Experts Explain How To Avoid Becoming Cash Poor with a 401K in Retirement

In an effort to be prepared for the increasingly higher costs of retirement, it’s possible to save too much money in your 401(k) account, thus tying up liquid funds. This can lead to being “cash poor” in retirement — a state where you don’t have easy access to funds you might need for emergencies, travel, big expenses and even regular costs of living. Experts explain some ways to avoid this outcome and achieve financial balance. Wealthy people know the best money secrets. Learn how to copy them.

Diversify Your Savings

While saving in a 401(k), contribution limits will most likely put a ceiling on savings goals, according to Hao Dang, an investment strategist at Consilio Wealth. This means most people will need other savings vehicles while contributing for retirement. “The drawback with putting all retirement savings in a 401(k) is the distributions are taxed at ordinary income rates,” said Dang. “Pulling big chunks of money in any given year can prove to be costly.” Instead, consider diversifying your contributions between savings vehicles. He advised, “A Roth IRA, an HSA and even a regular taxable account can help provide optionality in the future.”

A Robust Emergency Fund

Chad Gammon, a financial planner at Arnold and Mote Wealth Management, said that while saving for retirement is crucial, it’s equally important to have sufficient funds for immediate needs. “The first strategy is to have an adequate emergency fund,” he continued. “This fund is typically equivalent to six to 12 months of living expenses in a highly liquid account. This would be like a high-yield savings account or money market [account].”

Long Term Growth Accounts

Additionally, Gammon pointed out that investing in long-term growth accounts outside of your 401(k) can prevent you from running out of available cash. Gammon added, “A brokerage account offers greater liquidity compared to retirement accounts and provides a wide variety of investment options, along with potential tax advantages. It’s wise to consult with a financial advisor or tax professional to discuss these strategies in more detail.”

Save Tax Efficiently

As a certified financial planner (CFP) and retirement planner with Discovery Wealth Planning, Chris Urban shared that as you accumulate wealth, ideally you want to save and invest in accounts with different tax treatment. For example, he said, good tax diversification might mean you have a pre-tax account such as a traditional 401(k) and/or IRA, an after-tax account, such as a Roth 401(k) and/or Roth IRA, and a taxable brokerage account. “[If] you are currently in — and plan to be in — the lowest or highest marginal tax bracket then perhaps spreading out your contributions might not make the most sense,” continued Urban. “However, once you get to retirement, you will have much greater flexibility with drawing down your assets — spending your money — in a tax-efficient manner if you have assets to pull from in accounts with different tax treatment.” This allows for more effective tax bracket management, Roth IRA conversions and so on, in the years when your income is reduced. “This approach also serves as an effective hedge against tax legislation by giving you the most flexibility and options,” he said.

Diversify Your Investments

Diversifying your investments is also crucial, said Justin Godur, a financial advisor, CEO and founder of Capital Max. “Consider a mix of stocks, bonds and mutual funds that offer both growth potential and liquidity,” Godur said. “This strategy not only provides financial flexibility but also mitigates risks associated with market volatility.”

Catch Up Contributions

Additionally, taking advantage of catch-up contributions can boost your 401(k) without locking up excessive funds. “Contributing up to the maximum limit while ensuring a portion of your savings remains liquid will provide a safety net for unforeseen circumstances,” continued Godur.

Perform a Regular Review

You should also regularly review your financial plan to adjust the balance between liquid cash and retirement funds as your needs change. According to Reagan Bonlie, the founder of Nudge Money and former J.P. Morgan wealth management executive, “Life circumstances can shift, and your financial strategy should adapt accordingly.”

Avoid Penalties

If you are drawing money out of your 401(k), Bonlie warned to be mindful of early withdrawal penalties. “Generally, it’s best to avoid taking money out before age 59½ unless absolutely necessary,” Bonlie said.

Consider a HELOC

If you own your home, a Home Equity Line of Credit (HELOC) can be a useful backup source of liquid funds, shared Bonlie. “It’s not meant for regular expenses but can be helpful in emergencies without disturbing your retirement accounts.” Balancing your liquid cash and 401(k) requires careful planning and consideration of your unique financial situation. By diversifying your liquid assets and planning your withdrawals strategically, you can ensure you have access to funds when you need them while still benefiting from the growth of your retirement accounts.