Here Are 3 Things 401(k) Millionaires Should Consider Before Retiring Early

For the record number of 401(k) millionaires minted during the pandemic, retirement may be tempting but the market volatility late last year offers a lesson: Paper wealth can be fleeting.

Since Covid first grabbed headlines, the combination of a market rally, an increase in savings, and a decrease in borrowing has boosted retirement account balances past pre-Covid highs. Fidelity Investments, for one, reported a record 760,300 401(k) and individual retirement accounts with seven-figure sums in the third quarter of 2021.

While the influx of wealth may stir dreams of early retirement, financial planners say savers need to consider a few things. “One of the sticking points is whether you can access your money without being penalized,” says Danielle Harrison, a financial advisor at Harrison Financial Planning in Columbia, Mo. Another is whether you can mitigate the risks that come with a longer retirement.

Here are some considerations for 401(k) millionaires:

A million-dollar nest egg may not be enough

For those planning to retire at age 65, let alone before traditional retirement ages, a $1 million portfolio may be too little to cover a retirement or 30 years or more, says Harrison.

She says investors should consider one rule of thumb often used by financial independence/retire early adherents to determine how much savings they’ll need: the “25x rule.” This guideline states that to retire, your savings should equal 25 times the size of your annual retirement expenses. In a $1 million portfolio, this rule assumes just $40,000 per year, which may not be enough savings for those with higher expenses or those who anticipate needing to cover rising healthcare costs.

Tapping retirement accounts early can be a challenge

In general, distributions from retirement accounts before the age of 59½ incur a 10% early-withdrawal penalty. There are a few exceptions that accommodate early retirees, however.

One is the “rule of 55.” Individuals between the ages of 55 and 59½ may be able to withdraw from their employer-sponsored plan penalty-free if they left their job during or after the calendar year they turned 55. The rule only applies to 401(k)s and 403(b)s, and it must be used with the plan you hold with your most recent employer. If you roll over your employer plan into an IRA, you can’t use the rule of 55, Harrison cautions.

Another option to consider, especially for those with IRAs, is rule 72(t). It allows an account holder to receive substantially equal periodic payments (SEPPs) from an IRA, 401(k) or other similar plan without incurring a penalty. Essentially, you must withdraw the same amount from your account every year until you turn 59½ or for five consecutive years—whichever lasts longer. Individuals may want to work through a 72(t) plan with a professional to avoid costly mistakes. Missing a payment, for example, could trigger penalties on all the funds you’ve withdrawn to date.

If you can’t avail yourself of these tax-code loopholes, Harrison suggests drawing money from other sources, such as a taxable account or a Roth account, before dipping into your 401(k) or traditional IRA.

Exposure to more risk

When you stop saving and start withdrawing from retirement accounts, you become vulnerable to sequence-of-returns risk. Market declines early in your retirement can be particularly harmful, potentially reducing the longevity of your portfolio.

This can be particularly problematic for 401(k) millionaires, says Harrison, as stocks are often overrepresented in their portfolios. She recommends rebalancing a portion of the portfolio into more conservative options for at least the first five to 10 years of retirement.

If you’re considering altering your retirement plans, Harrison warns you must carefully consider all the potential risks and costs. “It’s easy to miss things,” she says. “Maybe you’re leaving a pension on the table. Maybe you’re misjudging the cost of healthcare. If you’re not accounting for all the costs, you can get into trouble.”