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Too much in retirement savings?

Chris Farrell Oct 9, 2009

Question: This may be an odd question in this economy. I’ve always tried to max out my pre-tax retirement savings. However, I’m wondering if this philosophy still holds true when your employer’s contribution is significant (i.e. it’s over 10%)? This is a contribution, not a match.

This puts me at pretty much 25% pre-tax retirement savings. I’m 35. Am I better off taking some of my money and putting it into something post tax for more diversification? Or should I still contribute the maximum because of the pre-tax benefits?

Basically, is there such a thing as putting too much into pre-tax retirement? Renee, Minneapolis, MN

Answer: You’re right–you are in a different situation than most people. It’s a nice place to be, too. But yes, I do think it’s possible to put too much into a particular tax-sheltered retirement savings plan. The reason is that you can’t get access to the money without paying a steep 10% penalty as well as ordinary income taxes if you withdraw the money before 59 ½.

I have two suggestions for you to consider. Both assume that reducing the amount going into your pre-tax retirement plan doesn’t affect the company’s contribution, which is incredibly valuable. First, if you come under the income restrictions I would set up a Roth IRA. The contributions are funded with after-tax dollars, but the gains are tax-free on withdrawal in retirement. An additional benefit is that you can always withdraw the contributions without penalty or tax if you need the money.

The other is to set up a long-term savings plan that minimizes your annual tax hit. But you can always access the money. For instance, you could set up an automatic savings program–a set some of money is invested every month. Some of your savings could be regularly invested in a broad-based stock index fund, such as the Wilshire 5000, the Russell 3,000, or the Standard & Poor’s 500. Uncle Sam annual levy is minimal since there isn’t a lot of trading activity with an index fund and when you sell stocks much of the gain will come under the lower capital gains tax rate. You could also load up on tax-deferred inflation-protected I-bonds for the fixed income portion of your portfolio (or Treasury bills, certificates of deposit, and other safe investments). It provides an anchor to your savings.

A regular monthly investment into a mix of secure and riskier savings in taxable accounts accumulates with time. It may be tapped to fund a career change, a medical emergency, a home, or retirement. This approach is a simple strategy that gives you a lot of flexibility.

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