Significantly Decrease 401k contributions?

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novolog
Posts: 47
Joined: Tue Jan 30, 2018 6:24 pm

Significantly Decrease 401k contributions?

Post by novolog »

Hello Bogleheads,

My wife and I have been saving since we graduated college, first to pay down debt, and next to save for retirement. We are at a point in our life where we are planning to have children within the next couple years, and see a need for a house in the next ~5 years. We are considering saving money for a down payment on a house, and slowing down contributions to tax-advantaged accounts. We feel time is on our side for these accounts to grow since we have 30 years before we will access them.

Let’s make the following assumptions:
1) $184k in tax-advantaged accounts with 95% equities (this is actually a reality)
2) Average annual total real return of 5% on said tax-advantaged portfolio over next 30 years
3) We both continue to max out Roth IRAs until we are roughly 40 years old ($12k per year)
4) We continue to contribute to 401k’s, but only enough to get match from employer, until we are roughly 40 years old ($4k per year)

I feel reasonably confident that $1.5million (in 2020 dollars) will be 25x expenses when we are both 60 years old.

Given the assumptions above, if my math is close, In 30 years our tax-advantaged accounts should be around roughly $1.5million, which is the target.

The house would probably be $450k or less, with a 20% down payment.

————————————————————————————————————————————————————————————

QUESTIONS:

1) Are these reasonable assumptions?

2) If our goal is to purchase a home and generally have more liquidity, is it reasonable to continue our savings rate of roughly 40% but divert nearly the entire annual 401k contribution towards cash and/or taxable accounts at this time?

3) I have been lurking this forum for a while and I anticipate some readers will suggest simply continuing to max the 401k and using a Roth conversion ladder if we need the money earlier than 60 years old, but I am hesitant to put us in a position where we have extra capital tied up behind a tax loophole that I am not very familiar with. I am curious to know your thoughts on this?

4) Is this too much house?

EDIT: in Question #3 I meant to say Roth Conversion Ladder, not backdoor Roth.

—————————————————————————————————————————————————————

STATS BELOW:

28 Male & 28 Female, Married

INCOME
His Pre-tax Salary: $80,000 + $6,000 annual bonus
His After-tax & contributions Monthly income: $3,800
Her Pre-tax Salary: $80,000
Her After-tax & contributions Monthly income: $3,600
Total After Tax & contributions Monthly Income: $7,400

EXPENSES
His Monthly Expenses: -$3,400
Her Monthly Expenses: -$3,300
Total Monthly Expenses: -$6,700

ASSETS
His 401k: $67,500
His Roth: $19,500
His HSA: $1,000
His Savings Account: $12,000
Her 401k: $75,000
Her Roth: $22,000
Her Savings Account: $29,000
Total Assets: $226,000

DEBT
No Debt

Asset Allocation
His 401k
FXAIX Fidelity 500 Index Fund - Institutional Premium - 57% - ER: .015%
FSMDX Fidelity Mid Cap Index Fund - Institutional Premium - 7% - ER: .025%
FSSNX Fidelity Small Cap Index Fund - Institutional Premium - 6% - ER: .025%
FSPSX Fidelity International Index Fund - Institutional Premium - 24% - ER: .045%
FPADX Fidelity Emerging Markets Index Fund - Insitutional Premium - 6% - ER: .075%

His Roth
SCHB Schwab US Broad Market ETF - 100% - ER: .03

Her 401k
Vanguard Target Retirement 2055 Fund - Investor Class - 100% - ER: .15%

Her Roth
SWYJX Schwab Target Data 2055 Index Fund - 100% - ER: .13%


Thank you,
Novolog
Last edited by novolog on Tue Jun 30, 2020 5:59 pm, edited 4 times in total.
02nz
Posts: 5691
Joined: Wed Feb 21, 2018 3:17 pm

Re: Significantly Decrease 401k contributions?

Post by 02nz »

You're in really good shape with retirement savings for your age. You can afford to back off the retirement contributions a bit in favor of saving for a downpayment, but you may not need to (or not by as much as you think). On your questions:

1. 5% real real return is a bit optimistic, I would tend toward 3-4% real, to be on the safe side (valuations are pretty high by historical standards), and also because as you age your allocation should become more conservative (more bonds, so lower returns on average).

