Where to put additional savings?

[younginvestor2013]

Hello all,

I was wondering what you all think I should do given my situation. I am a younger investor (25), and hoping to be FIRE'd by my mid 40s, if not sooner. Therefore, I am only putting the minimum into my retirement plan to get my company's match. I have to put in 6% to get their 3% match.

I just recently started a new job, and recently bought and furnished a condo over the past year. So, to say the least, my "revenue" stream and especially my expenses have been all over the place. My income will be stable and predictable going forward. Now that I've almost finished furnishing/decorating my condo, my expenses should also level out.

I (*think*) I am in a position to save at least an additional 4-6% of my monthly take home pay going forward. I've already got a little over 2 months built up in my emergency (cash savings) fund. I don't foresee any big "life events" in the near future (i.e., wedding, moving, new car, etc) that would cause me to need substantial cash beyond what I already have.

So, since I want to be FIRE'd in my 40s, should I put the additional 4-6% into my Roth 401K or have Vanguard automatically pull the 4-6% amount each month from my checking and periodically invest it into my after-tax brokerage account? Another option would be to invest it into a Roth IRA through Vanguard.

I'm not talking about a substantial amount of money each month - the additional 4 - 6 % comes out to about $233 to $350. But, over time it will add up of course.

I'm inclined to continue to build up my cash savings even more, but I hate to pass up investment returns just to have cash on hand when I feel comfortable with what I already have.

Anybody else have a similar situation - how do you automate the savings?

 

[Senator]

Max out your 401K. Put in the full $18K and invest it in a S&P fund.

Another great place is a Roth IRA.

 

[NgineER]

My advice...
Find ways to cut expenses and work your hardest to increase your income.
To FIRE in 20 years, you need to put away close to 50% of your gross...

...10-12% is not going to get you there. Unless you have some sort of pension or inheritance.

Invest in a Roth IRA as you'll most likely have better investment options through Vanguard.

 

[Animorph]

My advice...
Find ways to cut expenses and work your hardest to increase your income.
To FIRE in 20 years, you need to put away close to 50% of your gross...

...10-12% is not going to get you there. Unless you have some sort of pension or inheritance.

Invest in a Roth IRA as you'll most likely have better investment options through Vanguard.

+1, 12% doesn't cut it to retire that early.

Get the match, fund a Roth IRA (contributions can be withdrawn without a penalty at any time, so that's better than a 401k Roth), and put the rest in your taxable account. Then work the numbers as you progress to make sure you have the gap to 59.5 covered as well as the following years. Your optimum taxable/401k/Roth mix will also depend on your tax specifics.

 

[GalaxyBoy]

I am a younger investor (25), and hoping to be FIRE'd by my mid 40s, if not sooner. Therefore, I am only putting the minimum into my retirement plan to get my company's match.

Not sure I see the reasoning above. Why only contribute enough for the match? Perhaps your investment choices are less than desirable (a common situation)?

Lots of good information here on the Bogleheads wiki.

 

[jetpack]

spend less or earn more. What's your occupation? Is there a way to go it alone? I don't see how you'd ER with 12% savings.

 

[donheff]

You are talking about ~$12K/year total savings (at current income level). Using back of the napkin guesstimates you might hope to have $600-800K (today's dollars) in your mid 40s? That would give you at best $20-30K "safe" income with 40 years of ER ahead of you yet you must be burning through around $70K now. Is that enough? Do you have an inheritance coming?

 

[Senator]

12% doesn't cut it to retire that early.

++1

Another thing you can do is start a side hustle to generate extra income. I did it a while back, and I added a bit to my income/NW.

You never know when extra money comes in handy. If you pay off/down your mortgage and have a HELOC, there is plenty of cheap emergency cash if you need it.

If you can do a HSA, that is very much like a Roth, with no time limit to reimburse yourself.

Keep trading time for cash as much as you can. If you can work overtime, at 1.5x your pay, do it at every opportunity.

There are no short cuts out there. If there were, everyone would be retiring at 25.

