My 401K is gonna be pissed!

December 10, 2009 · 42 comments

Screen shot 2009-12-10 at Dec 10, 2009, 11.38.09 PMI made a pretty impulsive move yesterday. I decided to reduce my 401K contributions from 8% of my gross salary to 5%. *Gasp* Yes, that does mean I am going to have less in my retirement accounts, but don’t worry, I have a ninja-riffic plan in the works. If you read my post on Monday, you know I’m flirting with the idea of living outside of my spreadsheet. As a result, my net worth come retirement may be a little lower, but I think my overall quality of life will improve.

There were a few things that lead to my decision to decrease my contributions.

1) I was contributing 8% to my 401K and fully funding my Roth IRA each year. At my current income ($50K) that works out to 18% of my gross income being invested in retirement accounts. If you keep up with PF blogs, news stories, and TV shows, you’ll notice almost all ‘experts’ recommend a 20-something individual save between 10%-15% of his gross income for retirement. I was contributing 3% more than the average recommendation. Obviously, the more you contribute, the richer you will likely be. But I don’t really care if I have $3MM or $4MM in my account come retirement, as long as I have enough to live a comfortable lifestyle I’ll be a happy ninja. Oh, and the government only matches 5% anyways.

2) I essentially just gave myself a 3% raise. I have contributed 8% to my 401K since my first day of work (at the ripe age of 22). I’ve totally learned to manage my money being 8% poorer than I could be. I now will be taking home about $1,200 more per year (after taxes). That’s $1,200 I can use to save for a house, take a vacation, buy a moped, or rent out an entire movie theater for a private viewing of Twilight III. Sure, most of those expenses are not necessary, but don’t forget, I’ll still be socking away 15% for my gray hair days ahead.

3) The third, and probably most important, reason I decided to reduce my retirement contribution by 3% is this: I had no plans for the short term. Sure saving 18% for retirement is great, but guess what? That doesn’t make me rich until I’m 60 years old. What if I want to have a good chunk of change accessible in my 40’s? What if I want to retire early, but don’t want to be penalized for withdrawing from my retirement accounts? Well my friends, this is where the ‘short-term’ investing game comes in to play. I have to start exploring other means to grow my money. I have been so focused on retirement, I completely forgot to establish a game plan for my 30’s, 40’s, and 50’s.

Sure, I am taking away 3% from my retirement accounts each year, but that doesn’t mean I’m going to waste it. Instead I will transfer that money in to an investment vehicle of my choosing (stocks, bonds, etc). I need to start growing money for a 5, 10, and 20 year time horizon so I can do things like pay cash for the next vehicle I purchase, move up in house as my family size grows, pay for my kids college, and basically enjoy pre-retirement life.

As long as I contribute 15% of my gross income towards retirement, I have no need need (or reason) to contribute more. I’ve realized for me, anything above that 15% mark can be better served in short term mutual funds, real estate, cash, and bonds.

If you aren’t sure what percentage of your income you should be setting towards retirement, ask yourself this question. Would you rather have access to $6MM at age 60, or access to $1MM at age 45 and $3MM by age 60. I use to think I wanted $10MM all at retirement, but I now think I’d be just fine with $3MM in retirement if it meant I had $1MM available to me much sooner.

I have a couple questions for you all, how much do you contribute to retirement (if any), how much would you ideally like to contribute to retirement (if you are currently meeting that goal), and would you rather have $6MM at age 60, or $1MM at 45 and $3MM at age 60? What strategies have you established for pre-retirement goals? What short term investment vehicles do you recommend? Do you think I’m crazy? Any helpful hints, tips, and criticism is greatly appreciated :)

1 WellHeeled

You're out of your mind insane!!!!

Hahah just kidding! It sounds very reasonable and prudent to me. You're still contributing to your retirement, but now you're balancing that with your short term needs. For short-term / mid-term investing, I think a taxable balanced fund might be a good way to go. If you're saving for a down payment though, I'd probably do 100% cash for that portion.

2 lenelein

I think its a good idea for you not only to focus on things that are far ahead in the future. Live your life today, otherwise you might regret it later! I don't recommend spending all your mones now (although that would pay you quite some fun ;) ) but rather split your savings between today and retirement.

