K for living expenses and got hit with the extra penalty fees.

    Fast forward to today when I am just starting to work into a Mustachian life plan. My immediate goals are 1) payoff my 30 year mortgage 23 years early. This could be in ~4 years at my current prepayment rate 2) maintain a 1 year liquid cash fund in case I lose my job 3) prepare to quit working by selectively investing

    I figure the mortgage payoff will provide me with a lot of freedom. I save 6% in interest which is an immediate return. I can sell the house easier if I decide to. And my basic fixed housing costs drop from $2300/month to about $700/month not including all the extras like maintenance and utilities.

    While I hate keeping a wad of cash in a savings account that pays so low an interest rate that it angers me (.1% are you f***ing kidding me?), I’ve had some bad patches in my life and want the security of a year’s living expenses should I need it. I’ll forgo the income potential from the investments for a few more years to avoid the risk that comes with higher potential returns.

    I think I might need to revisit the 401K though. I might be stupid for not contributing to get the employee match.

    • Reverend RobDiesel November 12, 2011, 8:29 am

      Steve – sounds like you’re on the right track. I’ve been mulling over paying my mortgage early, but right now I am about $30 underwater on my mine (house worth $170, I owe $196K) so I am loath to put more money in it if something happens that requires money – when the mortgage is closer to break even, then I’ll start throwing more ‘stash in it. :)
      The second reason is that I am making far more money in the stock market than the 5% interest rate, so for right now, I am letting it ride.

      As for having liquid cash, have you thought of something relatively safe like short-term CDs or something? YOu might earn a little more interest. Every dollar counts.

    • Tom November 12, 2011, 9:23 pm

      Not wanting to advertise, but ING Direct and some other online banks are offering around 1% interest on savings, I think it is slightly higher for checking with large balances. I think it is at .9% right now, if I recall correctly. It still isn’t the 6% it was a few years ago, but it is far better than .1%.

  • anonymous November 12, 2011, 8:28 am

    >> Let’s also assume your investments can grow at 5% after inflation.

    That seems very optimistic. Investments that grow faster than GDP are considered “alpha”, and most people will be lucky to even track inflation, after taxes and fees. An ETF like SPY can grow faster than GDP on a temporary basis, due to P/E expansion (optimism). But given the headwinds of inverted demographics, debt saturation, and peak (conventional) oil, odds are we won’t see SPY continue to throw off huge amounts of free money.

    So this means, if you have $300k in your 401k today, and your burn rate is $30k/year, then that 401k would last 10 years. If decades from now, the 401k “grows” to $1m, chances are, it will still only last 10 years. That is, your future burn rate will be $100k/year. This is not inconceivable if gasoline is $12/gallon, organic cheese is $30/pound, and property taxes are $15k/year.

    • MMM November 12, 2011, 11:45 am

      I agree with your conservative opinion on stock appreciation – except that you’re forgetting DIVIDENDS – your share of earnings, which is the true underlying reason stocks are worth anything. The average “real” (meaning inflation-adjusted) return of the stock market over a long period is equal to real GDP growth (which could be estimated at 3%), plus the dividend yield at the time of purchase. Right now the yield is 2% – not great, but still not to be ignored, since it is 40% of your total expected return!

      Alpha is the term given to the amount by which an investment outperforms the broader index of its asset type, or the overall stock market. Not the amount by which it outperforms GDP.

      As for the headwinds you mentioned – there is certainly a case to be made for slower GDP growth over the coming decades – the standard bear argument. But there’s also an opposing case that the bullish investors like to make. This has been true throughout stock market history, and the battle between these two camps determines the P/E multiple.

      • anonymous November 12, 2011, 6:39 pm

        I am not forgetting dividends. I don’t think a company ROI is any higher just because it pays dividends. Paying dividends just ensures that the company throws off real cash, which keeps management a bit more honest, compared to their pure capital gains competition.

        I haven’t done the math, but I am not sure that companies have been able to grow ROI faster than inflation in the past in the aggregate. If it seems that way, its likely that this was fueled by both P/E expansion, debt growth, cheap energy, favorable demographics. and ever increasing division of labor. All of those things are not in our future.

        On the energy front, in the old days, ROI for liquid fossil fuel was 100. Now its more like 10. And the trend is down. Big Oil gets excited about polar oil, ultra-deep oil, oil sands, shale oil, and corn oil. This implies the supply side is stuck. At the same time, everyone in Asia is getting excited about trading in their bicycle for a Mercedes with a V8 engine. They may have to settle for a Corolla with a 4-cyclinder, but the advancing demand curve is predicable.

        In the world of macro-economics, what happens when a stuck supply curve meets a rapidly advancing demand curve?

        • MMM November 12, 2011, 9:44 pm

          The price goes up, leading to the equally important macroeconomic concept of “substitution”!

          My own call for the next 100 years of economic growth is all of us spending our efforts harvesting the ridiculous amount of free solar energy that is showered on us every day. And converting from an extraction-based economy to a reuse-based one. But I don’t claim to be a better forecaster than anyone else (although I do know more about solar energy than most peak oil doomsayers), so I guess we’ll just have to wait it out and see.

          Note that the comment I made on “stock returns = dividends plus GDP growth” is more or less a studied and accepted economic truth when you are talking about the stock index as a whole. It is because even without ANY economic growth, a chunk of capital has a certain return value when put into use. There is a nice explanation of this math in A Random Walk Down Wall Street.

          I do agree that any stock appreciation beyond this value is due to P/E multiple expansion, and I also agree that this is why the stock market did better than GDP from 1950-2000 (http://www.multpl.com/) – and it’s also why our stock prices have gone down even as earnings have gone up since 2000.

          Also, why am I having this conversation with someone who doesn’t even have a name!? Make up a cool username for yourself, dude, and add a nice Gravatar picture too. Mr. Money Mustache is a sociable place! We’re all drinking beer while we’re writing these comments!

          • Tails January 14, 2012, 3:59 pm

            I’ve read that the reason stocks return more than GDP growth is that only half of the US economy is represented by public companies. Apparently, the public companies average out the less profitable small businesses and households.

  • Bill November 12, 2011, 11:28 am

    I contribute only enough to get the employer match (5%/4%). At 27 I have no idea what kind of tax bracket I will be in when I am in my 60s so it is hard to say if additional contributions will result in a lesser tax liability in the long run. What I do know is I can get immediate return on paying down student loans faster or pushing the money into rental properties. Given all of the management fees in my 401k I think I can get a better return investing the money myself (rental properties).

