Saturday, February 8, 2014

401k rich, cash poor

Posted on 3:23 PM by Unknown
Over at Reddit we came across the following discussion:
401k rich, cash poor (self.financialindependence)
submitted ago by DesertPlain

I'm 43, married. We have 800k saved in retirement accounts that can't be touched before retirement. We also have around 250k in home equity (400k value/150k mortgage), plus something like 50k in "normal" investments and savings.

In running FI scenarios, is it better to run simulations and think in terms of a single net portfolio of 1.1M? Or should I think in terms of two time periods, "before 401k available"/"after 401k available"? Logically, I'm thinking the latter makes more sense, but that unfortunately means that I'm nowhere even close to FI because 300k in non-retirement assets won't get me far. Is that the reality? Have I over invested in 401k accounts that I can't touch until retirement?
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[–]bernoulli33 17 points ago

Rule 72(t) will allow you to take payments from your retirement savings before age 59. http://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-regarding-Substantially-Equal-Periodic-Payments
[–]kyleko 9 points ago

This and Roth conversions are your answer. You can now think of this as one total portfolio.
[–]one_two_three_potato 3 points ago

You can think of it that way after the tax hit. Also, a 72(t) isn't a good idea for someone that retires very, very early.
As for the OP, I wouldn't say that you're over-invested, but I would consider your "long-term" money relatively well funded. If you can be as diligent in investing in your more "short term" monies (ETFs, individual stock, MLPs, etc) as you have been with your long term, you should be pretty well set in a few years.
Obviously this all depends on savings rate, tax rate, and retirement goals.
[–]tempacct111 1 point ago
EIL5?
[–]pled 3 points ago

With 72(t), aka SEPP, you can take regular payments out of your 401(k) at any age without penalty.
These payments are calculated with one of a number of different methods, all of which are based mostly on your life expectancy.
i.e., you can expect lower payments the younger you are.
These payments are called Substantially Equal Periodic Payments (SEPP). You have to keep these payments up every year until you reach normal retirement age. If you fail to take your payment, you pay a huge penalty, and you still have to keep taking your payments out.
[–]pled 7 points ago

You should think of it as 3 time periods, really: Before 401(k) available, After 401(k) available, and After mortgage is paid off. These 3 time periods represent vastly different investment and spending behaviors.
You can access your 401(k) money by rolling it over into a Roth IRA (paying normal taxes on that "income"). You can then take those rollover contributions out tax-free after they've been in the account for 5 years.
So your goal should be to build enough in liquid investments to float you for the first 5 years, then you can live off of those rollover contributions as they mature each year (or a combination of rollover contributions + other investments).
You didn't give us any details about your spending, but the math is pretty straightforward. If you're using a 4% withdrawal rate and you spend $40k/year, you need $200k in liquid investments to float you the first 5 years, and a 401(k) at $1M, allowing you to roll over 4% ($40k) every year until you die.
If your liquid investments grow in the 5-year wait period, then you obviously don't need the full $200k. You can do the math yourself and figure out exactly how much you need.
Lastly, I wouldn't consider your home equity as part of your investment portfolio in your retirement calculations, since it's not money that you can actually spend unless you downgrade into a less expensive home and pocket the difference.
[–]warriormonk5 6 points ago

72t isn't horrendously helpful to a 40 something in the current interest rate environment since it's based on I think the federal intermediate rate.
Roth conversions are going to be your best bet. You will need taxable savings to bridge the 5 year gap. Plus pay taxes on the conversion.
[–]bernoulli33 1 point ago

It starts to gain traction in your 40s. According to http://www.bankrate.com/calculators/retirement/72-t-distribution-calculator.aspx OP could take $26k/yr now.
[–]warriormonk5 3 points ago

You ignore inflation. Sure it's 26k now but it's also 26k 15 years from now. Both of the fixed methods are just that. Fixed. Once you open Pandora's box on that you can not stop without facing serious early withdrawal penalties. Most importantly you can't withdraw more until you hit 59.5.
The required minimum distribution is a better method since it's recalculated every year based on balance plus age but allows a smaller initial withdrawal. RMD is the only reasonable option for a 40 something if they plan on using 72t.
To the OP. You will need to look seriously into roth conversions to come close to withdrawing the typical 3.5% if all of your 800k is in 401ks as you claim. You will need taxable space money to bridge this gap.
If you are happy with the rmd method and how much it will provide in withdrawals then I wouldn't bother with Roth conversions.
[–]bernoulli33 2 points ago

Good points, thanks.
[–]oklaho 3 points ago

I personally try not to add housing into retirement calculations because it is as non-liquid as an asset can get. Unless you plan on selling it right at retirement.
[–]saywhatsmelly 1 point ago

Good questions. I'm in same boat you are in. Same age. About 1.1 mil in 401k/IRA/SEP between me and my wife. About 200k in regular tax brokerage and roth iras.
I usually just include as a single net portfolio when running FI scenarios.
[–]herbertmoore 1 point ago

I think that logically it is better to go with the 1.1M approach. Here is also something I have been thinking about: paying down your mortgage is essentialy a risk free way to earn FI returns - ie, if you are paying down a 6% interest loan, you are guaranteeing yourself that return because you will not have to pay it in the future. Therefore before buying any long term FI investment, I would consider whether it will be better than taking the guaranteed return on paying down debt.
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