In my case I save about 10% of my income for retirement (fi you can call it income, since I'm currently unemployed. But it would be 10% if I had the job I'm looking for…) and have most of my other money in bonds. Though the 10% sound a little low, please keep in mind that here in Germany we get some federal pension after retirement. I would still like to invest more but simple equation: no income, no investement!

Some of my bonds are giving out money every year and are easily accessible (I have the money in 3 days, I tried), this money is planned for moving if I get a job. The other part is in bonds were I reinvest everything I get in interest. Those are also accessable but I plan to not touch them until 10 or 15 years. Maybe I need to buy a home? Or want to travel the world? Or whatever? I don't want to wait until 67 (current age for retirement in Germany) to live a happy life!

3 Allen

I currently save 5% in the TSP + 5% match. I made the decision late last year to decrease my contributions from 12% to 5% in order to beef up my emergency fund. It's worked, and I now have 6 months of expenses saved up. I plan to increase TSP to 6% in the new year, add 5% in a Roth IRA, and decrease my taxable savings a bit.

4 Debt Advice

Hey – why not. You're still putting 5% more than a lot of people aside aren't you!! :-)

5 Ashley

I think this is an excellent idea. It's all well and good to save millions for retirement, but (don't get offended or anything) you might not even make it to retirement. My dad is a kind of morbid weird dude and reminds us of this all the flipping time, but it's true. I wouldn't limit your lifestyle now or in the near future too much, because you might not be around to enjoy the life you were saving for later. Like you said, you want to have a good quality of life all the way through it. But at the same time, you shouldn't go blow all your money like crazy. It's a weird balance to have to achieve. But I think you're doing it right.

6 Kyle

I am currently contributing 13% to my 401k with a 6% match. Right now it is the only retirement money we are putting away for both me and my wife. One thing people overlook is that your 401k match is a small, yet adequate safety net. You can reduce your contributions for increased income in times of dire need. I essentially just put my raises straight to my 401k contributions because I haven't seen the need for the increased income yet.

7 @missalphawrites

It sounds like you've been doing a lot of thinking about the now and the thinks you want. Way to be mindful :)

PS: Buy your 401k some fine chocolate and she will forgive you.

8 @missalphawrites

*things. Sorry I just woke up…

9 SS4BC

I told you this on Twitter, but I think this is a great idea.

I'm a firm believer that you should only contribute to your 401k up until the point of match, then max out the IRA, and then put your money in investments that you can access anytime you need to. You'll still have money for retirement, but like you said, you'll also have money sooner – and that is a VERY powerful thing.

Good work, ninja!

10 Investing Newbie

Dude, Twilight III is called Eclipse! GET WITH IT.

I have been contributing way less than the 10% (I think like 5 or something) but only because I'm stashing that money for a fine condo in a couple of years.

11 JoeTaxpayer

My only comment – in 2010 taxable income over $34,000 is in the 25% bracket. I'd monitor this, and since you are using IRA to top off your savings, make the decision based on this. i.e. do your taxes in March, and use the traditional IRA if your taxable income is over the $34K, or Roth if under. You'll have plenty of time to add to Roth or convert to Roth in any 15% years.

12 Courtney

I max out my Roth each year and invest 10% of my income into 401k (with 33% of first 6% match). I plan on slowly raising this amount to 15%, but only because I don't think I will always work in the field that i am now. I'd love to own a bookstore someday and who knows what kind of retirement plan I might have then. The more I put in now, the better.

13 Jessies Money

I'm a Canadian girl…so I do nothing with 401's or Roths or those such things.

What I do (do) is put $100/month into a personal RRSP (registered retirement savings plan). By no means is this the max, but it's what I can do right now.

In October, 2010 I will be able to start participating in my employee pension plan. They match a mandatory 5% contribution. I'm hoping that by next year I've gotten another sweet raise and can up my contributions.

14 Money Maus

I max out my Roth IRA and contribute to my Roth 401k up to the match. So that's 14% and 6%, respectively. Add in my employer's match of 3% and that's 23% that I am contributing to my retirement. I'm happy with this!

For any expenses within the next 3-8 years, I put that savings in my INGDirect savings account. Don't want new car / house downpayment savings to go kablooey in the stock market! ;)

15 Forest

I currently put 10% in to my 401k and then try my best to max my Roth each year.