2. How much of your Roth IRAs is contributions (not growth)? Those can be withdrawn at any time for any reason without penalty. And you can each withdraw $10K in earnings for a first-time home purchase. I would keep this in mind before you back off contributions to the tax-advantaged accounts. You don't want to set aside $90K in taxable, then say the home purchase doesn't work out for whatever reason, and the tax-advantaged space and tax savings in traditional 401k are gone forever.

3. Read this for the ways to access retirement savings (including tax-deferred) before age 59.5: https://www.madfientist.com/how-to-acce ... nds-early/. (Roth conversion ladders are not a tax loophole; Roth conversions bring tax revenue from the future to the present and thus make the government's budget numbers look better; we can't speculate here about the future but you can draw your conclusions about whether they're going away.) And: If you retire from an employer in the year in which you turn 55, or later, you can withdraw from that plan without the 10% early distribution penalty. You need to make sure your plan allows that kind of withdrawal, though, and you cannot retire at 53 and wait until 55, you have to retire no earlier than the year in which you turn 55. In short, tax-deferred accounts are more flexible than many realize.

4. Some people will say so but I think it's fine.
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novolog
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Re: Significantly Decrease 401k contributions?

Post by novolog »

Thank you for the reply 02nz
02nz wrote: Tue Jun 30, 2020 4:43 pm 2. How much of your Roth IRAs is contributions (not growth)? Those can be withdrawn at any time for any reason without penalty. And you can each withdraw $10K in earnings for a first-time home purchase. I would keep this in mind before you back off contributions to the tax-advantaged accounts. You don't want to set aside $90K in taxable, then say the home purchase doesn't work out for whatever reason, and the tax-advantaged space and tax savings in traditional 401k are gone forever.
Probably 75% of our Roth accounts are contributions

Even with moderate growth in our income, we probably will not be able to save for a down payment on a house within 5 years unless we eat into the 401k contributions. I agree that the tax-advantaged space is valuable.
02nz wrote: Tue Jun 30, 2020 4:43 pm 3. Read this for the ways to access retirement savings (including tax-deferred) before age 59.5: https://www.madfientist.com/how-to-acce ... nds-early/. (Roth conversion ladders are not a tax loophole; Roth conversions bring tax revenue from the future to the present and thus make the government's budget numbers look better; we can't speculate here about the future but you can draw your conclusions about whether they're going away.) And: If you retire from an employer in the year in which you turn 55, or later, you can withdraw from that plan without the 10% early distribution penalty. You need to make sure your plan allows that kind of withdrawal, though, and you cannot retire at 53 and wait until 55, you have to retire no earlier than the year in which you turn 55. In short, tax-deferred accounts are more flexible than many realize.
Thanks - I am familiar with this blog

For some reason I am attracted to the idea of treating the 184k in tax-advantaged as a pension that we get access to at 60, and simply forgetting about it for now, focusing instead on a taxable account we can access in the near term, should we need to.
tashnewbie
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Joined: Thu Apr 23, 2020 12:44 pm

Re: Significantly Decrease 401k contributions?

Post by tashnewbie »

Are you currently maxing 401k contributions?

Even if you continue to make the same 401k contributions and max Roth IRA contributions, you could save almost $35k ($10,500 - $6,700 x 12 - $12k for Roth IRAs) in one year and $70k in 2 years. I just don't see why you would need to decrease retirement savings this far out from an expected home purchase, especially since, as the comment above noted, there is the ability to withdraw penalty-free from those accounts for a first-time home purchase.

You'll want to think about whether both spouses will continue to work after kids are born. If one spouse decides to stay home for some time, it could be difficult to pay a $360k mortgage on one salary. What is the anticipated salary growth for each of you?
02nz
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Re: Significantly Decrease 401k contributions?

Post by 02nz »

So you need a $90K down payment, you have 40K in cash, so need another $50K. With about $3800/mo in positive cash flow, you should be able to save that up in just over a year, no? Or you can tap most or all of your Roth IRA and have almost all the down payment already. Or maybe that $40K is your emergency fund and you don't want to tap that?
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novolog
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Re: Significantly Decrease 401k contributions?

Post by novolog »

tashnewbie wrote: Tue Jun 30, 2020 5:20 pm Are you currently maxing 401k contributions?

