Personal Finance

We're in our 40s with $9 million in net worth and we think we are ready to retire but we feel anxious

Kristin Hitchcock

Published: December 8, 2024 8:34 am

During one of my recent Reddit scrolls, I came across a Reddit post that sparked some interesting discussion. The poster was a 35-year-old woman who was married with two young children. Her question was about balancing 401(k) contributions and investments as she dreams of achieving financial independence and retiring early (FIRE) by age 45.

She is currently maxing out her 401(k) and making after-tax contributions but wonders if she should rebalance her portfolio to prioritize investment accounts that would give her more flexibility during the first two decades of retirement.

Maxing out your 401(k) is indeed extremely helpful. However, if you’re planning on retiring early, you may miss out on some financial flexibility by relying on these retirement accounts. This is a very common problem with those retiring early (and something we’ve covered before).

What are my recommendations? Keep reading to find out. 

24/7 Wall St. Key Points

• If you plan to retire early, having easy access to money is crucial. Contributing to taxable investment accounts offers more flexibility than a 401(k).
• 401(k)s offer tax advantages upfront, but taxable accounts can be more tax-efficient in the long run, especially if you’re paying attention to capital gains tax.
• Also: Take this quiz to see if you’re on track to retire (Sponsored)

The Situation

In the Reddit post, the poster shared the following financial details:

• Combined retirement accounts (401k, 403b, IRA): $775,000
• Combined investment accounts: $800,000
• Home value: $750,000 (with $33,000 remaining on the mortgage)
• Annual income: $400,000 (combined, from W-2 sources)

The poster’s goal is currently to retire early, at around 45 (which is just 10 years away)! However, her current retirement account savings will not be accessible for the first 20 years or so of her retirement thanks to age restrictions on withdrawals. 

401(k) Contributions vs. Investment Accounts

So, when is maxing out your 401(k) not a good option? Here are some things to keep in mind:

1. Access to Funds

One of the biggest concerns for someone planning an early retirement is how soon they can access their money. With a 401(k), you generally cannot access funds without penalty until you reach 59½ unless you qualify for specific exceptions.

Therefore, since the poster plans to retire at around 45, she won’t have access to her balance for some time after retirement. She’ll need to fund those years in some other way. 

Investment accounts are much more flexible. Contributions to taxable accounts don’t have any withdrawal restrictions, so you can access those funds at any time. For those retiring early, this can be a huge boon. 

2. Tax Implications

Contributing to a 401(k) offers immediate tax benefits. Contributions are pre-tax. Therefore, it isn’t counted as income. You’ll be able to reduce your taxable income for the year and lower the amount of taxes you owe. For those who are on a higher income, this can be a big benefit. 

That said, those funds are taxed when you begin withdrawing funds. 

On the other hand, investments in taxable accounts don’t offer the same tax breaks upfront, but you do get quite a bit more flexibility. Capital gains taxes apply when you sell investments for profit, too. The rate depends on how long you’ve held the investment. 

Long-term capital gains are generally taxed lower than ordinary income, so this can still be a tax-efficient option. 

3. Asset Growth Potential

Both retirement accounts and investment accounts grow over time. The main difference is that the funds placed in a 401(k) grow tax-deferred, meaning you don’t pay taxes until you withdraw your earnings. 

In a taxable account, however, you will pay taxes on dividends, interest, and capital gains each year.

If you plan to retire early, it makes more sense to contribute substantially to a taxable account so that you can have your money might away, even if that does mean paying more taxes.

4. FIRE Strategy and Time Horizon

Early retirees often use the “4% rule,” which assumes that you can withdraw 4% of your portfolio annually without running out of money. If you plan to retire early, you must ensure you have enough money (that you have access to) to meet this rule. 

For someone in the poster’s situation, the challenge becomes having enough liquidity in the early years of retirement before the retirement accounts become available. Allocating more investments towards taxable accounts may offer a better balance.