The easiest way to become a millionaire is to max out your 401k contribution every year. Just put the money in a good index fund and you should be a millionaire by the time you retire. That’s easy to say, but it is extremely challenging to follow this advice. Very few workers can max out their 401k when they start working. Most entry positions don’t pay that much and the cost of living is so expensive now. It’s tough to save for retirement at all. Even if they can, nobody wants to save for retirement when they’re 22. Everyone wants to spend money and have fun at that age. That’s a shame because compound interest works best with those early contributions.

I didn’t want to save for retirement when I started working either. I want to live it up like my friends and coworkers. Fortunately, my dad convinced me to start saving for retirement right from the start. I contributed enough to get the match, and then increased it to the max over several years. Those early contributions paid off handsomely. My 401k balance surpassed a million dollars in 2021! It took me 25 years to become a 401k millionaire. If I maxed out right from the beginning, it would have taken less time. At least I made it before 50.

Cutting back on 401k contributions

Unfortunately, I think 2022 was the last year I maxed out my 401k contribution. My earned income will be under the maximum contribution limit in 2023.

  • For 2023, the max contribution limit increases to $22,500.
  • The catch-up contribution limit for workers age 50 and older increases to $7,500.

I’m turning 50 this year so my 401k contribution limit will be $29,500. Sadly, my earned income will be way below that. This is why I can’t max out my 401k this year. However, it isn’t the only reason.

I’m worried that we might have too much money in our 401k. Mrs. RB40 is also a 401k millionaire. The problem is the required minimum distribution (RMD). The IRS requires savers to take RMD from their retirement accounts when they’re 73. The exception to this rule is the Roth IRAs. Roth accounts do not require withdrawals until after the death of the owner.

RMD is 23 years away, but let’s figure out if it will be a big problem.

The RMD problem

The 401k and traditional IRA are a great way to defer tax. You don’t have to pay tax on the money you contribute to those retirement accounts. Once you retire, you can make withdraw and pay tax at that point. The big advantage is that you’ll pay less tax during your peak earning years. The vast majority of workers have less income after retirement and they should be in a lower tax bracket. Basically, you will most likely save on taxes when you contribute to your 401k plan.

However, some super savers can run into an issue. Some retirees have Social Security benefits, pensions, and passive income. The RMD could push them into a higher tax bracket when it hits.

Let’s look at my case. Joe is 50 years old and has a million dollars in his 401k. He retired early and has enough passive income to pay for his living expenses. He doesn’t need to make a withdrawal. His 401k balance can grow for 23 years before RMD. At that point, his 401k will grow to an estimated 4 million dollars. As a result, his RMD will be $150,000 per year. That sounds like a lot today, but it’ll be peanuts in 2046. However, Joe also has Social Security benefits and passive income. His wife also has a similar amount in her 401k, Social Security benefits, and a pension.

All these income streams probably will push them into the higher tax brackets when they’re 73. I know, it’s better to have more money than less. But nobody wants to pay more taxes than neccesary. Is there a way to avoid RMD?  

RMD workarounds

Let’s face it. It’s better to minimize tax if you can. This is why we have retirement accounts in the first place. Workers can defer the taxes until after retirement. However, RMD can cause a problem because the IRS controls the timing of the withdrawal. If you have too much money in your retirement account, you’ll have to pay plenty of tax when RMD hits. There are a few ways to mitigate this problem.

1. Save less

The first way is to save less. If you save less, then your retirement accounts won’t get too big. This is another reason why I’m cutting back on my 401k contributions. This year, I’ll max out my Roth IRA contribution and save a few thousand in my solo 401k. My 401k is large enough already. Interestingly, it feels bad to cut back so drastically. I’ve been contributing as much as I can for so many years. I guess it’s good to ramp down as I get older.

2. Withdraw more

Another way to minimize the RMD problem is to spend more before you’re 73. This will reduce your 401k balance and RMD. I like this option. Mrs. RB40 and I plan to retire full-time when we’re 55. We can start withdrawing from our 401k plans and live it up a bit. We’ll use the rule of 55 so we don’t have to pay the 10% early withdrawal penalty.

3. Roth IRA conversion

Here is the best solution. You can convert a portion of your 401k to Roth every year. When we’re 55, we can withdraw $60,000 to spend. Then convert $29,000 to Roth. This strategy will keep us in the 12% tax bracket and move some money to our Roth IRA every year. (The 22% tax bracket starts at $89,451.)  

Early retirement is the answer

Most workers will never have to worry about RMD. The median 401k balance of retirees is around $70,000. RMD is a luxury. It’s always better to have too much money than too little. However, if you’re worried about RMD, the answer is early retirement. You’ll save less and draw down your 401k earlier. You can also take advantage of Roth IRA conversion to minimize taxes. The RMD shouldn’t be a big problem.

Alright, it seems I don’t have to worry after all. We’ll start withdrawing from our 401k plans when we’re 55. Also, we’ll convert a portion to Roth as needed. I’m pretty sure RMD won’t be a problem when we turn 73.

What do you think? Do you worry about RMD? Am I missing something?

*Passive income is the key to early retirement. These days, I’m investing in multifamily properties with CrowdStreet. They have many projects across the United States. Go check them out!

image credit: Luca Ambrosi

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Joe started Retire by 40 in 2010 to figure out how to retire early. After 16 years of investing and saving, he achieved financial independence and retired at 38.

Passive income is the key to early retirement. This year, Joe is investing in commercial real estate with CrowdStreet. They have many projects across the USA so check them out!

Joe also highly recommends Personal Capital for DIY investors. They have many useful tools that will help you reach financial independence.

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