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Saving too much for retirement

Chris Farrell Jun 27, 2011

Question: I am someone who has drunk the Kool-Aid on saving as much for retirement as possible and maxing out contributions each year if you can since you can never “get that year to contribute” back. However…

I’m a 40 year old single female who is I think in good shape in terms of savings. I make a little south of $200k/year and have about $300k in savings ($150k in an IRA, Roth IRA, and my 401k; $120k in mostly index funds, and $30k liquid) and own my own home in a gentrifying area with a low fixed rate mortgage. I have some school debt at very low interest so I’m comfortable with that, and no other debt. I chose not to convert my IRA to a Roth IRA this year because I believe I’ll be in a lower tax bracket in my 60s than I am now, by “retiring” early (eg: going from being an executive to working part time somewhere fun).

I max out my annual 401k contribution and had been contributing to my traditional IRA each year as well — but my accountant has been somewhat discouraging me from putting more money into my Traditional IRA, suggesting I put the money into funds with fewer restrictions. So when is maxing out your IRA each year no longer a sound investment? Karen, Los Angeles, CA

Answer: I am with your accountant on this one. You’re a good saver. It will add to your financial flexibility to put money into taxable accounts.

Here’s the thing: Over the past three decades with the rise of the 401(K) savings has become synonymous with setting money aside for retirement. I think it’s time to break the grip that retirement has on our approach to savings. Now, don’t get me wrong. It’s important that you fund your retirement savings. It’s the financially prudent thing to do.

But savings also should be geared toward funding transitions over a lifetime. Retirement is only one of those shifts in activity, although it’s a major one. Saving isn’t about old age. Saving should be about funding career and lifestyle shifts throughout our lifetimes.

You mentioned that you’ll want to retire early and work part-time–a so-called job-tirement. Well, in that case having savings in taxable accounts will ease the cost of transition.

Yes, you’ll pay taxes on dividends, realized capital gains, and interest payments along the way with your taxable accounts (depending on the investment). But if you pull money out of your 401(k) you would pay a 10% penalty plus your ordinary income tax rate on the withdrawal. You could borrow from the plan, but that maneuver reduces the long-term return on retirement savings.

With a taxable account you can tap the money at any time without penalty. You’ll pay Uncle Sam a long-term capital gains tax rate when you cash it in–assuming you’ve owned the investment for more than a year–but it’s still at a lower rate than ordinary income tax rates.

Financial flexibility is valuable.

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