Saving Too Much For Retirement?

I came across an article last night that gave me a lot of thought, entitled $150,000 Income, $150 Income Tax.  The author of the article and his wife both earn roughly $75,000 a year.  They both max their 401K saving contributions to $17,500 a year.  They max an HSA to $6,400 a year, and he maxes a 407 plan to $17,500 a year. In addition they have other deferred compensation for health care, dental care, and child care.  These are all “above the line deductions” and they end up with an AGI of roughly half their gross income.  Then they max their traditional IRAs, and by having 3 children have 5 total exemptions and a $3,000 child tax credit. All resulting in a $150 tax bill, based on $1,500 taxable income at 10%.  Total this family contributed $70,000 into tax deferred plans.  

While I greatly admire the hard work and dedication of the author, I think that he may be making some costly tax planning mistakes.  The author retired at age 33 and is able to spend the majority of his time with his young children which is awesome, very few dads, and these days even moms, have that ability. In fact his plan may just make sense because he plans to draw less income for a MUCH longer period of time, lets say 50+ years. But for the majority of people who are in these income ranges and don’t plan on retiring at age 33, let’s say plan on an early retirement of 50 or 55; here is what I think should be done differently.

Let’s assume a working career making this kind of money for 20 years. Contributing $70,000 a year for 20 years into tax deferred plans at an 8% return will result in $3.46 million,  over a 25 year period would result in $5.5 million.  These people paid .1% of income to federal taxes during their working lives, but now are retired.  Now children are grown, and they aren’t saving for retirement anymore.  With $3.5 to $5.5 million in the bank and roughly a 30 year retirement, how much would you draw per year?  Even if the money sat in cash, you could still take out $100,000 a year and not run out of money.  A married couple would be paying in the 25% tax bracket at this withdrawal rate.  It only makes sense to contribute to deferred comp plans at a rate that will result in a lower tax bracket in retirement.  Of course we have no way of knowing what the tax codes will be in 30 years, so we have to make educated guesses based on what it is today.  I would put in only enough into deferred comp plans to keep me in the 15% tax bracket today,  and enough so that by retirement I could fill the 0% bracket and possibly the 10% bracket based on my expected level of withdrawals.

In the above situation, I would contribute roughly $45,000 in tax deferred comp, instead of $80,000. This would be enough to drop into the 15% tax bracket, and pay just under $10,000 in taxes.  I would then put the rest of my savings into Roth accounts, Max our Roth IRAs, and contribute the difference into a Roth option on our 401K; still saving the money, but minimizing lifetime taxes.

Of course very few US households have this income level, and an extremely small amount of those households have a savings rate of anywhere near the author.   This “problem” may only affect 1/10 of 1% of the U.S. population.