    On the other hand…

    Speaking of employer contributions: These do no count against the $16,500 limit but the total of all employee contributions, employer match, profit sharing cannot exceed $49,000 in 2011 (assuming your compensation is greater than this amount). Obviously this far exceeds typical matches on normal income levels. Has anyone investigated if it would be worthwhile for both the employee and employer to adjust the compensation package for a year or two to total boost 401k contributions?

    For instance, on a $100,000 normal salary could one have their employer change their standard salary to $80,000 + $20,000 401k contribution?

    I haven’t looked into this at all. What are the advantages / disadvantages?

    • Reba August 6, 2014, 10:46 pm

      I like this idea. Did you ever find out any information on it?

      • TFrugal February 7, 2018, 12:34 pm

        Employers have to follow their Plan Documents that are subject to ERISA. They cannot unilaterally change their match formulas for individual employees.

  • jessica w. November 12, 2011, 9:46 pm

    I work for a non profit that doesn’t offer a 401K, the hubs and I are planning on maxing out each roth IRA for the year,but is there a way to set up a 401k by myself?

    • Gypsy Geek November 13, 2011, 10:01 am

      I am not an expert, but it is my understanding that setting up a solo 401k is only for the self employed. When I set one up, I had to do so by getting an employer social security number. So, unless you are getting paid as an independent contractor through a 1099, you have to depend on your employer.

      Again, this is my understanding.

      • jessica w. November 13, 2011, 1:57 pm

        That is what I thought. Thanks!

      • Elle January 5, 2018, 7:37 am

        Much later, sorry, but any recommendations if one doesn’t have a 401k? I also am in this situation (working in the UK for a British employer, but trying to build my ‘Stash in the US where I will in theory eventually retire). I will be maxing out my Roth IRA now every year, so I don’t know where to put the extra. I do have a pension fund here, but the advantages don’t seem as great (very minimal employer match, which I’m already getting), it would still be age-limited, and I’m worried about exchange rates etc. when I start using it. Is the best option just to put it in a regular old taxed index fund?

  • Nerode November 14, 2011, 4:52 pm

    MMM, your reference to life expectancy in the 19th century is accurate…but misleading, especially for the purposes of discussing retirement needs.

    Yes, a new born white boy in 1850 in the USA had a life expectancy of just under 40 – but likely wasn’t thinking too much of retirement yet.

    If he made it to 10 years of age alive, his life expectancy was 58+ – and he probably still hadn’t considered retirement.

    If he lived to 40, then he could expect to be alive until his late sixties.

    Of course back then, his retirement planning took place in the marital bed, and so his ‘retirement net worth statement’ read: 5 boys, 3 girls :-)

    Hmm, must talk to my wife again about retirement…

    See: http://www.infoplease.com/ipa/A0005140.html

  • Mike November 15, 2011, 3:30 pm

    ok, It looks to me that the calculation in Strategy 1 is way off mark. Since nobody has commented on this, it might also be that I’m not thinking about this clearly enough. Anyway, here it is:

    Now, the deal is, if someone needs 30k a year to live comfortably and they have 600k in their account already, only then can we say that they have enough.

    Having only $144000 right now sets them up to have $622,000 30 years later, which is obviously not enough.

    So am I right with this calculation or am I missing something glaringly obvious?

    • MMM November 28, 2011, 9:10 pm

      Yes, it is supposed to be glaringly obvious, but maybe it still was not. You just need to research and understand the term “inflation adjusted” that I repeated throughout the article, and it will make sense.

  • Michael November 16, 2011, 9:20 pm

    MMM, I don’t understand how you arrived at the $600,000 figure in your example. Your parameters were:
    1) Money needs to last 30 years
    2) You withdraw 5% per year
    3) You need $30,000 per year to live

    Can you explain the math behind arriving at $600,000? It would seem that $600,000 would last you 20 years, not 30.

    • MMM November 16, 2011, 10:25 pm

      The $600k is generating RETURNS of 5% per year (after inflation) in that example. So it gives you that cashflow FOREVER, and you will never even need to touch the principal. This is what assets do for you – you don’t have to use up the asset itself, you just live off of its cashflow!

      • Michael November 17, 2011, 1:05 pm

        Okay I see. So the “money needs to last 30 years” parameter is pretty much meaningless in that example. If the assumption is that you will live only on the returns on your $600,000 (and we’ve conveniently set the return rate and the withdrawal rate both at 5%), then theoretically you can live an infinite number of years on that $600,000.

        • Tails January 14, 2012, 4:26 pm

          For a 90% confidence rate of not living with your grand-kids:

          3.8% / 50 years (aka forever)
          4.3% / 30 years
          5.0% / 20 years


          However, 90% is not 100% percent. All facets of your life should come close to 90% for all of this to work out. See the MMM article on Safety Margin.

        • Melanie April 2, 2016, 11:26 pm

          Glad to be a part of this! I was an early believer in financial independence by studying the Road Map guy Joe Dominguez :) Now, at 57, I will soon be starting to see if it all worked out… I think it might.

          • Melanie April 2, 2016, 11:31 pm

            What about the Required Minimum Distribution– with the RMD, not sure if the $600,000 could last forever.

  • B November 16, 2011, 9:31 pm

    I am currently investigating my options for sheltering money. My wife works for one of the local school districts and i was just reading about her options. They offer both a 401k and a 457. You should consider adding a small section on the advantages 457 plans. They are pretty sweet.

    • William Bloomfield January 20, 2017, 1:41 pm

      Yes, 457 plans are great if you can get them, but you need to work for a governmental entity. I work for the State, so I fund both a 401k and a 457. If I ever leave state employment, I can access the 457 funds penalty free. Great deal for us government employees! (Not sure it’s fair to the rest of you that aren’t government employees.)

  • Personal Finance Source January 25, 2012, 3:11 pm

    My strategy is to withdrawal everything out of my 401k, move to the Cayman Islands and just not file taxes ever again in the US. They’ll probably put a warrant out for me but they won’t catch me.

    • moooooser February 24, 2014, 10:16 am

      The problem with that strategy (besides being illegal, and potentially immoral) is that it will be very, very hard to get your money to work for you. Buying stocks, real estate, or any other money producing asset will be difficult at best, and you run the risk of those assets being seized if they discover the truth. At least in my mind it is far better to have a little bit less money (after taxes) and not risk the potential loss of the physical and financial freedom associated with that strategy. But obviously YMMV.

  • Barbara February 23, 2012, 2:14 pm

    I retired at 47 in 2008. I keep my expenses low so I’m in the zero percent tax bracket. I take money out of my 401K each year to offset my medical expenses, which are fairly high. My health insurance is over $500/month because of pre-existing conditions and I have a high $2000 deductible. So I take out $7 – 10K each year from my 401K to cover those expenses. By filing form 5329 I can offset all but 7.5% off my medical costs from the withdrawl. Since I can’t be completly precise on the numbers I usually owe a small 10% early withdrawl penalty of less than $100. But that’s my total tax for the year. So I think it’s a good deal.

