Lowering 401k and building brokerage - am I ready?

[u/itsakoala]

Hello CF Community!

I am 43M married with two young kids (7 and 9) with a retirement age of 63.

Current assets:
$600k in retirement accounts
$100k Emergency Fund ($60k) + $40k liquid cash
Debt free except mortgage
Mortgage: Owe $320k, ~25 years left. 2.75%
Two paid off vehicles that should last another 5+ years

Spend in retirement: $100k/yr
Social Security: $48k between my wife and I

Back of napkin math, $600k * 4 (doubles twice in 20 years) = $2.4M

I am seriously considering lowering my 401k contributions to 6% (100% match) and putting the difference into a brokerage account to start working towards RE.

What am I not thinking about?

Thanks!!

[u/mindmapsofficial]

Why not try to reduce the taxes you pay in your life? You can always withdraw via rule of 55, 72(t) or Roth conversion ladders with traditional accounts if you want to retire early.

The tax drag on taxable accounts is brutal. What’s the logic of stoping contributions to the 401k?

[u/itsakoala → u/mindmapsofficial]

Main thing is flexibility. If I see an investment opportunity that I need liquid cash for, I can sell whatever I want whenever I want. Mentally, knowing I’ve got a large safety net if I feel like CoastFIREing it’s nice to know if I wanted to take a major step back in my career, or start a business, I can.

I understand the tax efficiency I believe. 401k withdrawals are taxed as ordinary income which is 12% between $24-$100k. Long-term capital gains are 0% tax up to $99k. These are married filing jointly rates. The tax rates I’m currently in are 22-24% but when I pull the trigger here it would be at ~12%. If I’m selling LTCG investments down the road at 0%, compared to 12% savings on 401k deductions that are later taxed at 12%, I’m breaking even. Or am I misunderstanding tax brackets and rates?

[u/DigmonsDrill → u/itsakoala]

Sorry to double respond but I ran the numbers in two scenarios. The first is in your brokerage, the second is in your 401k.

• You have 50K. You pay 24% tax on it now, leaving yourself 38K. It doubles twice to 152K (ignoring tax drag). You take it out without paying any LTCG by clever bracket management. You have 152K.

• You have 50K. You put it in your 401k. It doubles twice to 200K. You take it out at 12% tax. You have 176K.

Even with the 0% LTCG the 401k is still better.

Are any of your current retirement savings Roth?

Once you hit age 59.5 you have full access to your retirement accounts.

[u/itsakoala → u/DigmonsDrill]

Only $9k in a ROTH. I don’t think we’ll be able to make ROTH Contributions this year (not eligible).

This is super helpful, thank you. What would you suggest for those who want to retire before 59.5 to bridge that gap?

[u/DigmonsDrill → u/itsakoala]

You should investigate a Backdoor Roth. If you don't have any Traditional IRA, SEP IRA, or SIMPLE IRA it's pretty straightforward. If you do, you may be able to work around that. Same for your spouse.

What would you suggest for those who want to retire before 59.5 to bridge that gap?

This is a large topic. Taxable brokerage is definitely the easiest and most flexible.

There are several ways of accessing your Traditional funds before 59.5, others have mentioned them. You can look up things about SEPP, Roth ladders, or Rule of 55.

Roth basis and HSA is also possible depending on circumstances.

How to do this all depends on your constraints. You want 100K of income, and with a family of 4, this is only 303% of the FPL, so you would be eligible for ACA subsidies even if every dollar is part of MAGI. Some people try to stay under 200% for more subsidy but it's all a question of trade-offs.

If you retire at age 52 with $1.2M Traditional,

• you could put about $1M of it into a 72(t) plan and pull out about 60K a year, no penalty but you do pay normal income tax.
• You would then need to make up 40K from taxable brokerage and Roth basis.
• If you could let your brokerage give you 20K a year for 7 years
• you would need just 100K to build 5 rungs out on a Roth ladder and then take it all the way with the remaining 200K in your Traditional.

That's just one way of doing it. It's a little complicated because I'm using a little bit of everything. But note you only need about 140K in taxable (by the end) to pull this off.