 

[Closet_Gamer]

+1 on saving more than 12% but how about some kudos for a 25 year old person with a 12% savings rate, a vision and intelligent questions on how to handle the money??

Way to be thinking ahead of the game. Work your tail off to increase your income and then hold your absolute expenses flat moving forward. Let inflation slowly drive down your real spending and bank 100% of every raise and bonus you get. If you let you're spending grows with income, you're screwed.

Take risks to create step-ups in income. To do that you need to get promoted and/or hook into a company that is growing fast and you can grow with it. To a previous post, anytime you can trade time/swear for money, do it!

Good job being ahead of the game and getting a plan together. Good luck!

 

[RetireBy90]

+1 on saving more than 12% but how about some kudos for a 25 year old person with a 12% savings rate, a vision and intelligent questions on how to handle the money??

Way to be thinking ahead of the game. Work your tail off to increase your income and then hold your absolute expenses flat moving forward. Let inflation slowly drive down your real spending and bank 100% of every raise and bonus you get. If you let you're spending grows with income, you're screwed.

Take risks to create step-ups in income. To do that you need to get promoted and/or hook into a company that is growing fast and you can grow with it. To a previous post, anytime you can trade time/swear for money, do it!

Good job being ahead of the game and getting a plan together. Good luck!

OK, so saving 12% isn't going to get you retired in 10 years. However, I'm very impressed that you are saving up to 12% at this age. Don't let anyone beat you up about that. Puts you light years ahead of most even many years older.

So, some things worked for me, 1) I didn't always have the discipline to put my set aside into a IRA. Life happens so I would suggest there is some benefit to having the company take savings out of your check each month and put them into your 401K. Helps to keep you disciplined, 2) set up a savings outside the 401K for expenses you don't expect. If you need a car repair and don't have the cash to pay for it, you may be tempted to borrow from the 401K or otherwise raid the retirement savings. Having a pot of savings that you can use to cover unexpected expenses can make life easier and make it less likely you will be tempted to raid retirement accounts. 3) If you don't like the investment options in your 401K or expenses are high (anything over 1% is really high) then 2nd choice would be a Roth IRA. you are going to have to pay taxes on the income, pay now if you can afford it rather than later when the tax bite may be worse. 4) find a way to enjoy your early success with the good job now along with planning for FIRE. Don't be miserable now hoping to be happy later. There are lots of things to entertain or enjoy life without great costs, but don't forget to enjoy the journey.

Contrats again on gaining the wisdom to have your $$ serve you and your goals rather than being a slave to the $$. BTW are you available to talk to my sons - hehehe

 

[pb4uski]

For those who jumped on the 12%, chill out.

OP, I think that is a good start and as you receive raises over the years you can increase the 12% to higher percentages. That increased savings, along with investment results, should put you on a good position. But I would agree that if you want to retire real early as you say you would need to save a lot more. You can get an idea as to how much more with a projection tool like firecalc or Quicken Lifetime Planner.

Also, have you considered making deductible IRA contributions after the 6% to the 401k? You're in the 25% tax bracket based on the income you provided so it may be worthwhile.

 

[Cobra9777]

Congrats on a great start. As others have suggested, growing your income will help close the gap. My son is also 25, and in a very similar situation. I tell him the same thing: If you want to RE, work hard and focus on growing your career quickly. The rest will take care of itself. He saves 15% plus company match. But his spreadsheet assumes a conservative 3% salary growth rate, plus 2% growth rate in spending. At 45, the results are not very good (along the lines of what donheff mentioned earlier). But change those assumptions to 6% and 1%, and you're there, even with a constant 15% saving rate. 6% is very much achievable with periodic promotions, bonuses, and maybe stock compensation. But it's important to: (a) work at a company with plenty of growth potential, and (b) work smart and be a top performer.

To your specific question, I'd follow the conventional wisdom: 401K to get max match, then Roth IRA, then back to 401K, then taxable. I'd also get your cash reserve up a little higher than 2 months, but that's just me.

 

[younginvestor2013]

Thanks for all the replies.

