There are plenty of opinions on 401k retirement accounts out there and how you can build the proper amount of money to support a good retirement. A lot of people will tell you that you need to max out your retirement account at all costs in order to get the maximum amount of tax free growth.
The first thing that I’ll say is that any “saving” is good saving. Putting your money in a retirement account is way better than the alternative of not saving at all, or keeping all your money in a savings account. After we get past that key point, I’m not a huge fan of 401k funds. I believe everyone should contribute up to the point where your employer is matching your contribution. This allows you to maximize the amount of free money your employer is paying you. I’m lucky enough that my employer matches 6% for an 8% employee contribution, so I contribute just that amount and not a penny more. If you don’t have a 401k account to contribute to, a Roth IRA is a nice alternative to contribute to. There are 3 basic reasons why I want to keep a big chunk of my money in non-retirement accounts:
Who knows if I’ll be healthy or alive at 62.
Sounds depressing, I know. We are all saving to have enough money to do what we want when we are “retired”. Age 62 seems like a long way for me and I don’t want to wait until then to do what I want. Prime example: My father planned for a nice retirement and unfortunately, passed away at age 55. Seven full years away from age 62. I guess the good part of his planning, which I’m sure was an unfortunate consolation prize for him, was leaving the money to his family. We, of course, would give back every dime we ever earned to still have him around. My point here is, nothing in this life is guaranteed and I’d like my money to be available for me to spend well before age 62. Anything could happen between now and then. That being said, if/when I do hit 62, I’ll appreciate the portion I am contributing to my 401k as a bonus.
Dividend Investing has a great tax advantage
An added bonus to dividend stock investing is the fantastic tax rates that we are charged for receiving our monthly payments if we live frugally. You’ll pay the normal tax rates when you are accumulating your wealth, but a lot of us want to quit full time work before age 62. When we stop working, presumably our incomes will drop. Based on 2015 tax rates, dividend income is taxed a magical rate of 0.0% for the 10-15% tax brackets. The income totals for 10-15% tax brackets are up to $37,500 for single filers and up to $75,000 for married couples. During our working lives we might be above these limits, but maybe not in retirement. I know I won’t be above $75,000 per year. This is an incredible amount of income for not paying any federal taxes. My only explanation for why taxes are so low here is because there are a very small percentage of people living frugally off of dividend income in this country. In order to do that, as we’ve discussed, we must live a frugal lifestyle and have amassed a very large sum of money. The government is probably assuming if you have such a large net worth than you will be an average American over-consumer, driving around your fucking Escalade in traffic to get your non fat latté from Starbucks every morning.
With the strategy I’ve chosen, I find that the tax advantages of having a 401k are somewhat limited, given the fact that I won’t pay any federal taxes on my dividend income in semi-retirement in taxable accounts. I doubt I would ever have an income of $75,000 per year in dividends, but if I did, I know for a fact I wouldn’t be able to spend it all. Maybe in my old age, I’d be able to wear socks only once and then just buy new ones every week. That’s the dream, right? I don’t know, just thinking out loud…
My dividend income will continue on in retirement
Dividends payments don’t stop at any point. If we build a well diversified portfolio, then companies going out of business or cutting their dividends over time won’t affect our overall long term picture very much. We can anticipate this income for the rest of our lives. For that reason, our 401k accounts when we get to age 62 will only supplement our current dividend income. If you have a sufficient dividend income by age 62, the other money will only be excess. I’d rather have the increased passive income stream sooner rather than later. If you choose to contribute a certain amount to your 401k like myself, a good way to think about it is that income stream can balance out the inevitable increase in health care costs as you get into your “golden” years. God, I hate that phrase. Let’s call them your “relax without a care in the world” years.
Plan your money around your hopes and dreams
The important thing to stress here is that any savings are good savings. Some people max out their 401k accounts and it helps them sleep knowing that they will have a fortune to spend in retirement. I have no doubt that they will be well off down the road. You can’t go wrong with that strategy. I don’t strive for that type of life where I will keep earning money until 62 and then have TOO much money at that point, so 401k accounts don’t really suit me beyond my 8% contribution. Each of us is different, and we all have very different visions of our “perfect retirement”, so you should take it into consideration when deciding how to invest our savings.
For your reference, below is the tax bracket information for dividend taxation: