Starting out for a 22 years old

[NextInLine]

I have a nephew (of my dw) who just graduated from college last summer with a computer science degree which is in high demand in our area. Upon graduation, he took a job paid 65k. After 3 months a megacorp offers 85k and he couldn’t refuse. He had spent about $500/month during college. So he has room with a new “windfall”. He has a used Camry and has no interest of buying a new car any time soon.
His parents work very hard to provide him with full cost of college, but they have zero interest or knowledge of investment. He is very close with us. He stops by for a visit most weeks. He introduces his girlfriend to us before his parents. He has good influence on my 16 year old son.
He always comes to me for financial advice and a good listener.

I helped him to set up a rIRA and 401k with Vanguard. His company’s 401k matches 8% and has Vanguard as investment house so it makes very easy to set up. I suggest him to max out rIRA and put in 15% of salary for 401k and then gradually increase until max out 401k. I run a few compound interest calculator, and he was totally sold. After the tutorial, he picks vanguard target 2065 for rIRA and 2070 for his 401k. He likes “set it and forget it” type of setup.

He is very humble and grounded young man. His parents raised him well and I told them that often. He is on his way to FIRE. One day, I’ll introduce him to this community.

 

[mystang52]

Yes, he sure sounds like a [rare?] grounded young person. IMO details of how to invest one's IRA/401k money is almost irrelevant as long as the person is diligently "saving first." That habit alone will pay off huge dividends in the long run.

 

[street]

The young man will do well in life financially. He one has that mindset to achieve FIRE it will happen and with guidance from you he is sure to do well. Not many people his age have that vision.

 

[Ronstar]

Good for him! He's off to a great start. And you and his parents have reason to be proud of him and yourselves.

 

[Gumby]

If it were me, I would put my savings first into the 401k to capture the 8% company match, because that is a risk free instant 100% return on investment. Then I would shift my contributions to the Roth IRA, because he is not likely to ever be in a lower tax bracket, so now is the time to pay taxes on that money. Finally, after the Roth was full, I would go back to the 401K and top it off. He can obviously do all this concurrently through the year, but if I couldn't max everything, that is how I would prioritize.


No matter how he allocates it, though, he is doing great to start saving so young. He has time and the miracle of compound interest on his side.

 

[NextInLine]

If it were me, I would put my savings first into the 401k to capture the 8% company match, because that is a risk free instant 100% return on investment. Then I would shift my contributions to the Roth IRA, because he is not likely to ever be in a lower tax bracket, so now is the time to pay taxes on that money. Finally, after the Roth was full, I would go back to the 401K and top it off. He can obviously do all this concurrently through the year, but if I couldn't max everything, that is how I would prioritize.


No matter how he allocates it, though, he is doing great to start saving so young. He has time and the miracle of compound interest on his side.

Yes, he max out rIRA (6k) and put in 15% of salary for 401k (12k). Thus taken full advantage of company matching.

 

[pacergal]

Good for him and great guidance from you, Uncle!

 

[OldShooter]

Good job, Uncle. I'm surprised that this one has not yet been mentioned: "If You Can" by William Bernstein https://www.etf.com/docs/IfYouCan.pdf (free 16 page download)

I'm not 100% in agreement with Bernstein's suggested asset allocation bur as @mystang52 suggests, that is far less important than getting started with a good savings strategy. Tuning can come later.

 

[pb4uski]

....because he is not likely to ever be in a lower tax bracket, so now is the time to pay taxes on that money. ...

Not really. If he has $85k of earnings and puts $12k into the 401k, he'll still be in the 22% marginal tax bracket... so not really low. Heck, even if he maxed out his 401k with $20,500 for 2022 he would still be almost $10k into the 22% tax bracket.

Yes, he max out rIRA (6k) and put in 15% of salary for 401k (12k). Thus taken full advantage of company matching.

But since he did the $6k as a rIRA rather than a tIRA he lost out on 27.75% tax savings.... 22% federal and 5.75% Virginia (if applicable)... right?

 

[NgineER]

Good advice!

He could also consider contributing to a Roth 401(k) if it is offered. He would still get matching (but matching is pre tax). This would allow him to maximize the power of compounding and Gauss mentioned in another thread that the money might be available pre 59.5 without any waiting time...

One way to do this is available if you have a Roth 401k available at work that you can take distributions from or rollovers to a Roth IRA.

If I then roll over the ... Roth 401k to a Roth IRA, then the employer will calculate a "basis in the contract" in box 5 on the 1099-R that shows the distribution/rollover from the Roth 401k to the Roth IRA. This box 5 amount will be available soon, tax and penalty free, once the funds arrive in the Roth IRA -- regardless of your age.

The magic happens when this money lands in the Roth IRA. The box 5 amount is not considered a conversion, but rather gets booked to the Roth IRA "contribution basis" ie line 22 8606. See the instructions for IRS form 8606 for a reference -- and read the full instructions. They describe how to calculate line 22 in several different places. Maybe just search for "investment in the contract".

As I think it is well known, distributions from Roth IRAs before age 59 1/2 first come from the contribution basis and are tax and penalty free.

This strategy has been a huge windfall for me in freeing up cash-flow between retiring at age 47 and age 59 1/2.

The beauty of this method is there are no five year fixed waiting period ... and the ability to withdrawal tax/penalty free from the Roth IRA.

To fully flush this out, you should read the instructions for form 1099-R box 5 to establish how the employer determines the "investment in the contract" of the Roth 401k. I suspect that it is pro-rata between Roth 401k contributions and growth. It is possible that there may be a rule that the Roth 401k has to be established for 5 years before this would work. I would need to research this because I was past the 5 year point for first contributing to the Roth 401k, so any possible/potential limitation did not effect me.

-gauss

 

[matjung]

With 85K there is no need to worry about his financial well being.
One could rather ask if he is working 40, 50 or 60 hours a week.