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Should I Still Contribute to a 401(k) if I Plan to Retire Early?

A reader writes in, asking:

“If I plan to retire well before age 59.5, should I still be contributing to my 401-K? In case it matters, I am in my late 20’s and the goal is to retire around age 40.”

For a few reasons, even if you plan to prior to age 59.5, it is still probably a good idea to contribute to a 401(k) account.

First, in order to retire very early, you’re probably going to have to save more per year than your maximum 401(k) contribution limit, so you will probably also have money in a Roth IRA and in taxable brokerage accounts, each of which can be accessed prior to age 59.5 without penalty. (At least, contributions made to the Roth IRA can be accessed prior to age 59.5 without penalty. For earnings, one of several exceptions to the penalty would have to be met.)

Second, there are several ways to get money out of a 401(k) account prior to age 59.5 without having to pay a penalty. For example, there is an exception to the 10% penalty for any distributions that are part of a “series of substantially equal periodic payments” taken over your life expectancy. The rules are complicated, and I would urge you to work with a tax professional if you plan to take advantage of this option. But if you follow the rules correctly, you can get access to (some of) the money as early as you want.

Finally, even if you retire at age 40, there will still (most likely) be many years after 59.5 for which you will need savings. According to the Social Security Administration, the average total life expectancy for a 40-year-old is approximately 80.5 years. In other words, on average, there would still be more than two decades of post-age-59.5 spending that must be funded.

In short, the 10% additional tax that applies to certain early distributions from 401(k) accounts shouldn’t necessarily be a big problem, even for somebody who plans to retire early. And it is unlikely that that drawback overwhelms the benefits of contributing to a 401(k) account (i.e., tax-deferred growth, potential for shifting income from high-tax-rate years to low-tax-rate years, and potentially an employer match).

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