16 RainyDaySaver

I'm a bit bashful to admit that I did the same thing a few months ago — lowered my 401(k) contribution from 8% to 6% (match is only $1k a year, not a percentage, and I more than meet that with the 6%). We bought a house in June, and I wanted some extra cash flow for the time being. I can adjust the percentage quarterly, so I didn't feel it was too much of a rash thing.

17 30Something Finance

I max my Roth 401(k) by contributing between 9 and 10% of my salary. I can't do a Roth IRA, and like you, I've been thinking about how I should be planning for 1, 2, 5, 10, and 20 years out, rather than just looking ahead 40 years. At the same time, I have a ton of debt right now (mostly student loan debt and home mortgage/HELOC debt), so aside from keeping my emergency fund and fully funding my Roth 401(k), I put my money towards reducing the debt levels.

18 Tasha

I lowered my match from 3 percent to 1 percent about 6 months ago. I don't make very much money to start with, and when the economy took a tumble and my company got rid of its 401k match, I decided that I should have more money in my pocket and my savings account in case I lose my job.

19 livinglargevegas

we max out my spouse's 401K (and get a 6% company match) and max my 401a, 403b, and 457…as well as non-traditional IRAs. Yes, that is over $70,000 into pretax vehicles each year. Why? because our marginal tax rate is 35%. You are lucky you can still do a ROTH. I'd rather learn to live on less now. Short term we put about $1500 a month into a high yield savings account and $1000 a month into two mutual funds. How do we do it? We drive paid off 6 year old cars and bought a very small house. We do not rush out and buy the latest new TV or gadgets. Unlike you we don't plan to work until we are 67 or some other ancient age. We are 40 years old and plan to work 10 more years — at most.

20 livinglargevegas

doh. I mean "traditional" IRAs. and $60,000 pretax (the IRAs are non deductible contributions). time for more coffee.

21 livinglargevegas

I should add that I do not pay into social security (nor does my employer) so that is part of the reason we put more into retirement on our own.

22 Steve

My spouse and I are doing the same (except replace "non-tranditional IRAs" with "Roth IRAs"), though we're not even near the 35% bracket. It's just a matter of happening to make more money that we feel we need to spend to make ourselves happy. We just bought a new car and take we take a big vacation or two every year. Other than that… we could have bought a fancier car than we did, or get a cable plan, or go out to fancier restaurants, or hire someone to clean our house, or spend money any number of other ways. But we don't see the need because we are plenty happy with what we've got and our lives just as they are.

I only have vague plans for the money – something about retiring when the last of our (as yet unborn) children head off to college. But so what? We don't have any less vague plans for the present!

23 emis

You're right–in your 20s you should not sacrifice your ability to hit intermediate milestones, like buying a home, in order to contribute to your 401k IN EXCESS of what might be recommended and prudent level–I'd even argue that it's OK to contribute less to your 401k not in excess (though you should never miss out on the "free money" via matching, so always contribute at least what it takes to maximize that).

The #1 reason I contribute to my 401K today — to avoid taxes.

Right now the top of my income is taxed at 25-27% by the fed, plus 5.3% by my state, plus Social Security + Medicare… That's over 1/3rd of the money that I'm earning going directly to the government.

Now, if I have something VERY good to do with that 66 cents that I'd net–like buy a house, etc–then it's worth it to hang on to it. But if I am using that money for something more frivolous, like vacations, new/expensive car that I don't need, gadgets, etc, then it's a huge waste.

24 matt

I started late (29) so I contrib about 33%, at least until I catch up. Still puts me on track to retire with 2M- not that much with the eventual inflation, and not enough to pay for health care to live comfortably. 12% pretax to IRA + Full Roth funding + $3-5k into a brokerage acct annually.

25 WilburN

Obviously, grab any 401k match you can. Sounds like you're there.

Immediately after that, the best place for your money may be a Health Savings Account. That is, if you have access to a decent qualified high-deductible health plan (required to contribute to an HSA) and are healthy enough for it to make sense. I toss $6000 a year there ($1300 of that from my employer), and rarely do my wife and I have $1000 in medical bills a year. It's not only tax-sheltered, I don't even pay SocSec/Medicare on it (this is only true through an employee deduction plan). If I spend the money on medical expenses, I don't pay any tax at all, on contributions or gains. If I make it to 65, I can take it out taxably but no penalty (like a Trad IRA) or can use it tax-free for things like Medicare premiums and copay. But, for the mid-range? Health expenses are the big, big, big wild-card in trying to plan a budget for 15 years down the road. Having a targeted nest-egg for that makes a lot of sense.

