Where to Start

[Otis]

As I mentioned in another post, I've just turned 30. I would like to be doing "something else" by the time I turn 40. By "something else" I mean that I may swap careers, start my own business, or sit at home and watch The Price is Right (i.e. be an ER).

My wife and I are college-educated DINKs (Dual Income, No Kids) and plan to stay that way. We're currently both slaves to Corporate America, but are talented enough to have been recognized in our respective areas for accelerated promotions and the money that comes with it.

About a year ago, we recognized our destructive lifestyle and set out a plan to get out from our credit cards. In the past year, we have paid off $25k of credit cards (don't ask), increased our 401k contributions, paid off a vehicle a year early, refi'd our student loans, and reigned in our spending ($200 a week for groceries for 2 people... yikes). We'll be taking a Cruise in March to celebrate, as this was really a big deal for us to get our arms around.

Following the cruise, my general plan was to build up enough savings (we're near $0 now, everything's going towards Visa) to live on for a few months in case something bad happens.

Following that, I'm not sure what to do. I'm hesitant to put money into an IRA or further increase our 401k contributions because I don't want our cash tied up until we're old and gray, but I admit that I am a novice at this Wall Street stuff. My initial thoughts was to go for an Index fund for long-term growth, and keep some reserve in a Money Market account or some CDs. Knowing that I will want to begin cashing out SOME of my assets around age 40, what mix of investments would you recommend?

Additional Background:
Debt: Mortgage, $5k on the final visa (ironically, this is mostly the cruise, will be paid off shortly), student loans, and 2 years worth of payments on vehicle #2.

Investments: Approx. $50k in each of our 401k's, and a handful of IBM shares from my spouse's past job.

 

[Skylark]

Congratulations on making the decision to start saving for your future retirement.

I'd suggest that you look at retirement in two stages:

Stage 1, from now to about age 65, during which period you always have the option of returning to work if needed.

Stage 2, from age 65 on, when you likely will not be able to return to work.

I would do some long term financial planning and max out your 401k and Roth until you feel you have enough to cover your financial needs during Stage 2. This should be priority one.

After you have Stage 2 covered, then start saving for Stage 1. Stage 1 savings needs to be free from 401k restrictions, so it will all be after tax dollars that you are investing.

 

[IDunno]

I'm hesitant to put money into an IRA or further increase our 401k contributions because I don't want our cash tied up until we're old and gray, but I admit that I am a novice at this Wall Street stuff.

My theory is that it's OK to have money in a retirement plan (FWIW, I'm in my mid-30s).

Let's say you have $1,000,000 of which $200,000 is in retirement funds that you can't touch. I say that you can base your SWR on the $1,000,000, not the $800,000 of freely available money. Why? Let's see.

Let's say you use a 4% SWR (so you'll take out $40K the first year), and in the first year, there is 0% inflation and you make 4% on all your money. After the first year, you have $208,000 in the retirement funds, and $832,000 in the standard investment accounts. You've got to take the $40,000 from the standard investment accounts, bringing that total down to $792,000.

That sounds bad -- you're losing money! But, your retirement accounts are now up to $208,000. So your total is still $1,000,000. It's a wash.

So you should be able to use the value of retirement accounts in determining the SWR, but knowing that money will end up 'leaking' from the standard investment accounts to the retirement accounts.

Of course, if you have $900,000 in retirement accounts and $100,000 in non-retirement accounts, and you're in your 30s, you would likely get stuck after a few years, and have to withdraw money from the retirement accounts (with a nice big penalty).

You need to be careful when including the retirement accounts in the SWR rate, but it can be done.
-Scott

 

[Otis]

Congratulations on making the decision to start saving for your future retirement.

Thanks! From my perspective, I don't really have a choice. I can't see myself chained to a desk 10, 20, 30 years from now.

And thanks for the ideas. I need to spend some time with the calculators and Excel. As you prolly guessed I'm new to this forum. Wish I'd found it a year ago.

