Author Topic: Case Study: Starting from Scratch at 32.  (Read 1067 times)

CorvusJT

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Case Study: Starting from Scratch at 32.
« on: October 07, 2017, 08:40:17 PM »
Hello Mustachians,

Iíve read the blog for years without really going whole ham on a lot of the principles. But some big stuff happened in my life and I felt now was the time.

Single, pay quarterly taxes (contract employee) on $3500 a month income.

I live with my parents while I sort out some family issues. So I donít have rent or any major expenses. I telecommute, so no car. I didnít finish college, so no loan debt. Iím frugal, so no credit card debt. Save for a job last year, Iíve always worked for myself in some capacity so I never had a 401K or did any retirement planning.

My expenses are basically:

Left over expenses from a past business (shopify/shipping software): $50/mo
Health Insurance: $350, which will be cut in half once the next ACA enrollment opens up.
Food: $400/mo, I recently started seeing someone who likes to eat out.
Transportation: ~$100/mo, I live in the suburbs and take a train/bus/lyft into Chicago several times a month.
Tax bill: ~$1200 a quarter.

I have around $14,000 sitting in my checking account. And $3,500 in bitcoins (I would consider moving them if thatís advised).

Iíve always been pretty frugal, so budgeting and all that isnít a huge problem for me. Iím looking to get my own place in the next couple of months - renting in Chicago can be expensive, but I can work around that.

Down the line Iíd like to invest in some rental properties - in the Chicagoland area thatíd be a roughly $50k downpayment. I can also probably do some things to increase my income in the next few months.

I think the advice Iím looking for is - what might be the best way for me to start planning for retirement? Iím eyeing a Vanguard IRA. And how can I make it so that Iíll have capital for my future real estate plans? Should I be keeping some amount of money liquid for the latter - or sticking it all into investment accounts?

Thanks for the guidance.

Laura33

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Re: Case Study: Starting from Scratch at 32.
« Reply #1 on: October 08, 2017, 07:33:35 AM »
So, first, you're not really starting from scratch.  You've avoided a bunch of traps many people fall into, like student loans and CCs, are living below your means, and have a good emergency fund saved.  Give yourself credit for what you've done right.

Second, at this point I would prioritize an IRA.  I am assuming since you are a contract employee, you don't have access to a 401(k)?  You need to be putting something aside as a retirement kitty.  I am guessing at your income you should be well within the 15% bracket (caps out at $37,950 AGI, but you also get to knock about $10K off your gross income via one personal exemption and the standard deduction), so a Roth may be the best way to go.  One benefit of the Roth is that you can take out your contributions at any time with no taxes or penalties, and you can withdraw up to $10K tax-free to buy a first home once you've held the account for 5 years.  Note that in your case, I wouldn't recommend pulling anything from the account; I am a big fan of having some baseline retirement investments that are untouchable, and once you take it out, you can't put it back.   But the option is there.  You don't need to be fancy with this -- this is long-term money, so just put it in VTSMX or something similar.

Otherwise, I would wait until you are settled into your apartment before deciding on buying, etc.  You need to know what your baseline long-term costs and lifestyle are going to be before you can really decide about taking on a mortgage and rental property and all that.  So for now, I'd just start a post-tax investment account (you can do VTSMX for this as well) and sock away everything extra in there.  If/when you are settled and looking to jump into the rental game, then you can start focusing on a cash kitty for a downpayment.

A couple of other quick points:

1.  Bitcoin isn't an investment, it is speculation.  Hang onto that only if you are completely comfortable losing it all.

2.  If you're not doing it already, start tracking your expenses now.  Best to get in the habit now, before things get too complicated.  This is also the best way to avoid lifestyle creep -- you will notice increases right away, rather than getting to the end of the year and wondering where all your money went.

3.  Realize that the habits you are building now with the new SO are the habits that you will be stuck with if the relationship lasts.  Of course it's normal to try to impress someone early on and go out and do a lot of stuff; you like them, you want them to be happy, so you buy fancy dinners and give gifts and all of that totally natural stuff.*  But you're also trying to figure out if this is the person you want to spend the rest of your life with -- and a big part of that is seeing if you share similar expectations of the lifestyle you want to live.  So if you're comfortable spending $400/mo on food, then by all means, go ahead and continue as is.  But if your goal is to optimize value for money and live more frugally, start coming up with cheaper date options sooner rather than later.  And if the SO isn't happy with that, then they're not the one for you.

*The first vacation I took with my now-DH, we were wandering through the shops, and every time I'd say, "oh, that's cute," he'd immediately respond "do you want me to buy it for you?"  I appreciated that he wanted to make me happy, but I finally had to say "I'm just making conversation!  If I want you to buy me something, I'll tell you!"
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CorvusJT

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Re: Case Study: Starting from Scratch at 32.
« Reply #2 on: October 08, 2017, 08:14:15 AM »
Laura33,

This was a ridiculously helpful response in more ways than I expected! I also have an 800 credit score, so I'll give myself a pat on the back just this once, hah.

I do sit within that 15% tax bracket so I will definitely look into that $10k exemption and totally going with a Roth. The VTSMX is also what I was eyeing, so glad to hear I'm on the right path.

Other points:

1.) Bitcoins - that's $700 that I stored in an old merchant account that blew up to $3,500. I didn't earn the money so my brain won't think I "lost" it - so it's kind of there as a fun experiment. I sort of have plans to use it for LASIK (it would be life changing) once it hits a certain amount, but I will think about this a bit more.