Even if you continue to make the same 401k contributions and max Roth IRA contributions, you could save almost $35k ($10,500 - $6,700 x 12 - $12k for Roth IRAs) in one year and $70k in 2 years. I just don't see why you would need to decrease retirement savings this far out from an expected home purchase, especially since, as the comment above noted, there is the ability to withdraw penalty-free from those accounts for a first-time home purchase.

You'll want to think about whether both spouses will continue to work after kids are born. If one spouse decides to stay home for some time, it could be difficult to pay a $360k mortgage on one salary. What is the anticipated salary growth for each of you?
Yes - currently maxing 401k contributions.
02nz wrote: Tue Jun 30, 2020 5:21 pm So you need a $90K down payment, you have 40K in cash, so need another $50K. With about $3800/mo in positive cash flow, you should be able to save that up in just over a year, no? Or you can tap most or all of your Roth IRA and have almost all the down payment already. Or maybe that $40K is your emergency fund and you don't want to tap that?
Apologies - I think my income numbers are confusing folks. The pre-tax income number would be if we did not contribute to our 401ks. Almost the entirety of that difference between take-home pay and expenses is going towards tax-advantaged accounts. In other words, we don't have that extra income to save on top of the 401ks.
tashnewbie
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Re: Significantly Decrease 401k contributions?

Post by tashnewbie »

novolog wrote: Tue Jun 30, 2020 5:33 pm Apologies - I think my income numbers are confusing folks. The pre-tax income number would be if we did not contribute to our 401ks. Almost the entirety of that difference between take-home pay and expenses is going towards tax-advantaged accounts. In other words, we don't have that extra income to save on top of the 401ks.
How much do you currently bring home, after maxing 401k contributions?
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novolog
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Re: Significantly Decrease 401k contributions?

Post by novolog »

tashnewbie wrote: Tue Jun 30, 2020 5:37 pm
novolog wrote: Tue Jun 30, 2020 5:33 pm Apologies - I think my income numbers are confusing folks. The pre-tax income number would be if we did not contribute to our 401ks. Almost the entirety of that difference between take-home pay and expenses is going towards tax-advantaged accounts. In other words, we don't have that extra income to save on top of the 401ks.
How much do you currently bring home, after maxing 401k contributions?
Just updated original post so it's visible to everyone, but about $7,400
marcopolo
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Joined: Sat Dec 03, 2016 10:22 am

Re: Significantly Decrease 401k contributions?

Post by marcopolo »

I think reducing your 401k contributions for a few years to save for house down payment is reasonable.

You already are off to a great start, I am pretty sure my net worth was close to 0 at your age.

If you are in a stable job, one thing you could look into is if your 401k allows for loans. If so, that might be a way to save the money for the down payment within the 401k, thus saving the tax-deferred space.
Once in a while you get shown the light, in the strangest of places if you look at it right.
tashnewbie
Posts: 934
Joined: Thu Apr 23, 2020 12:44 pm

Re: Significantly Decrease 401k contributions?

Post by tashnewbie »

Are you in a high COL area? Your monthly expenses seem high for 2 adults.

Are you currently maxing Roth IRA contributions? Looks like you have $700/month after expenses, which is not enough to max both Roths.

I agree that you have done very well at your age (my NW was nowhere close to yours at the same age...actually mine was negative because I was in law school and had student loans).

It could make sense to reduce 401k contributions or look into withdrawing that money for first time home purchase. Also I recommend scrutinizing your budget and optimizing where reasonably possible.
majiaknight
Posts: 147
Joined: Tue Jan 26, 2016 2:55 pm

Re: Significantly Decrease 401k contributions?

Post by majiaknight »

novolog wrote: Tue Jun 30, 2020 4:30 pm Let’s make the following assumptions:
1) $184k in tax-advantaged accounts with 95% equities (this is actually a reality)
2) Average annual total real return of 5% on said tax-advantaged portfolio over next 30 years
3) We both continue to max out Roth IRAs until we are roughly 40 years old ($12k per year)
4) We continue to contribute to 401k’s, but only enough to get match from employer, until we are roughly 40 years old ($4k per year)

I feel reasonably confident that $1.5million (in 2020 dollars) will be 25x expenses when we are both 60 years old.