I don't like what it does to health policy. It encourages healthy people to segregate themselves into high-deductible plans, making traditional plans all the more expensive. But, from a personal finance standpoint, they're an incredible vessel.

26 lisa

I recently had a similar change-o-heart. I have been saving lots for retirement trying to "make up" for my grad student fiance's inability to save right now. But it has since occurred to me, that there are many things i'd like to do before turning 65, like have kids, and someday a house, and travel while young before there are kids, and that funneling all of my savings into retirement was going to make all those things less likely to happen when I wanted them to.

27 JFW

I understand your methodology, but you are flat wrong. I can't tell if you are initiating the counter argument just to be cute, or if you are serious. I am a commercial banker, and will give you my opinion:
If you would like a better quality of life now a combination of several things. (a) Responsibly (no more than 2x tangible net worth) leverage your assets to raise debt which can fund your short or intermediate term needs; this includes borrowing up to $50,000 from the 401k you don't seem to understand, you pay yourself back the interest. (b) make more money. (c) Get a grip and live a realistic life style for someone making $50,000.
Nothing in your financial plan can out perform compound interest over a long period of time. The whole point of taking on debt to today is to finance your future earnings. However, when you reach retirement, your future earnings are largely fixed therefor borrowing is not realistic then.
In short, you just gave yourself less than $1,500 per year (due to taxes you must now pay) in a raise but lost $1,500×1.08^30 or $15,094 in 30 years.

28 TimeSeriesAnalysis

Do you really think he doesn't understand the concept of borrowing?

Economic and financial models are much more complex then you make them out to be. Borrowing from a 401k could be devastating if one looses there job.

In light of the recent downturn in our market, it should not be hard to realize the dangers of risk vulnerability.

29 JFW

My advice: leverage whatever asset you feel necessary to raise the $15,094 now. Continue your previous contributions. You would have to borrow that $15,094 over something like 18 years at 6% or it not to make sense. Better yet, borrow $15,094 from your 401k. Repay the interest to yourself, and when you're done, increase your contributions some more.

30 JFW

FYI, that $15,094 is just what you give up in the first year you reduce your contributions 3%. Over 30 years at 8% your actually giving up $198,613.

31 PunchDebt

I think you are missing the point of the post. I plan to have at least $3,000,000 waiting for me by the time I retire (in future money). I won't miss that $198,613 because it will be a negligible amount compared to my total retirement balance. If you read more than just this one post, you would understand my investment strategies better.

Also, if you paid attention you will notice I simply reduced my retirement contribution from 18% to 15%. I am still meeting the majority of personal finance recommendations to fund between 10-15% in retirement. I don't understand why my reduction of 3% is such a big deal. Would you then tell me to put every single dollar I had into a 401K or Roth IRA? I would sure hope not, at some point one should stop funding for retirement to meet their shorter term goals. I made the decision to put 15% in my retirement. If you think I'm stupid for being 24 and contributing 15% then feel free to ridicule, but you're just wasting your time.

32 Erik

The lowering of your 401k makes sense but I'll offer a counter point. I was fortunate to do some independent consulting during the dotcom era and was able to put between 50 to 100k into a SEP IRA in 3 years. This added to my other 401k contributions. The more that you have in your account early the less you need to put in later.

So to me the question isn't should you lower your 401k percentage, it is should you do it now?

The whole sense of compounding interest is just not intuitive and we all 'know' it but don't really internalize it. Once you have 200k in a retirement account and watch it year to year it starts to sink in. A sample 7% return increases the value of your account by 14k without adding anything. Now you realize that new contributions don't have the impact they did earlier.

It is easy to move the lever down but I'd say wait as long as you can before doing it.

33 @bex

I think the "save 20%" rule is a pretty solid one… if for no other reason that you'll probably spend 20% of your adult life not working… either retired or unemployed.

