I made over $12,000 yesterday. No, I’m not a ridiculously compensated CEO or pro athlete. My stock portfolio didn’t reverse the course of the Dow Jones drop and skyrocket up 5% in spite of the market’s retreat, nor did I select a penny stock that quadrupled overnight. It didn’t even involve any illegal or illicit activities.
Actually, it was from five years of consistent saving, great timing for entering the market (starting investment in September 2008), and a generous employer contribution allowed by a lovely little tax loophole known as the 401(k). If you hadn’t guessed from my not so subtle title, my 401(k) plan became fully vested as I crossed the five years of service milestone. For those of you unfamiliar with vesting, it is a sequenced program where you gradually acquire a greater proportion of your employer’s 401(k) matching contributions as you spend more time with the company.
Generally, employees are not immediately entitled to any of their employer’s contributions, and it’s fairly typical for the plans to vest in 25% increments starting at the second year of service up until being fully vested at 5 years of service time. Most companies I have researched provide full vesting at five years of service time at the latest. The vesting process serves to encourage new employees to stick with their companies. It becomes more of a deterrent to leave when you can monitor the growing stockpile of 401k funds and realize how much you’d be leaving on the table by departing before the funds are fully vested. I have always planned on staying with my company for a minimum of five years after starting my career following college graduation. A large factor in this mindset has been that my company offers a wonderful 401(k) matching program that ranks among the top in its industry.
Now I haven’t loved or enjoyed slogging through long hours on stressful projects, but I’ve managed to overcome these obstacles in hitting the five year milestone. Fortunately, I am in both a good financial standing and fully vested where if I’m totally fed up with my situation, I can explore other opportunities as I’m building a substantial snowball of the f* you money lauded in personal finance circles.
The growth and sum of my 401(k) is pretty impressive, especially considering the fact that for my first few years, I only contributed 6% of my salary, and left many thousands of dollars in un-used funds below the maximum contribution levels. The reasons for this were twofold:
1) The fund options were riddled with unappetizing selections featuring high fees. You would be hard-pressed to find a mutual fund option presenting less than 1% net annual expenses. An extra 1% in expenses compounded over 40 years of saving adds up to astronomical differences in account values.
2) I had the early financial independence seed planted in my mind when starting my career and was more focused on stockpiling my net worth snowball in funds that were accessible before the silver hair set in and I was finally able to withdraw funds around age 59.
In the last two years, I have since reversed course, and started to max out the 401(k) account. The funds were finally adjusted to incorporate a S&P 500 index fund with expenses of only 0.05% and an international fund with a moderately high, but not preposterous 0.5% net expense ratio. I have adjusted my 401(k) asset allocation accordingly to have 80% of my funds in the S&P 500 index fund and the remaining 20% in the Internation fund. This fund combination provides a very respectable net 401(k) portfolio expense ratio of 0.14% which is at least a full eight times lower than my previous options where all funds exceeded 1%.
Furthermore, I decided to max out my 401(k) as I realized there were a couple different options to access the cash prior to silver hair and AARP membership without taking the standard 10% penalty which I would never advocate. The primary options include:
- 72(t)- The IRS calculates the substantially equal periodic payments (SEPP)one is entitled to in a complex calculation involving life expectancy, age, account value, and reasonable interest rate. The interest rate portion reflects the current Federal interest rates, so in our current low-rate environment, the payment amounts available would be reduced. I ran through a simple online calculator and a $100,000 account would provide ~$2,700 annually for someone in their mid-30’s. This alone won’t provide enough for a pauper to live on, but it would provide over 15% of my 2012 spending. With a 401(k) account that should be well over $100k and somewhere in the range of $150k by the time I reach FI, I anticipate this option could provide between $4,000-$6,000 in a more normal Fed interest rate environment. This would cover a sizable portion of my current expenses and still leave room for the account to appreciate for the interest earned above the approximately 3% withdrawn annually.
- Roth IRA Conversion- This provides another option for accessing funds during early FI. Upon reaching retirement, one can rollover 401(k) funds into a Roth IRA. Since you’re no longer employed, income will be minimal so the rollover will be treated with very low income tax rates. Once the funds are rolled into the Roth IRA, the principal invested, excluding any accumulated interest, may be withdrawn penalty free.
These are two primary reasons in addition to the nice income tax advantage, that I have decided to max my 401(k).
As a tribute to achieving full 401(k) vesting, I have been inspired to write a little poetry to celebrate the occassion:
Thanks for making me stay
How you have made me stick around
Even when I wore a frown
Your lure of riches
Made me put up with unsavory bitches
5 long years
With only a few shed tears
But now you are all mine
Every last employer contribution dime