Given the assumptions above, if my math is close, In 30 years our tax-advantaged accounts should be around roughly $1.5million, which is the target.

The house would probably be $450k or less, with a 20% down payment.

————————————————————————————————————————————————————————————

QUESTIONS:

1) Are these reasonable assumptions?
Mostly. I don't understand why $1.5m in 2050 is your target assuming no inflation in 30 years? Anyway, I don't think it matters that much as you're still very young and will resume maxing 401K probably after you get enough down payment.

2) If our goal is to purchase a home and generally have more liquidity, is it reasonable to continue our savings rate of roughly 40% but divert nearly the entire annual 401k contribution towards cash and/or taxable accounts at this time?
I had done the same to purchase my current house. Remember your salary may also increase in 3-5 years when you get promoted. I'd suggest you save the extra 401K money after getting company match now and reach your downpayment goal early so that you may start house hunting right before your wife is pregnant. When your family grows, you need a bigger house for the baby room with extra storage places and for hosting visiting parents.

3) I have been lurking this forum for a while and I anticipate some readers will suggest simply continuing to max the 401k and using a Roth conversion ladder if we need the money earlier than 60 years old, but I am hesitant to put us in a position where we have extra capital tied up behind a tax loophole that I am not very familiar with. I am curious to know your thoughts on this?
I think someone may suggest penalty free withdraw from Roth IRA. As we are talking about ~$90K in 3-4 years, you didn't lose much by not maxing pre-tax 401K. No need to complicate things by touching Roth IRA. Your family's current combined income is not high so it could be possible that contributing to Roth 401K makes more sense if you could become high incomer in the future which may result in higher tax in 401K withdrawal in retirement. So, I don't think you need to over think those tax planning tricks for long-term investment when you actually need the money in the next 3-5 years for the down payment.

4) Is this too much house?
No, I think you could easily afford it.
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novolog
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Re: Significantly Decrease 401k contributions?

Post by novolog »

tashnewbie wrote: Tue Jun 30, 2020 6:24 pm Are you in a high COL area? Your monthly expenses seem high for 2 adults.

Are you currently maxing Roth IRA contributions? Looks like you have $700/month after expenses, which is not enough to max both Roths.

I agree that you have done very well at your age (my NW was nowhere close to yours at the same age...actually mine was negative because I was in law school and had student loans).

It could make sense to reduce 401k contributions or look into withdrawing that money for first time home purchase. Also I recommend scrutinizing your budget and optimizing where reasonably possible.
Yes we live in a HCOL area/city.

We are maxing Roth contributions every year, but now that I look at our cash flow, it's likely we've been able to max because of gifts here and there on birthdays/wedding from family. We may not be able to max in the future given our current income and expenses.

I think you are right that we could save even more and tighten the budget, however, 40% of income already seems like quite a bit.
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novolog
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Re: Significantly Decrease 401k contributions?

Post by novolog »

majiaknight wrote: Tue Jun 30, 2020 6:35 pm
novolog wrote: Tue Jun 30, 2020 4:30 pm Let’s make the following assumptions:
1) $184k in tax-advantaged accounts with 95% equities (this is actually a reality)
2) Average annual total real return of 5% on said tax-advantaged portfolio over next 30 years
3) We both continue to max out Roth IRAs until we are roughly 40 years old ($12k per year)
4) We continue to contribute to 401k’s, but only enough to get match from employer, until we are roughly 40 years old ($4k per year)

I feel reasonably confident that $1.5million (in 2020 dollars) will be 25x expenses when we are both 60 years old.

Given the assumptions above, if my math is close, In 30 years our tax-advantaged accounts should be around roughly $1.5million, which is the target.

The house would probably be $450k or less, with a 20% down payment.

————————————————————————————————————————————————————————————

QUESTIONS:

1) Are these reasonable assumptions?
Mostly. I don't understand why $1.5m in 2050 is your target assuming no inflation in 30 years? Anyway, I don't think it matters that much as you're still very young and will resume maxing 401K probably after you get enough down payment.

2) If our goal is to purchase a home and generally have more liquidity, is it reasonable to continue our savings rate of roughly 40% but divert nearly the entire annual 401k contribution towards cash and/or taxable accounts at this time?
I had done the same to purchase my current house. Remember your salary may also increase in 3-5 years when you get promoted. I'd suggest you save the extra 401K money after getting company match now and reach your downpayment goal early so that you may start house hunting right before your wife is pregnant. When your family grows, you need a bigger house for the baby room with extra storage places and for hosting visiting parents.

