Why cutting funding to my 401k saved my hopes for financial independence and early retirement

Let me first say I love my 401k. I was extremely fortunate that my employer made this a priority for me even when I was not prioritizing it myself. My 401k contains the majority of my retirement nest egg.

However, once I got serious about accumulating enough wealth to achieve financial independence and retire early I realized I would need to cut down my funding of the 401k immediately.

Cutting down my 401k contributions to the bare minimum freed up enough money for me to save and invest and grow my “freedom fund” large enough to bridge the gap between the day I quit working and the day Itured 59 1/2 and could begin penalty free withdrawals from my 401k.

Without executing this strategy I would have had little hope of retiring early as I would have no access to my 401k and would not have the means to build a freedom fund.

401k Basics

A few basic points you need to know about the 401k plan before understanding why I made my decisions. Below is an excerpt taken directly from another article I wrote. To read the entire article which goes more in depth, follow this link.

The 401k retirement plan allows you to…

• Contribute prior to paying taxes
• Grow your nest egg tax free
• Earn free money in the form of the company match

You must…

• Wait until age 59 1/2 before you can take penalty free withdrawals
• Pay income taxes on all withdrawals made

Now that we got that out of the way, Here is my story…

401k contribution rates by age

When I was in my early 20’s I failed to understand the importance of saving for retirement at all, let alone 401k contributions. I mean really what 21 year old is thinking about this? I was more concerned with having enough money to go out on Friday night.

Lucky for me, my employer took care of me and convinced me to at least enroll and make the bare minimum contribution to receive the max employer match

20’s

In my 20’s my contribution was bare minimum. Something I regret now as I missed out on thousands of dollars in compounding. Somewhere in my mid to late 20’s I began the automatic annual 1% increase to my contribution rate. Every year my contributions would automatically increase 1%. So if I was contributing 3% of my pay this year, next year it would automatically go to 4% and then 5% the following year, and so on.

30’s

All through my 30s I was maxed out at 15%. I had started to realize that I would not be able to, nor did I desire to struggle financially in my retirement so I upped my funding. Also, I was making more money and at the end of each month realized a surplus after bills were paid. Being more mature, I decided not to spend the money but rather invest. Looking back, I could have been more aggressive but at least I made a change in the right direction before it was too late.

40’s

In my early 40’s I began to realize, I absolutely hate my job and the time I must commit to it each day/week/month/lifetime… and I can not wait to be done. It is here that I really started to research what it means to retire early.

Before this I was thinking 59 1/2 is a great age for early retirement. Now I can’t even imagine working that long. I would probably end up in a mental institution long before retirement if I needed to keep working that long as my job and the people and situations I need to deal with every day would drive me completely insane.

The decision I came to in my early 40s was that my 401k was funded enough to where I could contribute zero and simply allow compounding to take over. At 59 1/2 when I begin withdrawals, my 401k will have grown to well over what I would need for the rest of my life. To read more about the power of compounding, check out my article “How compound interest will make you rich. The key to long lasting wealth“

Once I realized that further contributions were not necessary to have a nest egg for retirement, the decision to cut contributions became easy. So I dropped my contributions to just 1% which allowed me to capture the full employee contribution. Compound interest would take care of the rest.

My path to Financial Freedom in hindsight and the birth of the Freedom Fund

Now at age 46 and just a few more years away from full Financial Independence, I look back with both regret and thankfulness. I regret not figuring this out sooner and taking massive action as it not only would have shaved years off of my need to work but I would have built a larger nest egg. I am also very thankful that I made the change when I did. I look around and I see a society filled with people who may never understand the freedom that comes along with having enough money saved up to work because they want to not because the have to.

I calculated this using the 4% withdrawal rate. To understand more about this, check out my article “How long will my savings last? The 4% rule simplified.“

Once I realized I had enough to retire at 59 1/2 I needed to figure out how I could bridge the gap between today and 59 1/2. Again I used the 4% rule to calculate how much I would need in savings to last me until 59 1/2.

The next step was to lower my 401k contribution to the bare minimum. Just enough to capitalize on the company match, not a penny more.

Finally, every penny I was putting into the 401k (plus some additional money I was able to come up with by cutting spending) would go into my “Freedom Fund”

My Freedom Fund would allow me to quit work and would pay my monthly expenses from the day I quit work until age 59 1/2 when I could begin withdrawing from my 401k penalty free.

Therefore the freedom fund could be defined as a fund created with the express goal of accumulating enough wealth to allow you the freedom to walk away from your primary source of income if you choose.

The moral of the story

The moral of my story is to start funding your 401k as early as possible and always be calculating where you are and where you are headed. Had I began my freedom fund sooner, I would probably be retired today.

I could always retire earlier and simply choose to pay the 10% early withdrawal penalty but I just can’t see myself doing that.

There is one other caveat for those of you who simply cant afford to quit working as early as you would like.

The rule of 55

The rule of 55 states that if you quit or are fired from your job between age 55 to 59 1/2 you may withdraw from your 401k penalty free. It has to be the 401k provided by the employer that you just separated with. It can not be a 401k from a prior employer. Furthermore, you can not quit before age 55 and then take the penalty free withdrawals at 55. You would need to be separated from your employer between the ages of 55 and 59 1/2.

So if you are 53 years old for example, it might make sense to just work for 2 more years and then retire and invoke the rule of 55. Do your research and check with your financial advisor anbd employers 401k plan before making any final decisions.

I hope my story was helpful. Good luck in your quest for Financial Independence, get that Freedom Fund started TODAY and happy saving!!!

Earl