 

[brewer12345]

Following that, I'm not sure what to do.  I'm hesitant to put money into an IRA or further increase our 401k contributions because I don't want our cash tied up until we're old and gray, but I admit that I am a novice at this Wall Street stuff.  My initial thoughts was to go for an Index fund for long-term growth, and keep some reserve in a Money Market account or some CDs.   Knowing that I will want to begin cashing out SOME of my assets around age 40, what mix of investments would you recommend?

I would not be shy about maxing out the 401k and the roth. Once you have done that, a mix of index funds and high yield CDs should do the trick after tax. You can always tap retirement accounts before 59 1/2 through 72t withdrawals, which you can do without paying penalties. In the mean time, getting the tax deduction is pretty worthwhile.

 

[BigMoneyJim]

I'm hesitant to put money into an IRA or further increase our 401k contributions because I don't want our cash tied up until we're old and gray,

Just to echo what brewer12345 said, you can withdraw from 401(k)s (EDIT: see clarification in my next post) and IRAs before age 55/60: http://www.retireearlyhomepage.com/wdraw59.html

Other than that my advice is that you're on the right track. Don't be overwhelmed by the investing stuff; it's a slow learning process for everyone. Keep getting rid of debt and saving money and you can learn as you go.

One rule of thumb is that if an investment is being advertised or recommended to you by a professional then it's probably underperforming and overpriced with respect to commissions and management fees, so avoid expert advice and resist letting anyone talk you into investing your money differently. It's almost always better to sit in one position than move your money per someone else's advice.

 

[Otis]

Just to echo what brewer12345 said, you can withdraw from 401(k)s and IRAs before age 55/60: http://www.retireearlyhomepage.com/wdraw59.html

Thanks for the link and the encouragement. Since finding this board on Friday I've been doing SO MUCH reading. At least "the plan" isn't too far out of whack.

 

[brewer12345]

Thanks for the link and the encouragement.  Since finding this board on Friday I've been doing SO MUCH reading.  At least "the plan" isn't too far out of whack.  

Otis, I didn't say it before, but I think you are on the right track. The biggest thing you can do to hasten ER is to remain frugal and shovel the excess into a balanced portfolio. You can get really complex on the investing side, but really, a mix of 25% intermediate term bonds or CDs and 75% equity index funds is more than adequate. If you don't feel like tackling the more complex investing topics, there is no need to do so as long as you stic with a low cost index portfolio and take care not to panic or move the money as the markets go through their periodic gyrations.

I'm 31 (as is my wife) and we saw the light about 5 years ago. We are on a somewhat different track than you because we have a baby and plan on having at least one more. My wife doesn't work full time (small business that will likely net $8 to 10k this year), so we no longer have the luxury of DINK income and low overhead. Even so, with moderately conservative assumptions, I still reach "escape velocity" at about age 45. If I luck out with returns or choose to make some drastic lifestyle choices (relocate, etc.) it could be as early as 39 or 40. This is do-able. Just keep plugging.

 

[BigMoneyJim]

A quick clarification an my earlier comment: You can't take penalty-free withdrawals from a 401(k) before age 55, but you CAN roll it over into a personal IRA and then use the 72t rules to withdraw without penalty from there before age 59 1/2. Same goes for 403(b)s, 457's and other "qualified plans". Apparently in the push to sell annuities some of these plans' trustees neglect to inform you you can do this, but you can.

 

[SteveT]

OK, I have been lurking here for months, and this is something I have wanted to ask about. Like Otis, I am confused about how to bridge the gap between early retirement and the time when I can withdraw from my 401(k) without penalties. I have looked at articles that explain how to withdraw early without penalty, but it seems like you have to jump through a lot of hoops to do it. Plus, I have not seen anyone on these boards posting that they are in ER and actually doing this rule 72t thing.

So, I have run my numbers in a spreadsheet and have this quandry. My 401(k) is growing nicely, and I have not even maxed out my contributions yet. Being 35 years old, it will be a long time before I would withdraw from my 401(k). But what if I want to retire at 45 or sooner? If I continue to put money into my 401(k) until I max it out, I will not have enough money after taxes to properly fund my after-tax saving accounts - the very funds I will need sooner than my 401(k) if I am to retire early. In other words, I don't see how I can max my 401(k) and have enough money after taxes to allow me to retire early.