3) I have been lurking this forum for a while and I anticipate some readers will suggest simply continuing to max the 401k and using a Roth conversion ladder if we need the money earlier than 60 years old, but I am hesitant to put us in a position where we have extra capital tied up behind a tax loophole that I am not very familiar with. I am curious to know your thoughts on this?
I think someone may suggest penalty free withdraw from Roth IRA. As we are talking about ~$90K in 3-4 years, you didn't lose much by not maxing pre-tax 401K. No need to complicate things by touching Roth IRA. Your family's current combined income is not high so it could be possible that contributing to Roth 401K makes more sense if you could become high incomer in the future which may result in higher tax in 401K withdrawal in retirement. So, I don't think you need to over think those tax planning tricks for long-term investment when you actually need the money in the next 3-5 years for the down payment.

4) Is this too much house?
No, I think you could easily afford it.
Thanks for the replies. The 5% expected return was real return, so in this assumption we are counting inflation. However, whether 5% real is a reasonable expected return over the next 30 years is certainly up for debate and something I'm interested in discussing.
It would certainly be nice if my salary grows in 3-5 years, but I think we'd like to plan for the worst and hope for the best :sharebeer
02nz
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Re: Significantly Decrease 401k contributions?

Post by 02nz »

novolog wrote: Tue Jun 30, 2020 7:16 pm Thanks for the replies. The 5% expected return was real return, so in this assumption we are counting inflation. However, whether 5% real is a reasonable expected return over the next 30 years is certainly up for debate and something I'm interested in discussing.
It would certainly be nice if my salary grows in 3-5 years, but I think we'd like to plan for the worst and hope for the best :sharebeer
Yes, "plan for the worst and hope for the best" by not assuming 5% real return! :happy
02nz
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Re: Significantly Decrease 401k contributions?

Post by 02nz »

novolog wrote: Tue Jun 30, 2020 7:16 pm I think someone may suggest penalty free withdraw from Roth IRA. As we are talking about ~$90K in 3-4 years, you didn't lose much by not maxing pre-tax 401K. No need to complicate things by touching Roth IRA. Your family's current combined income is not high so it could be possible that contributing to Roth 401K makes more sense if you could become high incomer in the future which may result in higher tax in 401K withdrawal in retirement.
(Note: The quote is of majiaknight, not OP) Why not plan on tapping the Roth IRA for the down payment (there's nothing complicated about that), and only reduce 401k contributions by enough to save the shortfall in taxable in the time frame needed by OP? That way, if the house purchase doesn't work out for whatever reason, they haven't given up nearly as much taxable space. If they do end up purchasing a house, this approach gives up the same amount of tax-advantaged space as your approach does. All upside and no downside, as far as I can see.

One other way to preserve tax-advantaged space is to fund the IRAs "in arrears" - you have until the tax filing deadline in 2021 to fund for 2020.

Finally, I don't know that I'd be in a rush to do Roth 401k in the OP's situation (especially if there's a prospect of one spouse staying at home - that would drop them into the 12% bracket, at which point Roth 401k makes more sense). Traditional 401k + Roth IRA is a good mix for most in the 22% and higher brackets, and that's even more true if they end up reducing 401k contributions.
majiaknight
Posts: 147
Joined: Tue Jan 26, 2016 2:55 pm

Re: Significantly Decrease 401k contributions?

Post by majiaknight »

02nz wrote: Tue Jun 30, 2020 7:30 pm
majiaknight wrote: Tue Jun 30, 2020 7:16 pm I think someone may suggest penalty free withdraw from Roth IRA. As we are talking about ~$90K in 3-4 years, you didn't lose much by not maxing pre-tax 401K. No need to complicate things by touching Roth IRA. Your family's current combined income is not high so it could be possible that contributing to Roth 401K makes more sense if you could become high incomer in the future which may result in higher tax in 401K withdrawal in retirement.
(Note: The quote is of majiaknight, not OP) Why not plan on tapping the Roth IRA for the down payment (there's nothing complicated about that), and only reduce 401k contributions by enough to save the shortfall in taxable in the time frame needed by OP? That way, if the house purchase doesn't work out for whatever reason, they haven't given up nearly as much taxable space. If they do end up purchasing a house, this approach gives up the same amount of tax-advantaged space as your approach does. All upside and no downside, as far as I can see.