I neglected to mention that I did inherit money through a UTMA when I graduated college. Currently, my after-tax brokerage account is at $200K, and my roth IRA/roth 401K is at $65k.

That last sentence will likely give you more background on why I feel comfortable attaining FI in my mid 40s. Assuming conservative contributions (12% of my $70k salary - I also earn anywhere from $10-$20k a year in cash bonus that is not calculated in my projections although I anticipate investing some/most of it), assuming conservative returns (4% net of inflation), and assuming conservative annual $ amount increase in savings (3% more saved each year), this puts me at a reasonable $1.3-1.5m by my mid 40s.

However, that $1.3-$1.5m is based off my overall current equities (retirement/non-retirement) plus the assumptions mentioned above. If you break out it by retirement/non-retirement, the split is such that I might have to pay penalties to access a portion of my funds in my 40s.

If you stretch my projections out to 60, I would be at $2m which is when I'd be able to access the money penalty free.

I've already started a thread on this concern of mine before, so - sorry to be redundant. I guess my main concern with this one was 1) invest the additional % of each pay into retirement or non-retirement funds and 2) if you suggest the latter, how to specifically do it (from a logistical perspective - like having it go directly from my employer to my vanguard brokerage).

The tax appeals of just investing more into my roth 401k are enticing and attractive, however I don't want to have a ton of money in my retirement accounts which would prohibit me from accessing it. On the other hand, I am looking at massive capital gains taxes if I invest in non-retirement accounts.

 

[younginvestor2013]

I also want to mention that I agree with some of your suggestions to get into a company with growth opportunities and focus on being a top performer.

I recently joined a smaller firm that is growing rapidly and have been receiving great remarks so far. Assuming I continue to grow with the firm I foresee my income increasing faster than I've modeled out. So, a primary focus of mine (as you've mentioned, too) is to control my costs. I am still discovering my cost base since I've just recently moved into a condo and furnished it. I'm confident in netting 12% to my savings each year, but also want to enjoy life along the way.

Given my current nest egg, I am close to the point where my yearly market earnings outpace my savings amount. As a result, I feel more compelled to "enjoy the ride" because...at the end of the day, if I were to spend $2k of my annual bonus on a very enjoyable/meaningful vacation to an exotic place, it has an immaterial effect on my overall financial modeling.

This same theory/approach could be applied to many facets of my life, so it will be important for me to control spending and understand what I want to splurge on and where I can cut costs.

 

[pb4uski]

You are wise to understand that if your retire so early that it is best to have accounts that you can have penalty free access from when you ER until you are 59 1/2. You need to balance that objective with 25% current tax savings for any tax-deferred contributions and probably paying less as a retiree when you use that money.

On your concern on your non-taxable accounts, as I'm sure you know, capital gains get preferential tax rates, 0% for people in the 15% tax bracket or lower and 15% if your tax bracket is over 15%, so essentially 0-15% depending on your tax bracket.

If you decided to invest non-retirement route, you can just set up Vanguard to automatic withdraw funds from the bank account that your paycheck goes into on the same dates so the effect is the same as if your employer withheld the funds and relayed them to Vanguard except that you can more easily control it and make changes as you wish.

 

[Cobra9777]

No question that having access to after-tax funds is very important for income flexibility and tax efficiency in early retirement. BUT, tax deferral is also extremely powerful during the accumulation phase. The fact that you're thinking about this balance at such a young age is indeed impressive.

In our case, we ended up with about 50/50 taxable/tax-deferred. But essentially all the taxable came in the last 7-8 years of employment. Prior to that, DW and myself just plowed the maximum allowed into our 401Ks. We were in a very high bracket, much higher than anything we will see in retirement. And this helped investments grow faster. The only real after-tax savings we had was about 6 months emergency fund. I was always concerned that we'd be in a position to ER, but with all our retirement funds in tax-deferred accounts. But by our mid-40s, expenses had flattened out or reduced slightly, while income was still growing at a very significant rate. So, even with college costs for 2 kids, the taxable account grew extremely fast, enabling ER at 52, with no dependence on tax-deferred balances.