Should I stop contributing to my 401(k) at a certain point, knowing that it will continue to grow nicely for 20+ years? Then I would have more money after taxes to put into CDs, bonds, etc. The sooner I can fill up those funds, the sooner I can retire.

What am I missing with this strategy?

 

[Hyperborea]

Should I stop contributing to my 401(k) at a certain point, knowing that it will continue to grow nicely for 20+ years? Then I would have more money after taxes to put into CDs, bonds, etc. The sooner I can fill up those funds, the sooner I can retire.

What am I missing with this strategy?

Steve,

If you are planning to retire early without maxing out your 401k I will guess that it won't be that "early" of a retirement - perhaps mid 50's to early 60's.   A lot depends on what your planned for retirement lifestyle will be.  What does your spreadsheet planning say for your expected retirement age?  For example, saving $10K a year for 30 years with a real growth rate of 7% (10% growth - 3% inflation) will only give you ~$1M and that will only fund about $40K / year.  If you started saving this $10K / year at the age of 25 then that puts your retirement age at 55.

If it is going to be close to 59.5 you will only have a few years to bridge before you can get at the 401k/IRA money without a penalty.  I would stuff as much into the 401k/IRA combos as you can.  As you get older and hopefully your income increases you will have extra cash beyond the tax deferred maximums that you can put away in taxable accounts.  This extra taxable money can be your "bridge" money until you get to 59.5.

If you are planning to retire earlier than that without maxing your 401k then you must be looking at some real low budget retirement - i.e. 3rd world living (Thailand, South America, etc.) or serious back to the earth stuff (raising goats, making your own clothes, etc).  If so then your financial planning will be different.  It may make sense in that case to have some cash outside the tax deferred accounts but I would really look at SEPPs (72t).  You will have a zero tax rate in these cases and will get a nice benefit from putting money away at 25%+ tax rates (federal and state) and then getting it out a 0% tax rate.

 

[farmerEd]

>>Should I stop contributing to my 401(k) at a certain point,

Yes you should, the trick is knowing when that "certain point" has been reached; Thats what I did.

Its true that there are ways to get at IRA money w/out penaly before 59 1/2, but you don't really want to be doing that at age 40 or 45...maybe a few years early, but not a few decades early.

The trick is to know how to balance the two; I was self-employed at had a Keough plan for my small corp which allowed me to save 30K per year pre-tax, so that account grew pretty quick; then once I felt that hit critical mass (such that it could grow big enough with modest gains for 30+ years), I focused on getting out of debt (including the house), and once the house was paid off, I focused all new savings into a regular after-tax brokerage account that I now live on. In my mind, I always took care of things in reverse order from when it would matter...i.e. take care of your regular retirement years (after 65+) first, then get the mortgage monkey off your back, then focus on the money you are going to need to fill the gap. The "gap" is a lot easier to fill if you have no debt and live below your means.


Good luck.

 

[grlcndream]

farmerEd - I like your philosophy here. Start with the oldest years first and work your way to the earliest you will need money for. That really makes sense to me.

 

[elb]

I have this same problem. Whenever I get advice from anyone it is always, max out the 401k first, etc. I am currently working on planning for the "gap", because who knows what tax laws will be in place 15-20 years from now and the SEPP 72t may not exist.

I am still maxing my 401k, because the tax breaks right now are just too tempting for me. I have also started a contribution to an after tax account as well. I may decrease the 401k contributions and increase the after-tax account contributions, still working it out.

You are not alone!

 

[BigMoneyJim]

SteveT, Hyper lost me with the 0% out thing, but the advantages of the 401(k) are tax-deferred savings and tax-deferred compounding interest, both of which are very powerful.

Usually you can make 401(k) withdrawals after age 55 without penalty if you've retired. However, you can roll your 401(k) over into an IRA after quitting your job at any age. I have done that.

Now that you have an IRA instead of a 401(k) you can use the 72t rules to set up substantially equal periodic payments at 35 or 45 or 23 or whenever you think you have enough to retire. I haven't done this myself, but I know I've seen a poster or two doing it; don't think any of the regulars are, though.