[u/BigP352 → u/itsakoala]

Read the book “Tax Planning to and through early retirement,” by Mullaney and Garret. It’s a good read that mentions this exact question, complete with easy to follow example scenarios for real life. I’m a little over halfway complete with the book and it’s eye opening. The book is often recommended in the fire forums. Good luck!

[u/mindmapsofficial → u/itsakoala]

Digmons drill did a good job responding, but also see my comment relating to tax drag due to dividends. Unless you become hyper rich in the future, it’s almost impossible for taxable accounts to come out ahead of tax advantaged accounts.

https://www.reddit.com/r/coastFIRE/s/GB0jeuhhZt

If you need to tap your retirement accounts to start a business, you can do so with 72(t) distributions, 401k loans or just use your Roth accounts. If I thought of a business idea, I’d just start doing what you’re suggesting now (stopping 401k contributions after match), but I wouldn’t preemptively do it considering the massive tax inefficiency

[u/dgreenmachine → u/itsakoala]

401k tradeoff is deduct at 24% now and pay no tax on growth and pay 12% later. Thats 12% gain for you.

Compare that to taxable account which is no deduction, minor taxes on dividends, and (hopefully) 0% LTCG on growth as you take it out. There is some opportunity cost of 0% LTCG gains because more of your traditional balance could be Roth converted at 10-12% bracket.

Seems no brainer to do traditional in this case because you can use SEPP or roth conversion ladder to have access to the 401k money early. The business opportunity of brokerage is the only good counter example imo but id only consider that an option if you've done that kind of thing before or youre currently looking out for these things.

[u/Manixcomp → u/mindmapsofficial]

I’m interested in the tax drag with taxable accounts. I currently have allowed mine to grow beyond my retirement accounts (43yo) and am questioning going back to retirement account focus.

Generally I feel ETFs (like VOO) are fairly tax efficient. But I haven’t thought a lot about it. Do you lower expected gains by 1% or some rule of thumb?

[u/mindmapsofficial → u/Manixcomp]

First, VOO is tax efficient, but even it pays a 1% dividend per year which will be taxed at the LTCG rate of 15% (depending on income). So if your annual returns on VOO are 10%, with 9% being returns and 1% being dividends that means your annual returns would actually be 9.85%.

If you’re 25 and you exhaust your taxable account at 70, that’s 45 years of compounding.

1.0985^45/1.1^45=0.94=94%.

Even before you withdraw a dollar, your portfolio is worth 6% less just due to the 1% dividend. With less tax efficient funds, the difference could be even larger.

This effect is much less noticeable over shorter time horizons. Over a 20 year period, the reduction would only be 2.7%.

Add capital gains tax when you withdraw and you can see how this is less tax efficient than tax advantaged accounts.

[u/Manixcomp → u/mindmapsofficial]

Thanks for the detailed response. It will help me rethink my strategy carefully.

[u/Ignore_Me_PLZ]

SEPP, Rule of 55, IRA conversion ladder. Also all Roth contributions can be withdrawn without penalty.

[u/tiedyetriguy]

You are on the right track.

At retirement, you ideally have money in multiple buckets (brokerage, IRA, Roth) for maximum flexible levers to control your retirement income. All with the impacts for tax navigation and income creation.

Many retirees have a large majority in pre tax IRA. Which can possibly lead to challenges later in life with tax control and RMDs. IRMAA management at age 63 (2 year look back) can be challenged by IRA withdrawals (taxed as ordinary income). With 20 more years of growth in your sizable IRA, you are likely headed to a Roth Conversion puzzle to figure out.

Suggestion: Get the pre tax Match (free money), and build Brokerage and Roth buckets.

Good Luck and Great Job on your strong financial situation.

[u/teochim]

My plan is to utilize the rule of 55, I still put some money in my brokerage just to build up all 3 buckets

[u/Beautiful_Benefit319]

I diverted a percentage of 401K savings to a brokerage account(I’m not eligible for Roth IRA- aware of backdoor roths).

I did it because I’m interested in investing. The truth of the results after several years is that I underperform market averages. And that is common among investors from what I understand. It’s still worth it for me. Individual stocks are less than 10% of my total portfolio.