    I want to start withdrawing some of the money from the 401K now, when I only have to pay 10% than when I’m forced to withdraw and I might be making SS putting me a higher tax bracket, plus who knows what gov’t might be charging by then. I’d rather pay 10% now, than 20 – 30% or more later.

  • Andrea October 11, 2012, 5:54 pm

    excellent post! i ran my numbers and i am only 5 years away from stashing my old woman money. this is such a motivator. :)

  • Sheepstache October 12, 2012, 5:40 pm

    I skimmed but I didn’t notice anyone else mention that retirement accounts don’t count towards the parents’ assets when you’re filling out a FAFSA so that’s another point in favor of stashing in a retirement account.

  • brenda from ar October 28, 2012, 10:34 am

    Just an additional note on 401k’s: If you sever from your job after you turn 55, or even during the year you turn 55, you are freed from the 10% penalty on distributions. This could be helpful for some who didn’t get as early a start as the triple M.

  • Austin March 29, 2013, 2:26 pm

    Mr. MM, keep up the great work. Internet anal guy here. Large life expectancy differences between the time social security was created and now is a myth! mostly held low by the infant mortality rate and high youth death rate. If you made it to 25 odds are you would live a very long life, not unlike today. And since the ones that die young rarely contribute substantially to social security, it didn’t make much of a difference in that regard!


    Nothing positive to say, just enjoy being an all around internet know-it-all. Carry on

    • Mr. Money Mustache March 29, 2013, 10:21 pm

      Thanks Austin – I’ve learned that from a few other sources since this post was written, too. Dang, it was a fun factoid while it lasted.

      But at least the overall message remains valid: you can withdraw money from 401(k) at any age :-)

  • Panhead May 19, 2013, 9:53 am

    Great Blog MMM, you and I could be brothers the way we have approached our financial lives, we even made some of the same mistakes (ie, timing of RE purchases). I’ve got about 3 years on ya tho!
    Anyway, with regards to 401ks, here’s the approach I plan on using.

    I save a sh*tload of an income slightly over $100k/year (saving about 70%) which seems to be your target audience. If you are doing this, then saving that $17,500 in the 401k saves you paying taxes on this money at the 28% federal rate. Since you will almost surely be in a lower tax bracket (likely 15%) when you retire, this is the only way to go. Obviously the match is nice too, if you get one, but not necessary to make the math work.
    Then, you should still have a sh*tload of money to put in after tax investments. First should be a ROTH IRA. Now, I’m single and with my income I can’t do a direct ROTH IRA, I need to do a backdoor Roth. Same thing, a couple extra steps. Google it or better yet go over to bogleheads for their explanation. As a side note, this is another good reason to have a solo 401k and not to have any deductible IRAs. You’ll see why when you do your homework on the backdoor ROTH.
    After this, you should STILL have a crapload of money to invest (after all, we are liviing on like 25-30k/year, right?). This get’s invested in taxable funds at Vanguard.
    Now, I structure my investments such that Stocks and muni bonds are in taxable funds (and nothing else). This is due to tax treatment of these vehicles at my tax rate and it lets me keep a sh*tload more of my hard earned $$ instead of giving it to Uncle Sam. My Taxable bonds are all in the 401k(s) that I have. I personally use my backdoor ROTH for REIT fund investing, but you can put anything here that does (or will) benefit from tax free treatment.
    NOW, after all that sh*t, the important part. If you are saving enough to have at least HALF of your stash (stache?) in after tax investments (and that should be easy) you can effectively draw from your 401k any time you want! How you ask? Just draw from your taxable funds as needed and if you need to sell some shares in taxable, you can re-balance in your 401ks and re-buy the same (or similar) funds without tax consequences. This really helps if you sell funds at a loss in your taxable accounts then re-buy similar (not the same or wash rules apply) in your 401k. Remember, you can write off some of your taxable losses against your income ($3000/year I think?) This lets you further reduce your taxes.
    Also, if you only want to spend only dividends, you can look at what your 401k has produced in dividends, and sell the same $$ amount in taxable to get at that income.
    People usually view taxable, tax deferred, and tax free as separate accounts, this can cost you money. They should be used for what gives us the greatest advantage, ie, to keep the most of our ‘stash’ from the ‘gubmint’.

    The key to making this work is to have lots and lots of money after tax (at least as much, hopefully alot more) than you have in tax-deferred, which should be the case for us ‘Mustachians’.
    Anyway, hope this makes sense!
    (sorry, that was more of an article than a post, lol!)

  • Robozorn June 24, 2013, 11:15 am

    I’m confused by the “need $600,000 at retirement age for 30 years of living expenses” calculation. I must be missing something here, but I am guessing this assumes a 15% tax rate, a 5% annual withdrawal and ZERO growth in the account? $600k is depleted in 30 years if the $600k doesn’t grow at all in those 30 years, but if there is even a little growth (what happened to 4 or 5%?), wouldn’t the withdrawal rate be canceled out about by the growth?

    Also, how does having a Roth IRA affect this calculation? Since you can withdraw the money tax free, it would lower the money you need in a 401k substantially. I would figure this out myself but I am HORRIBLE at math (obviously).


  • downtownshuter July 10, 2013, 12:02 pm

    I would like to share my strategy. I have never read it anywhere else and it seems obvious to me so I would like a tax expert to weigh in on this. I’ve read the rules over multiple times and also completed my own taxes this year and I believe I understand this correctly…

    If you are in the 10% or 15% tax brackets (taxable income up to $72K for married filing jointly) then the tax rates on long term capital gains and qualified dividends is 0%. So after implementing MMM’s strategy #1 above, I stash all our savings into plain old fully taxable investment accounts (I use Sharebuilder, now CapitalOne). Which means that once you are retired and have $0 ordinary income you can withdraw up to $72K/year (LTCG and dividends count towards figuring your tax bracket for this purpose) in long-term gains and dividends completely tax free. This is more than double what a mustachian family needs to live on. Or if you have side income you can take gains and dividends up until you reach $72K total. Gains can be timed whenever you want by choosing to sell or hold so if you earn a lot one year don’t sell any gains, and if you take a year off, sell a full $72K (minus dividends) of gains.

    While working, all capital gains can be deferred by not selling anything until you retire, and dividends are relatively small over the few years it takes to save to retirement, and are taxed at a reasonable 15%.

