The 401k is a great way to save money for your retirement. The tax advantages and ease of payroll deductions make it a no brainer.
But what happens if you want to retire early? Or you want to remain under certain income thresholds in retirement? Should you put all your eggs in one basket?
In this week’s video, Casey discusses multiple reasons why folks might want to save outside of their 401k plan.
Should You ONLY Save in Your 401k? – Links
Morningstar Model of US Retirement Outcomes
79% of Americans who make this one move won’t run out of money in retirement, researchers say – CNBC
Mullooly Asset Podcast – Money in the Right Places: Retiring Before Your 60’s
Should You ONLY Save in Your 401k – Transcript
**Click here for a PDF version of this transcript**
Casey Mullooly: If you want to retire early, you might want to consider saving outside of your 401k.
79% of Americans who save for at least 20 years in a defined contribution plan, think 401k, 403b, will have enough money in retirement to cover their expenses. 79%. The research also found that 72% of Americans who wait until age 70 will have enough to cover their expenses in retirement without having to return to work or drastically cut their spending.
But what if you want to retire before age 70 or before age 65? What if you want to hang it up at 62 or 57? The first thing you want to think about is diversifying your asset base. What I mean by this is saving outside of your 401k plan. 401k plans are great.
The contributions are automatically deducted from your paycheck. They automatically get invested and over the course of 20 years like the research found, that can really put you in a good place when it comes to retirement. But those tax advantages, I don’t want to say they work against you later in life, but you do have to pay tax on this at some point, and it can limit your options when it comes to early retirement.
So let’s remember those contributions are going in pre-tax, which means you don’t pay tax on it, which means when you take the money out, you do have to pay tax on it. So it’s taxable no matter what. And there’s a 10% early withdrawal penalty if you take the money out before age 59 and a half.
So while saving in 401k is great, it could make sense if you want to retire early, it could make sense to start splitting up your savings when you hit around age 50. You might want to start saving outside of the 401k in a taxable brokerage account or in just a regular old savings account.
So the idea here is you want to be able to have a bridge. You want to have money that you can access if you want to retire early, you want to give yourself options. You want to give yourself flexibility. You don’t want to have all your eggs in one basket. So diversifying your asset base and your tax base is definitely something early retirees want to consider.
Another reason why saving outside of the 401k could make sense is if you want to stay under income thresholds for things like Medicare. So early retirees, one of the biggest hindrances to early retirement is paying for marketplace health insurance.
Medicare starts at age 65, so that seven to eight year window between age 57, let’s say, and 65, it’s going to cost you a lot of money potentially to buy the Marketplace Health insurance, the health insurance and the Medicare premiums are based on something that’s called your modified adjusted gross income or MAGI for short, 401k or IRA distributions are taxable.
Let’s remember, they’re always going to be taxable. So those distributions are going to impact. They’re going to raise your modified adjusted gross income, and you want to pay attention to these thresholds, especially for Medicare Part B and Part D premiums, and it’s possible to make all of this work. Saving in the 401k is great. We’re not saying that you shouldn’t save in your 401k at all.
There’s a lot of people out there, a lot of hot takes about the 401k and how it’s a scam. That’s not what we’re saying here at all. What I’m saying is that save in your 401k, it’s possible to do it for that 20 years like the research found. You can start at age 30, wrap up around age 50, and then start to scale it back and diversify your savings into other buckets. Because like I said, you want to give yourself as many options and as much flexibility when it comes to choosing your retirement date.
A lot of moving parts as always, if you’ve got questions, feel free to get in touch with us and we can point you in the right direction there. So that’s going to do it for this week’s episode. Thanks as always for tuning in. We’ll see you next week.