Having said all that, I'd still recommend you stick to the conventional wisdom at this point: 401K to max match, then Roth IRA, then back to 401K, then taxable. The Roth can provide a lot of flexibility; and tax-free growth/withdrawals are hard to argue with. When you get deeper into the 25% bracket (or higher), I'd probably maximize deferrals first, then Roth and taxable. You sound like a really smart guy, so I'm sure you'll figure out the right balance that works for you.

Regarding logistics, my Megacorp payroll dept had the ability to split direct deposits into multiple accounts. If your company offers this capability, you could just direct a predetermined amount of your net pay directly to the relevant account at Vanguard. I used this method to automate savings into a Fidelity brokerage account for several years. But after a while, I found it more effective to just make manual monthly transfers. My expenses were too lumpy for a fixed amount.

 

[donheff]

Don't forget that you can get some retirement funds out early without penalty. Search the forum for threads with 72t in the title.

 

[younginvestor2013]

No question that having access to after-tax funds is very important for income flexibility and tax efficiency in early retirement. BUT, tax deferral is also extremely powerful during the accumulation phase. The fact that you're thinking about this balance at such a young age is indeed impressive.

In our case, we ended up with about 50/50 taxable/tax-deferred. But essentially all the taxable came in the last 7-8 years of employment. Prior to that, DW and myself just plowed the maximum allowed into our 401Ks. We were in a very high bracket, much higher than anything we will see in retirement. And this helped investments grow faster. The only real after-tax savings we had was about 6 months emergency fund. I was always concerned that we'd be in a position to ER, but with all our retirement funds in tax-deferred accounts. But by our mid-40s, expenses had flattened out or reduced slightly, while income was still growing at a very significant rate. So, even with college costs for 2 kids, the taxable account grew extremely fast, enabling ER at 52, with no dependence on tax-deferred balances.

Having said all that, I'd still recommend you stick to the conventional wisdom at this point: 401K to max match, then Roth IRA, then back to 401K, then taxable. The Roth can provide a lot of flexibility; and tax-free growth/withdrawals are hard to argue with. When you get deeper into the 25% bracket (or higher), I'd probably maximize deferrals first, then Roth and taxable. You sound like a really smart guy, so I'm sure you'll figure out the right balance that works for you.

Regarding logistics, my Megacorp payroll dept had the ability to split direct deposits into multiple accounts. If your company offers this capability, you could just direct a predetermined amount of your net pay directly to the relevant account at Vanguard. I used this method to automate savings into a Fidelity brokerage account for several years. But after a while, I found it more effective to just make manual monthly transfers. My expenses were too lumpy for a fixed amount.

This is helpful. I am thinking that the best option for now is to plow as much into my retirement accounts and while leaving my taxable money sit, for two reasons:

1) to avoid huge capital gains taxes in 20-25 years that I will incur if I were to invest in taxable accounts vs. retirement accounts

2) to be able to take advantage of the tax benefits in retirement.

My modeling shows that if I were to leave my $200K in taxable accounts sit for another 20 years without adding any money to it, I'd have about $500k in today's dollars.

If I continue to throw in 12-15% of my income into my retirement accounts, combined with my current balance of $65k and market returns, I'd have about $615,000 in today's dollars in 20 years.

If I let that $615,000 sit in my retirement accounts without touching it or contributing any further, by 60 I'd have about $1.3m in today's dollars that I could tap into.

So, it seems that in 20 years at age 45, I'd just need to fund my lifestyle from 45-60 with post-tax savings to avoid penalties. Given a $500k nest egg, that might be tough to do. However, I still think this is the most reasonable approach because it could be "very do-able" if I manage to move up the corporate totem pole and save more money, and if investment returns are more favorable, or do to an inheritance, or any combination of the above.

Am I thinking this through correctly, or have I made any incorrect assumptions in your opinions?

 

[gauss]

Thanks for all the replies. ...

The tax appeals of just investing more into my roth 401k are enticing and attractive, however I don't want to have a ton of money in my retirement accounts which would prohibit me from accessing it. On the other hand, I am looking at massive capital gains taxes if I invest in non-retirement accounts.