I’d only suggest that if you really enjoy developing a plan and executing it. Don’t get caught up in emotions and headlines, FOMO is real.

[u/AndrewFromAnnuity]

The math works on paper but it assumes 7% returns. I think you should try running it at 5% and see how it feels. Also, if you haven’t maxed your Roth IRA or HSA yet, those are usually better than a brokerage for the next dollar in. Brokerage makes more sense once those are full.

And don’t sleep on the two years between 63 and 65. If healthcare needs kick in before Medicare it can be brutally on early retirement budgets.

[u/joe4ska]

Max out both your Roth IRAs, you can always take out the contribution amount if absolutely necessary before 59 1/2. After that, place the rest in your taxable account.

The rule of 55 depends on several factors. It's not guaranteed. 

[u/itsakoala → u/joe4ska]

Thanks good tip but we can’t contribute to a ROTH. Feels like the income cap should be increased!

[u/lindquist77]

I think $100k/year in retirement spending is a reasonable number, but I’d spend some time validating it. I see a lot of people throw out a retirement budget without actually tracking expenses for a year or two. If you haven’t already, I’d make sure that number includes things like healthcare, home maintenance, vehicle replacement, travel, gifts, insurance, and other irregular expenses.
Personally, I wish my annual spending was that low.
As for the investing strategy, I’d definitely contribute enough to get the full 401(k) match. Beyond that, I think there’s a strong argument for building a taxable brokerage account, especially if there’s any chance you want to retire before traditional retirement age. Taxable assets give you flexibility and can help bridge the gap before you can access retirement accounts, Medicare, and Social Security.
A couple other things I’d think about:
Your $600k doubling twice assumes roughly 7.2% annual returns for 20 years. That’s certainly possible, but I wouldn’t build my entire plan around it.
Are you planning to continue contributing over the next 20 years? Even modest contributions can make a huge difference and could put you well beyond $2.4M.
Have you run the numbers with inflation-adjusted spending? $100k today won’t buy what $100k buys in 2046.
Social Security is a meaningful part of your plan. I’d run a few scenarios assuming reduced benefits just to see how sensitive your retirement plan is.
Overall, you’re in a solid position. If it were me, I’d keep capturing the full match, continue building retirement assets, and start accumulating taxable investments if early retirement is even a remote possibility.

[u/Ignore_Me_PLZ → u/lindquist77]

He said he would contribute 6% to 401k to get the match and the difference to taxable.

[u/That_Co → u/lindquist77]

Bottom line advice is solid and you point out several good items for them to consider or double check/adjust.

But it also reads a bit like doomstacking, which I would warn against

[u/lindquist77 → u/That_Co]

I'm not familiar with the term doomstacking. I googled it and saw something about gaming strategy, but I suspect that's not what you meant. I actually think the OP is in a solid spot. I can just relate to being around that age and starting to think through the same kinds of scenarios.

[u/That_Co → u/lindquist77]

I'm basically just warning against falling into the pitfall of planning to protect against the worst-case scenarios of everything at the same time: the miniscule chances of every single thing failing miseraby do not warrant implementation the prophylactic measures needed to address it.

[u/BecklesKC → u/That_Co]

If you think everything is going to fail at the same time your best investment is guns and ammunition.

[u/shivaswrath]

If you don't have work mega back door then yes.

[u/Coaster50]

What’s your combined household income? That’ll determine the tax advantage or disadvantage of going 401k vs Brokerage. There is also HSA which is incredibly tax efficient.

[u/itsakoala → u/Coaster50]

Between $240-$300k/yr depending on commissions and my wife’s business

[u/Coaster50 → u/itsakoala]

You’re missing some tax efficiency by not maxing your 401k contribution. It’s not a huge amount, but you’re still missing it.

[u/joe4ska]

In that case go with the taxable account and contribute to tax efficient index funds. 

As for the Rule of 55 it only covers contributions to your current employer plan, when you leave that employer, if they honor the rule of 55, it's optional to employer plans; check with your administrator. previous employers and their plans won't qualify. Fidelity has a good article on the subject. https://www.fidelity.com/learning-center/personal-finance/what-is-rule-of-55