    Other Pros:
    -In case you want to take out hundreds of thousands of dollars all at once (to buy an investment property or start a business for example) you could do so and still pay only the 15% tax on gains and dividends instead of the marginal income tax rates if you pulled it from a 401k/IRA, plus your deposits always come out tax free since there are no gains.
    -If you like to choose your own investments this gives you that option, instead of being stuck with the choices your 401k plan offers.
    -This is simpler than dealing with 401k, roll over, convert each year, track basis vs. gains (you can only withdraw your basis from the Roth tax free, gains have to wait)
    -No 5 year waiting period

    -You don’t get the tax arbitrage of deducting from your pay at 25% or 28% or higher now and then paying 10% of 15% later when you convert it to a Roth.
    -They could change the law/tax rates at any time but isn’t that the case with any investment?


    • Three Wolf Moon December 9, 2013, 4:04 pm

      I went through the form 1040 instructions, specifically the Qualified Dividends and Capital Gain Tax Worksheet for Line 44, and can’t find any flaws with the strategy. The only thing to point out is the $72k number ($72,500 for tax year 2013) is for married couples filing jointly, singles are limited to $36,250. Looks like a great idea!

    • baulrich March 18, 2014, 10:43 am

      downtownshuter, some aspects of your strategy are a very important part of mine and I wanted to elaborate on them. And they do pertain to the overall question of this thread: How much is too much in a 401(k)? These rules are very important for those who will retire early.

      First, the important facts/rules:
      – for those filers in the 15% bracket or below, the (Federal) tax rate on realized long-term capital gains is 0%.

      – Balances in tax-deferred retirement accounts like a 401(k) or Traditional IRA can be converted to a Roth IRA. The amount converted is treated as taxable income.

      – For any tax filer, some taxable income is shielded from tax by the standard deduction and exemptions.

      – The PRINCIPAL (amount contributed) of a Roth IRA can be withdrawn at ANY time, even before 59.5 with NO tax or penalty. There is a 5-year waiting period before distributions can begin, but this is from the Roth account creation date.

      From those known facts, all retirement planners can employ a strategy that incorporates the following:

      – Start a Roth IRA now, even if it’s just a token amount, to make sure the 5 year waiting period doesn’t apply to you if you need to take a distribution of principal before 59.5.

      – After “retiring” or even while “taking a year or two off”: Each year, convert a portion of your 401(k) or Traditional to a Roth IRA. This provides 2 benefits.
      1) Although the converted amount is taxable income, if converted during a tax year with little/no other income, it’s essentially tax-free as long as the amount is less than your standard deduction + allowed exemptions. For married couple, filing jointly, this is about $20,000. That’s right, you’ve moved money from a tax-deferred account to a tax-free account and paid NO tax and will pay no tax on the principal or future earnings.
      2) Now that the converted amount is in a Roth IRA, it’s no longer off-limits till age 59.5. For those worried about having “too much” in a 401(k) or Traditional IRA, this is a HUGE safety net. The money is available free of taxes and penalties, even before 59.5.

      – For any year in which you are in the 15% tax bracket or below, you should CONSIDER long-term capital gain harvesting by selling (and re-buying) securities to take advantage of the 0% capital gains rate for those in the lower tax brackets. This is VERY important for those who may later be in a higher tax bracket OR those who may later want sell a good-sized chuck of securities from a taxable account for a down-payment on house or other investment. Note: This is actually the opposite of what suggest about deferring those gains until retirement when they’ll be taxed at only 15%.

      Example: Married couple in early 30s has around $100K in Roth IRAs, $30K in a 401(k) and $100K in a taxable brokerage account, but the cost basis of the brokerage account is $80K. Wife works right now and makes $30K/yr and husband is going back to school and next year hopes to start job making 60K/yr. Because this couple is in the 15% bracket or below, they can realize (by selling then re-buying securities) the $20K capital gains in their taxable account and pay 0% federal tax on it. Their cost basis is then $100K for that account.

      Benefits/Potential benefits: Since the couple has increased their cost basis of their $100K taxable account to $100K, they’ve potentially saved $3K (15% of 20K) with little cost (the actual cost is the state income tax that may be paid, but that’s a matter of paying now vs. paying later). Looking ahead 5 years from the transaction, the couple are both working making a combined $110K and their taxable account has grown to $120K. They want to liquidate that $120K to buy a business, etc. They will now pay capital gains tax on $120-100 = $20K vs $120-80 = $40K.

      Don’t forget that capital gains do factor in to figure the marginal tax bracket. So in addition to saving the 15% tax on the 20K, the couple has reduced the likelihood that their future realization of capital gains will bump them into a higher tax bracket. In the scenario above, it would not.

      Also don’t forget the possibility of locking in a tax-free capital gain now and getting to claim the capital loss in a future year (when it is not in fact a loss from the ORIGINAL cost basis. For example selling for $100K something with a cost basis of $80K and paying 0% LTCG due to tax bracket, but selling those securities 3 years later for $95K would result in a $5K capital loss during that year due to the new $100K cost basis.

      In summary, I think you could tweak your strategy some to take full advantage of the power of tax-deferred accounts like 401(k) or Traditional IRA. Especially with the knowledge that you can use years with little/no other income to convert them to Roth essentially tax free. And the benefit of being able to get to that money tax/penalty when needed before 59.5.

      In addition, for that money you have in taxable accounts, consider tax harvesting now (if tax bracket allows). If tax bracket prohibits, do this during a year off or early during your early retirement. Especially important if you do plan to later be in a higher bracket or make a large capital gains transaction.

      One other note regarding your comment: Concerning your example about withdrawing up to $72K per year to stay at or below the 15% bracket. You are correct about the bracket cut-off, but withdrawing $72K from a taxable account would not generate anywhere near $72K in actual taxable income, because only the capital gains are taxed. The cost basis amount has already been taxed once.

      • wij May 2, 2014, 9:49 am

        Good points baulrich about taking cap gains and/or doing Roth conversions while in a low bracket during small-income years. I would just add that these forms of income do count in determining your MAGI for ACA insurance purposes, even if they are taxed at 0%.

        So, the amounts of income you take this way might make you ineligible for Medicaid or premium tax credits. This probably shouldn’t dissuade you from the strategies, but it is worth factoring how these steps will affect your health insurance costs, at least until Medicare kicks in for you.

  • cptacek July 10, 2013, 1:35 pm

    I am using Strategy #2 to pay for land. In my old life as a single gal making quite a bit as a software engineer, I accumulated quite a bit in my 401k. Since I got married, we moved to the boonies, I got laid off at a similar job, lost 1/3 of my income and started a farm. Thus, we are poor, and pay no taxes. So, I pay the taxes on money transferred from the IRA to the Roth IRA (0%) and then the next year take out money to pay for land with no penalty.

