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?
There are two facts you have wrong:
- 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.
- 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.
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.
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.
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.
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.