I’m 41 and planning to retire in a few years off of $10 million – should I even factor my 401k savings into my financial plan?

Aesop’s timeless children’s fable, The Ant and the Grasshopper, extols the values of preparation, hard work, thrift, and saving. The moral of the fable is summed up as: “Work hard today to get ready for tomorrow.” Many millennials raised on this fable who have become fatFIRE (i.e., 8-figure targeted Financial Independence Retire Early) devotees. However, they may find that their huge nest eggs need to be managed for taxes ahead of their retirement age goal in order to avoid huge capital gains levies. 

fatFIRE  Dilemma – An Ant With Too Much Saved?

Although the fable, “The Ant and The Grasshopper” teaches the values of hard work and saving, fatFIRE devotees who ascribe to that strategy may be akin to ants who have saved too much without proper management.

A 41-year old Reddit poster is assiduously maxing out his 401-K and wants to amass a $10 million nest egg F.I.R.E. target  in the next few years. However, he is concerned over how to manage the funds to minimize the taxes at withdrawal, and his focus has been on growing his investment account; leaving the retirement account funds to just grow passively. His profile looks like this:

• 41 years old, married, in a very high-cost-of-living city.
• Net worth (not including house, retirement accounts and startup equity) is $6.5 million.
• His target of saving $750,000 per year and investing it has him on track to hit his $10 million goal in 2027.
• His 401-K gets matching funds from his employer, and across all of his retirement accounts, he has $1.5 million. 
• His current plan calculates that his safe withdrawal rate on the $10 million will allow him to leave the 401-K untouched until RMD triggers when he is in his 70s. 

His post-inquiry tried to solicit advice on any alternative strategies to manage his finances.

Controlling the Eagle’s Bite

US federal taxes take the biggest bite off the top of retirement account withdrawals.

US Federal Taxes on capital gains are what take the biggest bite out of gains accumulated in F.I.R.E. nest eggs unless strategic planning on managing assets is deployed. As the goal of F.I.R.E. is to retire early, any retirement accounts will inevitably face the 10% early penalty on top of federal taxes at the account holder’s highest tax bracket at the time, assuming that he or she is still in their most recent tax bracket while still employed. Luckily, there are some options that can be used as far das irect management of the retirement account is concerned, which can include:

• He can start partial conversions to a Roth 401-K and pay taxes at his current tax bracket.
• He can leave the funds to grow in the 401-K and just take required withdrawals under RMD rules, as per his current strategy.
• When he decides to officially retire, he can use the 72t SEPP Rule, which would allow for penalty-free withdrawals of the same calculated amount every year for a minimum of 5 years, until he reaches age 59 ½.  

Thinking Outside the Box – The Bigger Picture

There are also some additional financial considerations that may be applicable to the poster’s situation, although these are hypothetical assumptions. There are undisclosed details that may render some of these points moot.  However, given that he is viewing the 401-K funds as a “backup” to his F.I.R.E. strategy, these may be attractive:

• Larger Home Purchase: Depending on the parameters of his 401-K plan, he can possibly take a low-interest loan against the 401-K to fund the purchase of a larger home. As he is in a high-cost-of-living city, the real estate value will likely continue to rise in the future. Provided he sells his current residence afterward in under 6 months, he can take advantage of the 1031 exchange rule to eliminate capital gains, if any, that would be incurred. He can then repay the loan to the 401-K account and avoid the 10% penalty. Home equity in a more valuable property can provide other financial options during his and his wife’s golden years.
• Startup Equity: This is nebulous, but the term implies that he also has some share ownership in his current company. He should see if there are any penalties or forfeiture clauses if he decides to quit early. If not, then the company stock may have future value, which can increase exponentially if the company is planning to go public.
• Start a Part-Time Side Hustle and Make it a Full-Time Business to Lower Tax Bracket: If the poster has a hobby or pastime that can be registered as a standalone business, he can pursue it part-time, and then declare it as his new occupation post-retirement. All of the expenses he normally incurs in that pursuit can then be deducted against revenues. Losses that he incurs can be applied against capital gains from his primary account gains. As long as he registers a profit in 2 out of 5 years, the IRS will allow the company to continue, along with his reduced tax bracket, which sets a precedent for when RMD hits.