    One thing. The Roth IRA vehicle must be in existence for 5 years; however, the money you transfer to it does NOT have to reside in it for 5 years. If you start a Roth IRA today, 7/10/13, say with $1000 and leave it alone gathering dust for 5 years, then put this plan into effect in 2018, you can start your first withdrawal of the new money you put in in 2019. You wouldn’t need to wait until 2023.

    BTW, you are the first blogger I have seen recognize this strategy. My broker (that I am getting rid of this month) was floored by my suggestion to do this, but he agreed it was a great way to float the land purchases.

    • Ines June 18, 2014, 7:44 pm


      can you put some links up supporting your strategy of withdrawing Roth conversions penalty free after only one year. My research still shows a 5-year waiting period, but maybe I am missing something.

  • Robinson July 22, 2013, 6:17 pm

    Ever explored indexed universal life insurance policies as retirement vehicles?

    A problem with qualified plans is that you don’t know for sure what your withdrawal income will need to be when you’re retired (risk of large unforeseen costs that bump up your tax bracket)

    Also leaving money from a retirement account to your heirs is hugely problematic tax wise, whereas treating a permanent life policy as an investment can rack up a huge death benefit

    Think of it as this: there is value in the bet that you, as a young healthy human being, will survive many years. And it turns out you can use that bet as a VERY lean retirement vehicle

    The myth that permanent life coverage is too expensive is pervasive because of high upfront costs but take a look what you pay for even the cheapest MF or ETF over a lifetime and it’ll be comparable to an IUL policy

    Good read on this: tax-free retirement by Patrick Kelly

    • BC September 10, 2013, 3:58 pm

      I have been looking into a VUL life insurance policy as an investment vehicle. Similar to a Roth, you contribute after tax dollars into cash value policy. The difference being that the cash value can be easily accessed after the first ten years and the contribution limits are much higher that current Roth limits.

      This is particularly important to me as my wife and I are heavy into investment real estate. This means that our income likely wont be dropping much at retirement. In order to avoiding adding to our taxable income, a vehicle such as this is highly attractive. There are caveats with any investment and this one has high frontloaded fees(which are offset by lack of tax burden). Caveat aside I don’t understand why more people don’t utilize VULs. The cash value can also be used to show banks you have ready access to cash if need be, and the cash value is protected against legal judgements.

      What am I missing here?

      • downtownshuter September 11, 2013, 9:31 am

        there are some pros and cons of VULs.
        the biggest con is probably fees and investment options/expenses. you probably don’t have index funds inside the VUL so in addition to the high upfront fees, look at the management fees within the investment funds inside the VUL.
        also, check into any riders that they may try to sell you (add on features for an additional annual cost). there are probably some good VULs out there, and they may fit especially well for certain tax situations.

        regarding withdrawing tax free after 10 years, i would guess that contributions and investment earnings would be treated separately, but i’m not really sure.

        all in all, they are relatively complex products so do plenty of research and read the fine print. they have a bad rap in general, you can probably find some sites with common complaints and see if they apply to your situation.

      • robinson September 11, 2013, 2:29 pm

        again, I highly, highly recommend reading Patrick Kelly’s “Tax-Free Retirement” – much more about IULs as opposed to VULs. I believe taking loans out against the cash value at low interest rates is what he really recommends since loans aren’t taxed, and then having the death benefit pay back the outstanding loans plus interest


        I’m less familiar with VULs but I know that they have more investment risk, since IUL performance bottoms out at 0% regardless of the index’s performance

  • Frank August 22, 2013, 4:12 pm

    This posting was very useful to me. I was worried cus I have way too much in my 401k, Roth’s etc (about 700k), but only about 475k in my taxables. I am planning to work till next April to top the taxable up to 500k.

    I thought I was stuck, but there seems to be enough loopholes to allow me to get to the 401k stash without the penalty if I ever needed it..

    So I think I will plan to continue to contribute to the 401k at the max rate to avoid taxes up until I quit… Plus save another $25k to taxable savings.

    The Wife intends to work (teacher, good medical, Summers off) for the next few years so with the rent we get plus her salary I should not have to touch the stash in any case.

    Either way I think this still gives me the green light to quit in April.. Do you all agree?


    • MooseOutFront November 7, 2013, 9:36 am

      Frank I think you’re GTG. Keep making the 401k this year and next and then start in with the Roth rollovers or capital gains taking to fill the gap between your wife’s income and the top of the 15% bracket, currently $72,500.

  • Lori November 19, 2013, 2:07 pm

    Please explain…..Is a traditional 401k option better for most people? I currently contribute to Roth 401k, but after reading your blog I am confused at which would be better. I understand that the amount of money I am making now (higher tax bracket) is most likely more than I will need at retirement age (lower tax bracket), but since the money that I am putting in the Roth 401k now should be growing in value, wouldn’t it be better to pay higher taxes on less money than lower taxes on more money? FYI I make approx. $40,000 a year.

    • downtownshuter November 22, 2013, 9:57 am


      If the tax rate during your contribution period and your withdrawal period is the same, Roth 401k and Traditional 401k work out the same monetarily.
      If you contribute $10K to a Roth 401k and are in a 25% tax bracket, you need to earn $13,333 and pay taxes of $3,333 upfront. Then say that $10K grows at 10%/year for 30 years, you end up with $174,490 and you can withdraw that tax free.
      If you instead contribute $13,333 to a traditional 401k, you pay no initial tax and that also grows tax-deferred for 30 years and 10% and becomes $232,652. Then you pay 25% tax when you withdraw that so it nets out to $174,490
      The benefit for many early retirees is when they withdraw the money they often have a lower tax bracket, say 15%, so the traditional 401K would end up with $232,652*(1-15%) = $197,754, which is more than you would have with the Roth.

      It comes down to two things, the tax rate you pay when you are making your contributions, and the tax rate you pay when you are making your withdrawals.

      Keep in mind tax brackets and rates change every year, so any example will be overly simplified. Tax rates could all go up or down 10, 20, 30 years from now. Or they could go up then go down, or vice versa. It’s a guessing game. The Roth at least locks in your tax rate so you aren’t at risk of much higher future tax rates

      If you are making $40K you are probably in the 15% tax bracket, and I would personally contribute to a Roth at that point. If you get up to a 25% or 28% tax bracket, I would lean towards a traditional if you plan to retire soon (<10 years).

      There may be some other rule differences that would favor one vs. the other also.

      • Bfinleyrad September 15, 2016, 7:54 am

        “If the tax rate during your contribution period and your withdrawal period is the same, Roth 401k and Traditional 401k work out the same monetarily.”

