Is saving solely in a 401(k) plan enough for your retirement? As you might expect, the answer to this question is usually - it depends.
The first thing I would mention is that, typically, when you are saving while you’re working, you want to be targeting a savings amount of about 20-30% of your net income. So, if you’re funding 20% or 30% into your 401(k) and that’s enough to cover that, then maybe it is enough to cover it - but there are some other factors you want to be considering with this too. Whenever you are funding a 401(k), typically, most people are funding it with pre-tax dollars. So the thing to consider there is that every dollar that you put into there, you are getting a tax benefit today - but in the future, when you withdraw it, you’re going to have to pay taxes on it. So we want to be thinking about how we can structure your retirement accounts so that not all of the money that you’re tapping into in retirement is taxable. This gives you a little bit of flexibility on how you can budget your income in retirement.
The second thing to keep in mind is that if you are planning on retiring early, prior to age 59-½, there are some limitations on how much you can actually pull out from a 401K or an IRA. So, if one of your goals is to retire early, it’s going to make sense to have some savings in a taxable account or a brokerage account that will allow you to tap into that to bridge the gap until age 59-½.
As I mentioned before, one of the biggest mistakes I think people make going into retirement is that they end up with a large 401K plan - 100% of which is taxable. Then, when you start planning your retirement income, if you need, let’s say, a $100,000 a year of retirement income, you’re effectively committing to $100,000 a year of taxable income, as opposed to if we’re able to save in a few different buckets, that allows us to mitigate some of those taxes and do some planning even in your retirement.
So there are a couple of other places that you can be putting funds -
- A brokerage account, which is effectively a taxable account, is like a bank account that you invest in.
- A Roth 401(k). Most people who have access to a 401(k) can fund Roth contributions, and what that means is that it's post-tax dollars being funded, but when you pull that money out for retirement, there are no taxes on it.
In an ideal world, we would have roughly a third of your investments in taxable sources like a brokerage account. A third of the investments in Roth funds, where there’s no tax, and then you would have a third of it in the pre-tax traditional kind of 401(k).
The other thing to kind of be considering with this is that if you do have other goals outside of retirement that you are saving for - it would likely make sense for you to have that money placed in an area that is a little more flexible, because like I mentioned, you can’t tap into the 401(k) until you're 59-½ and most cases - the other piece of that, of course, is that all of that is taxable when you withdraw it.
I think one of the things that Summit does really well is work with our clients early. If you’re in your 40s or 50s and you’re planning for your retirement, what we’re going to try and do is set up your plan so that you're saving into each of those buckets and in an appropriate amount, based on your goals, which will allow you to have a much easier retirement from a tax planning standpoint. It gives us a lot more flexibility and just makes sure that we don’t put all of that in the 401(k) bucket.