If your 401k allows after-tax contributions (not to be confused with Roth 401k), and if your employer allows in service withdrawals, then you could have the best of both worlds.

Contribute all available funds to your after-tax 401k and then rollover the amount to your Roth IRA. Once the funds are in your Roth IRA you will be able to withdrawal any contributions or rollover/conversions before age 59 1/2 without penalty or taxation.

I suspect that you might not have access to this type of 401k given that you have a small employer, but it doesn't hurt to ask. In 2015, up to $53,000 can be saved in this fashion if your employers 401k plan allows it.

DW and I each starting doing this in 2010 when the income restrictions on Roth conversions were removed. FI came shortly thereafter.

-gauss

 

[younginvestor2013]

If your 401k allows after-tax contributions (not to be confused with Roth 401k), and if your employer allows in service withdrawals, then you could have the best of both worlds.

Contribute all available funds to your after-tax 401k and then rollover the amount to your Roth IRA. Once the funds are in your Roth IRA you will be able to withdrawal any contributions or rollover/conversions before age 59 1/2 without penalty or taxation.

I suspect that you might not have access to this type of 401k given that you have a small employer, but it doesn't hurt to ask. In 2015, up to $53,000 can be saved in this fashion if your employers 401k plan allows it.

DW and I each starting doing this in 2010 when the income restrictions on Roth conversions were removed. FI came shortly thereafter.

-gauss

I'm confused on this process and not fully following your logic given my situation/context.

Are after tax (non retirement/401K) contributions just like automated deductions from each paycheck into a brokerage (taxable) account that happens to be the same sponsoring broker of my 401k plan?

If so, you are suggesting that I essentially contribute $53K (or whatever amount I can feasibly contribute after taxes etc are deducted from my pay) to this account?

This would require me to live off of my taxable brokerage account and I would have to pay taxes to sell equities to do so.

So Id' basically just be transferring my equities from Vanguard (selling them to eat/sleep/drink/etc) and investing in new and similar equities through my 401k's brokerage (also in post-tax taxable accounts).

I'm confused as to why I would do this?

 

[younginvestor2013]

Bump up.....anyone familiar with what Gauss was discussing?

 

[RetireBy90]

Bump up.....anyone familiar with what Gauss was discussing?

If I may try


I think your referring to after-tax 401K contributions and conversions to Roth IRA. If so, then:


You can contribute up to 17K to a 401K each year and deduct it from your taxable income (employer
reports taxable income with 401K contributions removed already).
After this, if your plan allows and depending on other limits you can contribute after tax money to
the 401K. Since this is already taxed, you can roll it into a Roth IRA without paying taxes. Thus you
can contribute above the 17K limit on 401K and 5K limit on IRA. You will want to convert as soon
as allowed after the contributons so that you don't pay any taxes on any gains.
There are several items that you need to take into account when doing this, and not all 401K plans
will allow this, but it is very helpful if you need to move more into retirement savings.

 

[gauss]

Thanks for the nice summary in my absence RetireBy90.

I am referring to a feature of some 401k employer plans that accept after tax contributions.

The strategy that I described will allow you the advantage to fund Roth IRAs at about 10 X the normal ~5K limit which would not be possible with plain brokerage accounts.

-gauss

 

[NgineER]

I think that what Gauss was eluding to as well is that you can access the rolled over Roth IRA after five years and access this money tax free.

One interesting approach that you might like is to do a Roth IRA conversion ladder... Do a google search or read this link: http://jlcollinsnh.com/2013/12/05/s...-roth-conversion-ladders-from-a-mad-fientist/

In essence it allows you, if you have the funds to carry your expenses for five years, to do a low tax cost roll over every year until you deplete your tax deferred account and after five years years you can access the converted amount tax free and after 59.5 be able to access the gains tax free.

Be vary of stopping your contributions to live a little.... When you do that, you are automatically increasing your spend and your plane ER withdrawals are now at a higher level.