        Two things:
        1. If you were in a place where you wanted to max out your contribution, wouldn’t this make Roth contributions better, since $18k in Roth contributions will be worth more when withdrawn than $18k in Traditional contributions due to tax savings?
        2. Isn’t there a flaw in the example of being in the same tax bracket at retirement and when making the contribution, because technically when you make the contribution you are avoiding taxes which would otherwise be at your highest tax rate (perhaps around 35%)? Meanwhile, when getting distributions in retirement, if you withdraw an amount equal to your former salary, most of the distribution will be taxed at a much lower rate (perhaps putting the total taxes around 25%).

  • jim November 29, 2013, 11:30 pm

    OK – please help me out here. I am “challenged” when it comes to retirement planning. If spouse wants to retire now (age 55) and I don’t intend to retire for another 5 years – can we make it on the $800,000 we’ve saved in our 401’s and Roth’s? Our expenses aren’t more than $7K/month and we’ve got about $90,000 left on the house. We’re currently throwing $4K/month at the house. once that’s dead, we can live quite comfortably on $3K/month – assuming no health issues. I only make $55,000/year. I’m totally confused and would sincerely appreciate your input. Thanks.

    • T Schmidt December 2, 2013, 3:12 pm

      I’d probably ask this on the forum rather than comments on an older blog post, but short answer is probably, but it depends. Does that 3K a month include continuing to contribute to your 401K? How much? What are the costs of health insurance to cover the gap until you get to be 65? How are you going to continue to throw 4K a month into the house if your spouse retires since that equals 48k a year which doesn’t leave much else to live on. And the other thought is of course, stop spending so much a month!

      • jim December 2, 2013, 11:56 pm

        Thanks for the response. No, we would no longer contribute to her retirement funds if she quit her job, but we also would no longer have a mortgage ’cause she’d take $90K out of her 401 (without a penalty, but we’d have to pay taxes on it – another $28K-ish). As for health insurance, I would cover us thru my employer. So we’d have an easy $2K/month (net) to live on and without a mortgage, we can do that easily (and I’d continue to contribute to my retirement funds). We’d let hers sit untouched until I retire and even then we may not need to touch it ’cause we’d be eligible for social security. Does that answer your questions?

        p.s. – what forum? thx.

        • GeauxBig December 6, 2013, 8:44 pm

          At the top of this blog is a tab that will lead you to the MMM forum where there are people who can help you with specific questions.
          Good luck Jim!

          • jim December 6, 2013, 9:48 pm

            Thanks much – don’t know how I ever missed that – ha!

  • KarlaCash February 6, 2014, 4:29 pm

    After starting reading your blog I began to wonder if I should keep putting the max (now 17.5k) into my Roth 401k. I’m 40 and already have 466k in there that I am told will be ~1.4M at 60 (previously planned “early” retirement <- scoff). I have some Roth IRA savings as well. If I bring it down to just putting in enough to get the match (6%) and doing it pre-tax, I wold be able to invest the rest in the _real_ early retirement stache.

    I know I'm a late bloomer, but I wonder if that would be the best plan…

    • Ted Hu March 17, 2014, 4:44 pm

      That is a good plan. I’ve arrived at a similar conclusion – a tranche of cash for pre-59 ½ retirement and another tranche thereafter. The SEPP is a good way of achieving that goal especially if one is able to maintain a +/-$30k/yr cost structure.

      I will start RMD SEPP this tax season to rebalance toward my pre-retirement. And at 30k/yr, the ordinary income tax rate is lower too <=15%. And when you transfer it into the mutual fund and redeem it as long-term capital gains, anything less than 72,500 is tax free.

  • Lassbt May 4, 2014, 5:17 pm

    So glad I found this thread. This is the plan for my husband and I. Or, mostly my plan for us (as he is not especially interested and is happy for me to do all the planning ;)). We maxed out 401K’s until we decided to retire in our 40’s. We are there now with house paid off, no debt, etc… We have 5 years worth of yearly expenses in HYMM right now, and then more $ in Roth, and will convert more to Roth from 401K’s to bridge the time between now and 60 (with a good cushion built in). Husband also has skills that can earn us $ along the way if needed or wanted. So overall a pretty solid plan similar to others I have read on this thread. Husband has stopped working and I will do so later this year or early next year to build up more in our taxable funds.

  • peskypesky May 23, 2014, 9:56 am

    This is a very interesting article and it addresses some concerns of mine. I got into the 401k game late (age 33), so I tried to put a good chunk of my pre-tax income into it every year. I knew I was playing catch-up.

    Now, because the market has done so well in recent years, my 401k balance is looking good (for my age). I just turned 48 and have $292,000 in the 401k. Do you think that’s a good amount, according to the principles of this article? Too much? Too little? Just right?

    Second issue: I am really hoping to retire or semi-retire early…..like in the next couple of years. I have no debt and no dependents. I am very frugal. I have been researching SEPP’s to see how much I can withdraw from the 401k without incurring the 10% penalty. Right now, it would be about $11k/year. But with that (and my $42k savings account), I know I can’t do full retirement in the USA. So I am considering living/traveling in cheaper Third World regions for many years (Central America, Southeast Asia).

    If I stay in the States, I will only be able to semi-retire.

    My current thinking is to travel/live in Asia for a few years on my savings. Hopefully the 401k will continue to grow at a healthy rate. Then, the SEPP will be larger…..maybe about $15k/year. Fingers crossed.

    Any thoughts?

  • Matt May 29, 2014, 7:04 pm

    I wonder now that I went part time at a job if I should change my Roth 401K and Roth IRA contributions to traditional now. I put 40% in the Roth 401K and max out Roth IRA. by taking the tax deduction now the Long term capital gains on my taxable accounts will be 0% . capital gains run $15000 to $20000 a year. This would lower my income to below $36900 per year. Part Time job $32000/yr minus $12300 and $5500 for IRA. Saving me a lot of taxes today. I hope that the Roth accounts will stay tax free but could that change? A large part of my income comes from 2 rentals which have a lot of write offs so that income and part time income are what I live off. Shouldn’t have to use retirement accounts until I am required to take RMD. I may be putting too much in 401k and IRA but i don’t need the money but should use it to benefit on the tax advantages. Any thoughts on this Long Term capital Gains question. Roth or Traditional 401k and IRA’s which is best? Like to hear some ideas on the matter.

    • baulrich May 30, 2014, 12:23 pm


      You are wise to consider not having all your eggs in one basket (after-tax retirement accounts) vs. traditional (tax-deferred) accounts. And you may also want to consider saving some in taxable account other than retirement accounts. It’s hard to offer specific advice without a more complete picture of your situation including age, estimated years till full or partial retirement, value of each retirement account as a percentage of other savings or total net worth.