Yes there are hoops and complications, but if you're saving for retirement it's really hard to beat tax-deferred accumulation.

At the moment I am not maxing out my (new) 401(k) because I may make some financial changes and want to build a cash cushion. Some may want to save for a house, have several months' expenses in an emergency fund, pay down debt or have other after tax needs. In that case there's definitely a balance. But I don't see a problem having all of your retirement savings going into 401(k)s and IRAs.

I've seen a couple of arguments in the past against using tax-deferred vehicles. They made the point that you could invest in individual stocks and defer taxes by holding long term. Dividends still generate taxable events, but you don't pay the cap gains until you sell them. Not my thing, though.

Afterthought: Typically people earn most in the years just before retirement. Perhaps we could max our 401(k)s early and then reevaulate as we reach some %age of our retirement target and then ratchet up the after-tax savings to fill the gap when we have a better idea of how big the gap is. I'm too far away from retirement to know when I'll have enough.

EDIT: I bet some of the guys over here are taking 72t withdrawals: http://www.72t.net/

 

[Hyperborea]

SteveT, Hyper lost me with the 0% out thing

If one is retiring to a very low cost retirement (as one must be doing if they are going to retire really early and are not able to max out their 401k) then their tax rate will likely be 0%.

 

[LiveWell]

I have this same problem. Whenever I get advice from anyone it is always, max out the 401k first, etc. I am currently working on planning for the "gap", because who knows what tax laws will be in place 15-20 years from now and the SEPP 72t may not exist.

You are not alone!

You bring up one of my top 5 concerns about ER... namely having the govt. change some laws that my planning depends upon. There has been a lot of talk recently about social security which could have a big impact on ER planning. Does anyone here who is 20+ years away from collecting social security believe they're ever going to see a dime? I don't. So my planning doesn't even take that into account... if I'm wrong and I do get some social security then i'll consider it a bonus. But what about other ER accounts? If Bush is talking about changing the social security system isn't it possible that some future politician starts changing the laws surrounding IRAs and 401ks (or RRSPs if you're in Canada)? Ack... I think what my brain is having a hard time puzzling out is how to plan for the next 10 years, let alone 50 or 60 years of retirement given that so many things will change.

-LiveWell

 

[retire@40]

You bring up one of my top 5 concerns about ER... namely having the govt. change some laws that my planning depends upon.

I base my plan on what I know to be real today. If you start basing your plan on something that doesn't exist today and something that may or may not exist 50 years from now, your plan will be more theoretical than it would be otherwise.

Even though I am almost positive that the tax laws will not be the same in 50 years are they are today, I still base my long-term plans on todays tax laws as we know them. Then, year by year or month by month, I make adjustments to my plan as things change. Tax laws may change, my living expenses may change, ROI may change, etc.

If you want to be ultra-conservative and assume, for example, that you will not get any SS benefits, there is nothing wrong with that. But I would make that plan B. So, you could have a plan A for things as they are, Plan B for a worse-case scenario, and Plan C for a more optimistic view.

With all this planning, don't forget Plan X if we die before any of the other plans come to fruition :-/

 

[Otis]

Sorry to drag up such an old post, but I thought I'd stop in and give a mid-year update.

The wife and I celebrated this week by sending the last sizeable check to Mr. Visa. For the first time in 10 years, my Visa has no carryover balance -- next month's payment will be less than our grocery bill. It'll be an interesting shift in the next few months as I'm able to shovel that money into savings instead of paying for someone else's country club dues.

We're about 2 months behind where I really wanted to be. We ended up buying some art while on vacation in March, and did some home improvements earlier this summer so we'll be better able to sell sometime next spring. On the other hand, I managed to squeak an out of cycle raise (7%) in March, followed by an 8% annual raise in June, so although my 401k contribution saw most of the increase, I'm hopeful I can still catch up and be where I wanted to be by the end of '05. (For those that wonder, I took a promotion last fall at around 5 yrs with my company that'd normally be given to someone w/ 10-15 years experience. Compared to my peers, I was way behind the pay curve, so my boss saw fit to try to catch me up ... next year won't be quite as kind).


