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$175K Income - How should I invest?
Old 09-28-2008, 12:42 PM   #1
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$175K Income - How should I invest?

Quick Stats:

Age: 31, Married, 1 Child
Full Time Income: $90K
Side Work / LLC Income: $85K
Wife's Part Time Income: $20K
Cash Savings: $41K

Child's 529: $2500
My 401K: $30K
Traditional IRA: $41K
Roth IRA: $15K
Wife's 403B: $16K
Mortgage: $130K @ 5.5% (Value of home: $200K)

I want to invest 15% of my full time income (minus the LLC work) to retirement. Right now I only contribute 6% to my 401(K) in order to meet the employer match benefits.

Should I open an SEP account to lower my tax bill? Would I have the same tax effect by simply putting the money in my traditional IRA or be better off throwing into a ROTH or my employers 401K instead? My future income will not likely be $175K a year (Hope it is!) but it could easily be knocked down to $90K or so.

I am very interested in potential passive income through money investments and early retirement. Your advice is greatly valued.
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Old 09-28-2008, 01:41 PM   #2
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Something doesn't match, and you don't provide any info. With almost 200k annual income you've only got 100K +/- in savings? And you only contribute 6 pct to the 401K?

On top of this your mortgage is incredibly low, so where does your money go? You're interested in ER, then half of it is understanding your retirement needs. If you're blowing through 100k + annually in living costs, you've a long road ahead of you.
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Old 09-28-2008, 04:20 PM   #3
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As mentioned, it isn't clear at all where the vast majority of your money is going. A mortgage is usually a person's largest expense, and yet yours is pretty low. Could you post more information on your expenses? As it stands now, it looks like you need to seriously cut back on miscellaneous expenses so that you can invest (and you should have been able to invest a LOT this year with almost 200k in income). Did all your money go into the buisness?

Investing is only one aspect of reaching early retirement, it won't even get your half-way there by itself. It also requires understanding your expenses, keeping them well below your income and increasing your income.

The answer to your original question though is, yes, you want to tax-defer as much money as possible. The higher your income, the higher your tax rate will be, and the more advantageous it is to make sure you are using tax-deferred accounts. You essentially are losing a larger percentage of your income if you are a high wage earner and not using a tax-deferred account vs. being a low wage earner and not using a tax-deferred account. You essentially leave money on the table by not using a tax-deferred account, in your case, you are losing well over $10k each year you don't use a tax-deferred account, plus all the compounding interest that would have been earned.

Based on your current consumption/savings, assuming a 6% increase in salary each year (since it seems you are fairly good at increasing your income), 3.5% for inflation, a return of 8% on your investments (which would require you a good investing strategy), and your current savings rate of only 8%, you (and your wife) are on course to retire at 56. This assumes your buisness stays steady over the next 25 years, that it neither dies or grows explosively. It also assumes your expenses would only increase with inflation from this point on. Social security is not accounted for, since it is so far off, but near your retirement age, you could probably reduce your retirement age a year or so if it seems like the program is still working well. If your income drops to 90k, you would have to cut back your expenses from whatever they have been lately, or else you would never retire. Early retirement pretty much revolves around what % of your income you are saving each year more than anything else when predicting how early you can retire during the early accumulation stage, as you get close to retirement, the focus shifts to how well your investments are doing.

So essentially the act of saving a large percentage of your income (and increasing it so saving a larger % is easier) early in the accumulation stage is by far the single most important thing someone can do to reach early retirement.
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Old 09-28-2008, 04:42 PM   #4
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Thanks for your reply.

I only spend $3500 a month and the rest is saved. My income prior to February of this year was $90K a year. The first gentleman mentioned that I have $100k of savings. If you add this up again you'll see 215K saved (145K in savings and 70K of equity in my home). I don't have any other debt besides my mortgage. This has been a very good year -- prior to this year I didn't have near as much saved.

The reason I capped retirement at 15% of my full time job's income was to start building up cash investments that I can benefit from in the short term (Ex. 10 years down the road). I figure 15% is enough to cover me at 59.5 years old but most retirement vehicles (401k, IRA) seem to be geared towards you waiting until 59.5 to use it. If I invest in cash investments then I can take advantage much faster and generate passive income which might help me retire early.

If I am looking at this wrong then please let me know. Can I use retirement accounts such as ROTH and 401K to retire earlier? Should I open an SEP account or simply put the money into my pre-existing IRA account to have the same results?

Thanks!
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Old 09-28-2008, 04:50 PM   #5
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SEP has a higher limit, right? If you are anticipating lower future income and thus a lower tax bracket, I'd shelter from tax now as opposed to using a ROTH and sheltering either.

Also, the 72T rule lets you take equal payments from your retirement accounts before 59 based on a life expectancy table ( or something like that) and that max withdrawal has usually run above 4% which is the generally accepted safe limit on this board (but not universally!). Run some fire calc tests and play with different scenarios.

You're income went up at the right time! The market is having a sale!
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Old 09-28-2008, 04:53 PM   #6
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You can access 401Ks and IRAs before 59.5. IRAs can be accessed penalty-free through what's called 72t distributions. Some 401ks can be accessed penalty free as early as age 55, or you can roll them over to an IRA and use 72t distributions. The contributions you made to a Roth IRA can be withdrawn at anytime, penalty- and tax-free. Given your high income, I would absolutely max out tax-deferred accounts before contributing to taxable accounts.
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Old 09-28-2008, 05:09 PM   #7
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Thanks for the info.

It looks like I have a few options to stick with tax-deferred accounts:
Which would you recommend?

1) Increase my employer 401(k) to max.
2) Contribute the $8500 (or more) to my IRA account through my broker.
3) Open an SEP IRA account and put the money there.

From a tax standpoint would an SEP have the same tax effect as a regular IRA account? Can I still use the 72T rule with SEP?
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Old 09-28-2008, 05:10 PM   #8
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If you mean as a shelter from April 2009's tax bill, yes.
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