      Your post does seem to confuse capital gains rules though.

      You won’t pay capital gains on any gains in your retirement accounts, regardless of whether they are Roth or Traditional. Tax is only incurred when distributions are taken as income. Of course that only applies to the Traditional (tax-deferred) account. With the Roth, even the distributions are tax-free, as the tax has already been assessed.

      Besides investing in Roth or Traditional retirement accounts, you can also invest in a regular taxable account. This should be considered if there is a chance you’ll want to access some of it before the required retirement age (59.5) is reached. With this type of account, you do indeed need to be aware of capital gains taxes. But the good/great news for you is: a) you only incur gains when securities are sold. (I’m curious/skeptical that you have $15 – $20K in capital gains annually.) If it’s in a retirement account at all it doesn’t matter, because the gains aren’t taxed…. but I’m curious for an explanation. b) your capital gains tax rate is determined by your income for that year. And if you are in the 10 or 15% tax bracket, your capital gains tax is 0%. That’s great news for you. Your income is at a level that with the standard deduction plus any contributions to a Traditional IRA (not Roth) you can keep yourself in the 15% bracket even with a significant capital gain from the sale of securities in an after-tax account or selling a rental property! Which means you avoid (federal) capital gains tax, even for gains incurred in a taxable non-retirement account.

      One other potential strategy for you. If you do start investing some in a Traditional IRA/401(k) as opposed to a Roth… Not only does this help lower your tax burden now, but it creates opportunity in the future to avoid the tax completely (instead of just deferring). For example, if you no longer have rental income and wanted to take a year off from work (in your 40s or 50s) and had no income for that year, during that tax year you could convert, say $10,000 from your traditional IRA to a Roth IRA. That conversion would count as taxable income for that year, but with no other income, it would be shielded from tax by your standard deduction and any exemptions. But plan thoroughly, because if you buy health insurance through an exchange and want to continue to do so, having a year with no income or income below a certain threshold may qualify you for (means-tested) medicaid instead of a highly-subsidized plan through the exchange if you are somewhat above the poverty level.

      To summarize, you don’t need to worry about capital gains when investing in retirement accounts. But (with planning) you may be in a situation to avoid capital gains tax even within a taxable account/ or rental property sale. And it’s very likely you could diversify among other types of accounts so you don’t have all your eggs in one basket (in case rules do change for a Roth, etc.).

      hope that helps….

      • Matt May 30, 2014, 5:40 pm

        i have taxable mutual funds that total $450,000. That’s were the LT capital gains come from. The rest of my portfolio is $190,000 in Roth accounts and $540,000 in traditional Ira. I have 2 rental properties that give income of $28900/ year and are paid off. I retired last year and have a part time job that pays $32,000 a year so I decided to keep putting 40% into the 401k. I just think that instaed of roth 401 and IRA i would be better off taking the tax savings now and roll traditional IRA to Roth when I stop working . I would than save tax on those gains because I should be able to keep income below $36900. What if I go over some does that mean all Capital gains are taxed? i just can’t bring myself to lower saving in the 401k when I don’t really need the money. I guess a true mustachians would work even less but I like to stay a little busy and this new PT position allows me to take off whenever and provides health insurance. Added plus.

        • baulrich June 2, 2014, 2:28 pm


          Congrats! Looks like you are in a great position.

          And to answer your question: All capital gains are taxed at 0% if you are in the 10 or 15% bracket and 15% if you are in a higher bracket. And the capital gains themselves factor in to figuring taxable income, to calculate the tax bracket. Which is why planning is very important… It’s not exactly fair, but the capital gains tax is all or nothing. (15% or 0%).

          I do think spending $100-$200 to talk for a couple hours with a tax planner would be worthwhile.

          But here are some back-of-the-envelope notes on your situation.

          First a question. What’s the balance of the Roth 401(k). I didn’t see it listed. And to clarify, the $450K is in a taxable NON-retirement account???

          Assumptions: You are single, have no other dependents.

          Right now your (approximate/estimated) income is:
          32000 – PT salary
          20000 – approximate max capital gains from taxable investments
          29000 – approximate max rental income. This is probably lower because surely you are deducting some expenses for the rental property.
          810000 – total gross income

          -17500 – maximum 401k contribution (potential)
          -5500 – maximum IRA contribution (potential)
          -6200 – standard deduction for individual
          -3950 – exemption for 1 person
          47850 – taxable income

          At a glance, it looks like you can get your taxable income down to 47850 if you switch from Roth 401(k) and IRA to Traditionals. I think this is probably wise, even if you aren’t able to get your taxable income below the $36,900 threshold to stay in the 15% bracket.

          You’d still have to reduce your income by about $11,000 to avoid capital gains taxes. To know if that’s advisable, you’d need to calculate your estimated rental expenses for the 2 properties. The calculation above assumes that your net rental income was $29000. But if you had $11000 in rental expenses, then your net income from rental would only be 18000.

          You may also want to evaluate your mutual fund holdings, at least in your taxable account. Your risk tolerance needs to reflect your position in life and your likelihood of needed to liquidate holdings. But it seems like you are in a position to have holdings that don’t generate so much capital gain annually. Another question is whether the funds themselves are producing dividends or if you are initiating buy/sell activity. Hopefully, the former.

          In a nutshell. Yes, max out Traditional retirement accounts now instead of Roth accounts. Estimate your annual NET income from rental activity so you can estimate your total income. If necessary, look at adjusting your MF holdings in your taxable accounts so that they don’t produce so much capital gains.

          That’s my take on it…..

          • Matt June 2, 2014, 6:31 pm

            i’m single and the rental income goes down to about $12000. after expenses and depreciation. I plan on replacing windows and a porch floor over the next several years to improve the property and take the write offs. I max out 401k at 40% ($14000/yr) and the roth 401k value is $76000 and $90000 in traditional 401k. As far as the mutual funds Acorn has about $300,000 in it and a large amount of that value is capital gains if I sell.($100,000) so I structured my other investments around that holding. It’s in the taxable accounts so I would owe tax on the sale of shares. That account just throws off those gains each year. My initial investments only were around $36000 all the rest is growth. the fund has done well for me. I sell very little in mutual funds the only sales were last year to purchase the 2nd rental property. I changed my 401k back to traditional and will also do $5500 in a traditional IRA and deal with the taxes at 70 years old. Current financial plans show me not really needing my retirement accounts to meet 100% of my full time pay for the rest of my life, but I’m not just going to save every penny for someone else to spend. I always lived like MMM but at some point I won”t go without things I want. I do have a Toyota Tundra and Avalon and i know that I don’t need 2 cars but if you can afford them and still kick back and work on my terms or quit if need be what does it hurt.