Goodbye Mr. Visa! Hello Mr. Savings Account!

 

[riskadverse]

Congratulations, you're on the fast track now. I would suggest swapping you Visa credit card for a Visa debit card in your wallet.

 

[saluki9]

Congratulations, you're on the fast track now. I would suggest swapping you Visa credit card for a Visa debit card in your wallet.

I agree that it sounds like you're doing well. but I would think long and hard before trading a credit card for a debit card. Lots of things not to like about debit cards, consumer protection being one of them.

 

[Tommy_Dolitte]

>>Should I stop contributing to my 401(k) at a certain point,

Yes you should, the trick is knowing when that "certain point" has been reached; Thats what I did.

Its true that there are ways to get at IRA money w/out penaly before 59 1/2, but you don't really want to be doing that at age 40 or 45...maybe a few years early, but not a few decades early.

The trick is to know how to balance the two; I was self-employed at had a Keough plan for my small corp which allowed me to save 30K per year pre-tax, so that account grew pretty quick; then once I felt that hit critical mass (such that it could grow big enough with modest gains for 30+ years), I focused on getting out of debt (including the house), and once the house was paid off, I focused all new savings into a regular after-tax brokerage account that I now live on. In my mind, I always took care of things in reverse order from when it would matter...i.e. take care of your regular retirement years (after 65+) first, then get the mortgage monkey off your back, then focus on the money you are going to need to fill the gap. The "gap" is a lot easier to fill if you have no debt and live below your means.


Good luck.

Very insightful....very insightful....

 

[maddythebeagle]

--------------------------------------------------------------------------------
Congratulations, you're on the fast track now. I would suggest swapping you Visa credit card for a Visa debit card in your wallet.
---------------------------------------------------------------------------------

I think if you pay your credit card off every month, there is not great sin of using a cc esp. if you are getting rewards. I personally dont spend any more paying with a cc vs. cash. I find a cc a great tool and know that I have to pay for it at the end of the month. I love putting stuff on it auto. (phone and electric) so that I have 1 bill to pay.

 

[riskadverse]

In the past year, we have paid off $25k of credit cards (don't ask),  ...
$5k on the final visa (ironically, this is mostly the cruise, will be paid off shortly), ...
For the first time in 10 years, my Visa has no carryover balance -- next month's payment will be less than our grocery bill.       

I would still recommend to Otis swapping the card he carries in his wallet to be a debit card vs a credit card.

Consumer protection can be achieved by using the Visa credit card he keeps at home, although using a cruise charged to the credit card as a reward for paying off the credit cards, doesn't sound too kosher to me.   As for paying off the balance every month, a ten year history is hard to overcome every month. 

It sounds like he's doing most everything right at this time - no sense in tempting fate.

 

[Otis]

I would still recommend to Otis swapping the card he carries in his wallet to be a debit card vs a credit card.

Consumer protection can be achieved by using the Visa credit card he keeps at home, although using a cruise charged to the credit card as a reward for paying off the credit cards, doesn't sound too kosher to me. As for paying off the balance every month, a ten year history is hard to overcome every month.

It sounds like he's doing most everything right at this time - no sense in tempting fate.

The credit card has been tucked away for several years now in favor of a debit card or cash for most purchases. The balance stopped growing significantly many moons ago. It's just taken this long to get enough momentum to pay it down, for lots of personal reasons too complex to explain here. Yes, I use a Visa for online purchases and other mail order because I don't like giving out my debit card number, secure server or not.

To some extent, I resent the implication that we'd run the visa back up after working the way we have to pay them down. I suppose that's expected. Lots of people would look at the $0 balance and drive to the local shopping mall with drool on their chin and a goofly little smile. However, this particular lesson cost us several thousands of dollars, not only in interest paid, but also potential lost growth on the investing we should have been doing. "Tempting fate" or not, that's a hard lesson to forget. Perhaps most importantly, if I ever expect to escape the job that I hate, I cannot carry a visa balance again. Ever.