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I've been hearing stories about people who invested a lot into their 401k and when they retired, they couldn't use the money fast enough. They said that there's a limit in terms of how much they can withdraw per year and that they'll die before using up all the money. Is this true?

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    Where did you get this information from? – Pete B. Jan 29 '18 at 11:44
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    You are probably hearing about people who must take minimum distributions even though they don't need the money. It makes optimizing your taxes harder. This is a good problem to have, really. – JimmyJames Jan 29 '18 at 15:10
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    from my parent's co-workers who recently retired... heh :) – Vic Jan 29 '18 at 15:57
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    It baffles me that people complain about paying taxes on money that they saved which saved taxes at the time. If you don't want to pay taxes on it then give it to charity! – D Stanley Jan 29 '18 at 18:43
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There are two facts you have wrong:

  1. There is no limit to 401(k) withdrawal amount. In fact. There is a minimum amount you have to withdraw based on your life expectancy to ensure that taxes are paid at some point.
  2. 401(k) amount do not "go away" when you die - they are passed on to your heirs.

Remember that a 401(k) is a tax deferred account. Contributions are pre-tax, meaning you do not pay the tax in the income that is contributed at that time - you pay the tax when you withdraw it. Plus, most 401(k) plans have a company match, so you essentially get extra income that will be available when you qualify for distributions.

So I don't see a scenario where you can have "too much" in a 401(k). You might have been better off if a roth 401(k) is an option and your tax bracket is higher at retirement (since roths are after-tax, you pay a lower tax percentage up front and get tax-free withdrawals), but at worst you're paying the difference between your tax bracket at retirement and the tax bracket when you earned the money, which is usually more than made up for by a company match.

  • sounds to me like if I'm going to put A LOT of money into 401k, then roth 401k is the way to go... – Vic Jan 29 '18 at 17:07
  • Minor quibble: it seems unlikely to me that someone would end up with "too much money" in their 401(k) if they only put in enough to max the employer match. So the marginal dollars they put in that were "too much" wouldn't have earned that match. – stannius Jan 29 '18 at 17:16
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    @Vic not necessarily - if your tax bracket now is higher than you think it will be at retirement, then getting the deduction now and paying the tax later is a better option (and vice-versa). – D Stanley Jan 29 '18 at 17:35
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    @DStanley That's not quite true. Tax bracket is the marginal tax rate. However tax deferring takes money out of 'top' (you get full deduction at marginal rate) while you fill from 'bottom' (you first fill your deduction, than 10% bracket...). While Social Security taxation makes things more complicated you need to effectively be in higher tax bracket in retirement than now for ROTHs to make sense. – Maciej Piechotka Jan 29 '18 at 19:27
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    @MaciejPiechotka I believe that's what I said - you'd be better off in a roth if your tax bracket is higher at retirement. – D Stanley Jan 29 '18 at 19:31
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That’s for sure incorrect.
You can take all the money out of all your retirement accounts, no matter which type, on any given day.

You need to consider though that for non-Roth accounts, this is considered taxable income. Whatever you take out from a 401(k) or Traditional IRA, you will have to pay taxes for; the more you take out within a given year, the higher your tax rate for the year will go.
In addition, if you are below the minimum age, you will owe an extra 10% tax on it.

Those consequences will probably lead you to (voluntarily) limit your taking out, to save on taxes. You will have to find a balance between taking enough to use it up before you die, and saving on taxes.

  • okay, but does it still make sense to invest a lot into 401k though? Let's say I have like 5 million dollars in my 401k when I retire... I'd have to pay a lot of taxes in order to use them all right? – Vic Jan 29 '18 at 2:53
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    Yes, but the contributions were deductible, so you saved that tax in earlier years. 401(k) is a tax deferred account, not a tax free account. – D Stanley Jan 29 '18 at 2:54
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    @Vic: Also, all the profits made from dividends & trading within the 401k are (AFAIK - I'm not an accountant) not taxable, only the money you actually withdraw. As for using up all the money before you die, why? As long as you have enough income to live comfortably, according to your preferences, having a big chunk of money invested gives you a nice feeling of security. And unless you'll terminally ill, or bent on suicide, how do you know when you're going to die? You could be like my neighbor, who lasted until 102 (and was in good health until the last few months). – jamesqf Jan 29 '18 at 4:11
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I've been hearing stories about...

It's one thing to sit down with a friend or relative and hear about their financial mistakes, and quite another to hear something second or third hand. In the latter case, you really have no ability to ask probing questions.

They said that there's a limit in terms of how much they can withdraw per year...

No. Once separated from the job, one can make regular withdrawals if over 55 when they left the job. If they are younger, they can roll the account into an IRA and take withdrawals over their projected lifetime. There are no number limits on the withdrawals.

The concern might be taxes, but look at the 2018 tax table.

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A married couple unfortunate enough to have saved $5M in their retirement accounts has a recommended 4%/yr withdrawal, or $200,000/year. The tax bill (assuming no deductions, the simplest return) is $30,819. They are in the marginal 24% bracket, i.e. the next $100 is taxed $24, but their tax divided by the $200K is 15.4%. Had they been in the 15% bracket while they worked, the Roth would have been a good choice, but to have saved that $5M, they likely spent much of their careers in higher brackets, 28%/33%.

To be clear, if you are talking pre-tax 401(k) vs other choices, it's possible (and actually probable) for the mix to not be 100% ideal, so in a sense, the "too much" may have some truth, but only in that regard.

  • unfortunate enough to have saved $5M. I hope I'm that unfortunate ;) – CactusCake Jan 30 '18 at 17:01
  • "Saved" is probably not entirely the right word: if one started back in the 1980s with moderate contributions & employer match, invested reasonably well (say index funds), and left the money untouched, then (untaxed) dividends & market growth mean you might have many times what you originally saved. – jamesqf Jan 30 '18 at 19:01
  • I am a bit in awe of the level of correctness you seek. And I think I'd agree that one saves, say $1M, and it grows to the $5M. In my answer above, I should have used "accumulated?" If we agree on the right word, I'll edit and delete our comments. With your approval. – JTP - Apologise to Monica Jan 30 '18 at 19:48
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Yes, too much of your money can be caught up in a 401(k) if you intend to retire early (before age 59.5). My brother is in this exact situation where he has enough to retire in his 30's. He can't do so effectively though, because he would need to access the money in his 401(k).

If you plan to retire before 59.5, then it would be wise to split your investment between an 401(k) for when you're older and other investments for when you are younger.

The other answers cover that there is no risk of not being able to spend all of your money before you die. This answer focuses more on the title of your question.

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    While plausible - it does not address the claims in the question - "can't use the money fast enough" - "die before using all the money". Certainly you can have a lot of your wealth tied up in a 401(k) - then the decision becomes do I pay the 10% penalty to tap it earlier? (the tax applies both before and after 59 1/2) – D Stanley Jan 29 '18 at 19:54
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    @danjuggler your brother should consider a Roth conversion ladder to get access to his money sooner, without penalties. – stannius Jan 29 '18 at 21:32
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    Tell your brother to look into substantially equal periodic payments. That's how you can access your retirement accounts early without penalty. – D Krueger Jan 30 '18 at 12:12

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