            Thanks for your thoughts..

            • Lori March 21, 2015, 8:50 am

              Just remember that when you withdraw from an RRSP you don’t get that contribution room back, so you are permanently reducing your contribution limit.

  • Skye August 20, 2014, 1:51 pm

    What about self-directed IRA’s? This is a not talked about option that many do not understand. I basically use Strategy #2, invest in a Traditional 401K (maxing it out), and then roll it over to a Roth IRA the following year after leaving a job. PS, a little unknown fact is company matches are always done on Traditional (pre-tax) money even if you opt for Roth with your own proceeds. Then I take an extra step and move it into a self-directed IRA which allows me to invest that money in practically anything so as long as I do not benefit directly. IE, live in a rental property. You get fancy options like check writing privileges if you go the route of forming an “IRA LLC”, but I opted for sans that to keep fees lower and administration more simple. I usually use the money to purchase notes, liens, and as downpayment on investment property. This is a great alternative than the typical Mutual Fund options that most brokerages of IRA’s will only let you work with.

  • Chris August 21, 2014, 6:41 pm

    We are just thinking about this issue. Our salaries took a big step increase after about 10 yrs of working and we were thinking of putting even more into retirement in order to minimize a tax increase (I work for a university so can contribute to both a 403b and 457b) which currently is 34,000/yr.

    Previously we’ve been more or less maxing out the 403Bs we have but not the 457b, but I’m htinking that I might shift to primarily funding the 457b since there is no early withdrawal penalty on any part (contributions or investment gains). That way we can still minimize current taxes. I’m still looking into to all the details of the 457b before we go down this path but it really seems like it’s better than the 403b or equivalent 401k for early retirees. I’m trying to find the downsides to this.

    Does anyone else have any thoughts about 457’s? I’ll probably check the forums as well.

  • Juanita August 27, 2014, 6:16 pm

    Great blog, but you have to keep in mind one thing. The Roth rollover loophole may not work for every 401k plan because many plans (and I used to work as a 401k customer service associate) do not allow a partial withdrawal/rollover when you leave the job and therefore you may not have the luxury of rolling over once a year to create a 5 year pipeline of ROTH money. They may only give the option of a full payout. So, you HAVE to roll the whole thing over to an IRA if you want to do a ROTH conversion (unless you had contributed to it as ROTH already). I understand what you are saying though, you want to pay taxes at the lower tax bracket, so contributing as ROTH to begin with would only be favorable if you didn’t make much money while working anyway. What I don’t know is if you can roll over from an IRA to another IRA. I know you can roll from an IRA to a 401k, but that’s another story…

    • Tyler Simpson September 26, 2014, 2:43 pm

      This is a great point. Another one to consider is this: if you are in the position of having to roll your 401k into an IRA then converting that into a ROTH, you need to remember your other IRAs that you may have out there. This is because, the IRS doesn’t let you simply pick and choose which IRA you want to Roth. If you are going from 401k–> IRA–>Roth then any other IRA that you have must also be converted. Keep this in mind when considering taxation.

    • Tyler Simpson September 26, 2014, 2:48 pm

      Also if by roll from an IRA to another IRA you mean you have, lets say, a sharebuilder IRA and you want to roll your assets from an IRA at Scott Trade, Ed Jones etc, you can definitely do that and it is not considered a taxable event. And no liquidation is necessary, meaning you don’t have to sell and transfer as cash and rebuy you can roll the assets themselves directly.

    • Tom September 30, 2014, 4:52 am

      Yes, this is true, and is my issue with the TSP. If I want to move it, I have to do it as a lump sum, which would put me in the 40% bracket or so! Also, if I move it, I’ll no longer have access to the G Fund, with is mindblowingly good and you can’t get anything like it outside of the TSP!

      • Derin January 30, 2015, 10:02 pm

        Tom, have you solved the problem of the lump sum transfer for converting from TSP? Also, curious to hear your thoughts on why the G Fund is so great?

  • Conrad November 19, 2014, 12:16 pm

    What I’m trying to figure out is what to do with my money if my 401k sucks? I can get up to $900 dollars in actual matching from my company (thats the real number after calculating the percentage of my earnings). The only accounts offered all have high fees. I know I can invest the $5500 in a Roth Ira, but what should I do beyond that? Invest the rest of my savings in a Vanguard Total Stock Market Fund? Or would I be better off plowing the money into my 401k and to hell with their high fees?

    • downtownshuter November 19, 2014, 12:52 pm

      First of all, complain to HR. In my experience they will take it into consideration down the road.

      For the time being, I would take the extra after the match and Roth IRA and put it into a taxable account, Vanguard is probably ideal. The taxes are pretty moderate if you’re not turning over your portfolio frequently (which you shouldn’t be). It sounds like you’re in a modest tax bracket (I’m guessing based on your match $ being relatively low, which could be wrong if your company only matches like 1%) so your long term capital gains and dividends might even be taxed at 0% . That’s if you’re in the 15% tax bracket which for a single person taking standard deduction and personal exemption and no student loan interest, etc. would be around $47K gross income.

      Even if you’re over that the tax is only 15% on the distributed gains and dividends, which are pretty low for Vanguard funds.

  • Dang December 17, 2014, 1:10 pm

    Just a heads up the NoDebtMBA link is now dead. Does anyone know if the ROTH IRA loophole still works?

    • des999 March 13, 2015, 7:01 pm

      yes, the roth conversion ladder is still an option.

  • Fred Strom January 24, 2015, 8:05 am

    I am currently 67 and will not withdraw any funds from my 401k until age 70 1/2. I was told that I must exhaust my 401K and pay all the withholding tax by age 83. Is that true in that I had planned on leaving my money in my 401k and keep getting withdrawls until age 100. Must I totally remove the funds from my 401K and pay the withholding tax prior to age 83?

    • Ellen January 24, 2015, 10:59 am

      There is no law requiring that you deplete your 401K by a certain age as long as you are taking the mandated withdrawals starting at age 70 1/2.

      • Juanita Martinez January 31, 2015, 5:40 am

        No you do not have to deplete your 401k at any age but you do have to start taking the minimum required distribution or MRD a.k.a MDR at 70 1/2 if you are no longer working for the company hosting that 401k. If you are still working for the company, you don’t have to start taking MDR until you retire. Whoever told you that should not be talking to anyone about retirement planning.

  • KYle February 11, 2015, 11:04 am

    Does anyone use IUL (life insurance) as a retirement vehicle. I’ve been trying to weigh out the pros and cons over 401k. its very hard to find unbiased info.


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