Of course, you are correct that it needs to be a blend of retirement savings, early retirement savings, short term savings, long term savings, college funds, and the obligatory "fun fund."

As long as you are maxing out your match on a 401k, there's no harm in putting a chunk into a S&P 500 index fund, or a municipal bond fund. They get you pretty decent growth which is ALMOST tax-free… but no penalties for early withdraw.

34 Mr. IRA Refugee

Basic math says taxes will go way Way WAY up in the next few years. As such I am reducing my pre-tax retirement account contributions. The math is simple: If you add up the 'official' debt (~$13 trillion), social security and medicare promises made( ~$50 trillion) and other stuff the government owes you'll get a total amount owed of $60 to $100 trillion (depending on whose numbers you use,). ALL federal tax sources now amount to only $2 trillion per year. Even if you make an optimistic calculation, factoring in even unreasonably low interest rates and assume only minor economic contraction from future tax increases, the overhang of a $50 – $100 trillion debt can't be handled with only $2 trillion in revenue. IRAs WILL be a prime raiding ground for money hungry congress! Money you put in is not safe and is highly at risk! There has even been some limited congressional discussions about 'nationalizing' IRAs – taking the money and giving you a credit in the social security system. The talk was along the lines of 'what if' discussions – but the fact that it progressed as far as it did shows an extreme danger to your future IRA balance! Put money in a tax deffered plan only at your extreme risk!

35 Tangurena

I'm 49. Most of my 30s, I could barely afford to contribute anything to my 401k. My ex had spent my 401k and IRA that I had saved up when I left a large manufacturer at age 29 (back then, they mailed you the check). I was 39 before I had another 401k. I spent 2 years out of work (not by choice) during my 40s, and even after the spectacular losses of 2008, I've got about $75k set aside for retirement.

While reducing contributions is your choice, and only you can say it is the correct one or not (and maybe not until looking one or 2 decades in retrospect), you might end up working at a places where a 401k is not an option at all.

Because I've gone so long with no ability beyond an IRA, and back then, the annual contribution limits were like $2k/year if and only if your employer lacked a retirement plan, it is my estimate that I need to sock away at least 30% of my income in order to have any sort of retirement before age 70. By the spreadsheet I'm using to track my bucks, it will be somewhere around 68-72 before I hit my first megabuck.

36 Ckb

15% is probably a good level. You may even find, if you do that through your 20s and 30s, that you can throttle back a bit from there.

One thing that wasn't clear to me was whether you were counting the 5% match as part of that 15%. You should! It's real money that you get just for being a good little saver. If you're not counting it, you're _really_ saving 20%, which is still an abundance of savings.

The caveat is that people like to use fancy terms like "consumption smoothing" to talk themselves out of prudence–I'm not saying you're doing this–because they imagine that "retirement" consists of a comfortable home and membership at the golf club, when the risk is that it involves nursing home care and medical bills. Savings has two purposes: to gratify future desires and to reduce the risk of poverty. The second of those is plainly the most important: you can take that cruise to Alaska now or later, but once you're disabled, you may no longer have to option to work and save.

37 PunchDebt

I did not include the 5% match, so you are correct that I'm saving 20%. Thanks for mentioning that.

I definitely agree, having enough money to survive comes first, vacations/golf/toys come second :)

38 Ckb

Then rock on, man. You're in the best work savings plan I've ever heard of (the TSP), you get a defined benefit pension if you keep playing on the Federal team (and I'd buy into FERS three or four times over if I could), and your savings rate is magnificent. I wish I'd been where you're at in my early 20s.

39 WilburN

There's one critical, crucial reason why 'retirement' (401k and IRA) savings are important.

It's not just the tax benefits.

It's that they won't be touched, 95% of the time, in a bankruptcy or a civil case.

Most bankruptcies in the US are at least partially medical-related, and most of those had some insurance. It's a reverse lottery out there, and you've got a ticket. On the civil judgements… you may think you have no enemies, but there are people out there who fund their lives by filing malicious suits against people.

40 Sandy L

I max mine out and have since I started working because

a) I already pay enough taxes and don't want to pay more than I have to and
b) I don't trust myself to not spend it if I had easier access.

I built and spent my emergency fund about 5 times before I realized the money was too easy to access..as soon as I started buying bonds with that 5 year penalty..I haven't spent a dime.

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