I get your point but this would at least complicate my portfolio. I always put high growth stock index fund in tax-exempt like Roth/After-tax account and bond like funds in tax-deferred like Pre-tax account to maximize tax-efficiency at withdrawals. However, if with your proposal you count on the Roth IRA contributions for down payment in 3-5 years, then I wouldn't put high volatility stocks in the Roth IRA. So, if I put those money in short-term bond funds or CDs, they may save me little tax in interests compared to taxable account. Pre-tax 401K is good but at the expense of flexibility especially when you want to save for a downpayment in 3-5 years.

One other way to preserve tax-advantaged space is to fund the IRAs "in arrears" - you have until the tax filing deadline in 2021 to fund for 2020.

Finally, I don't know that I'd be in a rush to do Roth 401k in the OP's situation (especially if there's a prospect of one spouse staying at home - that would drop them into the 12% bracket, at which point Roth 401k makes more sense). Traditional 401k + Roth IRA is a good mix for most in the 22% and higher brackets, and that's even more true if they end up reducing 401k contributions.

I only said "possible" as we don't know the necessary details to understand OP's tax situation and job potentials to recommend pre-tax or roth 401K. When I was at OP's age on my first job, I earned less than OP family's combined income and DW was still at graduate school. However, I predicted future high income growth at that time so I did Roth 401K and x2 Roth IRA with single income for the first 2-3 years. Now DW and I both work for high tech in the Bay area with a 5 year old and our marginal fed tax bracket is 35% (mfj) so we have selected Pre-tax 401K in recent years.
Maybe my family are just lucky to have quite a lot of tax-advantaged spaces as both companies offer After-tax 401K option with mega-backdoor options so we have too many tax savings vehicles to max nowadays: $57000*2 401K + $6000*2 IRA + $7100 HSA + 529 ($15000*2) + EE savings/iBond ($10000*2*3).

babystep
Posts: 245
Joined: Tue Apr 09, 2019 9:44 am

Re: Significantly Decrease 401k contributions?

Post by babystep »

You need 90k = 20% of 450k. You have 29k+12k = 41k. You are in the 22% bracket.
It is amazing to see that even though you have high expenses and still you are contributing maximum. I can't believe that I am going to say this. Maybe slow-down on 401k a bit? Let us say if you save 6k+6k = 12k per year after tax then it will take about 5 years to get to the down-payment.
Looking at your discipline, I would imagine that you will be able to get back to higher 401k contributions later.

Another thing that you need to calculate is how are the expenses going to look after buying a house. Do they go down or go up?
Shael_AT
Posts: 49
Joined: Mon Jul 15, 2019 2:36 pm

Re: Significantly Decrease 401k contributions?

Post by Shael_AT »

His 401k
FXAIX Fidelity 500 Index Fund - Institutional Premium - 57% - ER: .015%
FSMDX Fidelity Mid Cap Index Fund - Institutional Premium - 7% - ER: .025%
FSSNX Fidelity Small Cap Index Fund - Institutional Premium - 6% - ER: .025%
FSPSX Fidelity International Index Fund - Institutional Premium - 24% - ER: .045%
FPADX Fidelity Emerging Markets Index Fund - Insitutional Premium - 6% - ER: .075%
Hey, I wanted to pop in and say that me and the wife are a year older than the two of you, and both of our 401k's are almost identical to yours.

The only difference being we have a bigger risk appetite so we rebalance FXAIX 50/ FSMDX 10 / FSSNX 10/ FSPSX 15/ FPADX 15 and do so yearly. Otherwise, identical asset allocation. Been contributing since 2009.

You two are in a good spot.

We slowed down on 401k to accumulate equities and cash / municiple fund assets in our Vanguard Brokerage 24-36 months before seriously house hunting to build up that down payment. Between DP and the closing costs, taxes, fee's, unexpected move in "why is the water backing up from the sewer line" problems, we are glad to have slowed down and saved up a very liquid and accessible hunk of cash.

Good luck
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