2.) Expenses - I have a good grasp on what my expenditures are (sorry I used approximations in my examples). I could always be better and bring more transparency to things. But between my book keeping software and Mint, and with some new goals now, it should be fine.

3.) I've gone from making 12k a year, to 70k a year, to 19k, to 34k, to 42k - within that flux of incomes, the only thing I've had trouble with cutting back on is feeding my significant others lol. Otherwise I'm frugal in every sense. So I will work on that, and the new SO has her own financial/life goals to meet so this could work.

One last question I have has to do with allocation. I know you can't really tell me the distribution that I absolutely should do, but can you give me some general direction?
I'm thinking I'll only hold about 3 months of projected expenses and put the rest away - should that be 50/50 IRA and VTSMX? If I'm not mistaken the maximum contribution for the Roth IRA is $5,500 - does it make the most sense to put that amount in, and then whatever is left into the investment account?

Thank you again for the time you took to respond. I genuinely appreciate it :)

Physicsteacher

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Re: Case Study: Starting from Scratch at 32.
« Reply #3 on: October 08, 2017, 10:48:55 AM »
You can, if you wish, invest your IRA in 100% VTSMX. Many on the forums recommend doing exactly that. You might also consider Vanguard's target date and lifestrategy funds if you want some exposure to bonds and international stocks. At this early stage of your investing life, getting the perfect asset allocation isn't nearly as important as getting started and socking away as much as you can. Most of the growth in your first couple of years will come from your ongoing contributions. There's no tax consequence for changing investments within an IRA so you can always fine tune later.

It's almost always a good idea to max out your IRA (Roth or traditional) before starting to invest in a taxable account.

MDM

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Re: Case Study: Starting from Scratch at 32.
« Reply #4 on: October 08, 2017, 11:41:31 AM »
I do sit within that 15% tax bracket so I will definitely look into that $10k exemption and totally going with a Roth.
At some point, if you have no pension - even if you stay in the 15% bracket - it would be good to contribute to traditional accounts (IRA or, if you get the opportunity, 401k etc.) so you have at least a $250K traditional balance at retirement.

That's because withdrawing from the $250K at 4%/yr would be $10K/yr, on which you would pay $0 federal tax.

Rules of thumb for traditional vs. Roth assume a marginal withdrawal tax rate of 15% or more.  Without sufficient taxable income, however, one will not reach that 15% marginal withdrawal tax rate, making the rules of thumb inoperative.

Laura33

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Re: Case Study: Starting from Scratch at 32.
« Reply #5 on: October 08, 2017, 12:04:14 PM »
I do sit within that 15% tax bracket so I will definitely look into that $10k exemption and totally going with a Roth.
At some point, if you have no pension - even if you stay in the 15% bracket - it would be good to contribute to traditional accounts (IRA or, if you get the opportunity, 401k etc.) so you have at least a $250K traditional balance at retirement.

That's because withdrawing from the $250K at 4%/yr would be $10K/yr, on which you would pay $0 federal tax.

Rules of thumb for traditional vs. Roth assume a marginal withdrawal tax rate of 15% or more.  Without sufficient taxable income, however, one will not reach that 15% marginal withdrawal tax rate, making the rules of thumb inoperative.

I think you might have flipped this:  the traditional IRA gives you the tax break now, but you pay taxes on withdrawal, whereas the Roth is the one that you contribute post-tax $ to and then have tax-free withdrawals later.  So if you want $10k/yr tax-free, you want that $250k in a Roth IRA, not a traditional one.*  Unless I missed some more subtle strategy?

@Corvus:  I would always max out your tax-sheltered options before saving in a regular taxable account.  There are exceptions to this (e.g., CC debt, no EF, massive fees in a 401(k)), but those don't apply to you.  So like Physicsteacher said, I would put both accounts in VTSMX, but set up the Roth to max out first, and then just put the leftovers in the regular taxable account. 

*This is one reason I am doing Roth 401(k) now, even though my tax bracket would say traditional.  After @15-20 years in a traditional 401(k), I have plenty of investments that I will need to pay tax on at my future tax rate; I like having a kitty that I can withdraw from without having to pay tax so I can do a little tax bracket arbitrage from year to year.
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MDM

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Re: Case Study: Starting from Scratch at 32.
« Reply #6 on: October 08, 2017, 12:26:36 PM »
I do sit within that 15% tax bracket so I will definitely look into that $10k exemption and totally going with a Roth.
At some point, if you have no pension - even if you stay in the 15% bracket - it would be good to contribute to traditional accounts (IRA or, if you get the opportunity, 401k etc.) so you have at least a $250K traditional balance at retirement.

That's because withdrawing from the $250K at 4%/yr would be $10K/yr, on which you would pay $0 federal tax.

Rules of thumb for traditional vs. Roth assume a marginal withdrawal tax rate of 15% or more.  Without sufficient taxable income, however, one will not reach that 15% marginal withdrawal tax rate, making the rules of thumb inoperative.

I think you might have flipped this:  the traditional IRA gives you the tax break now, but you pay taxes on withdrawal, whereas the Roth is the one that you contribute post-tax $ to and then have tax-free withdrawals later.  So if you want $10k/yr tax-free, you want that $250k in a Roth IRA, not a traditional one.*  Unless I missed some more subtle strategy?
Withdrawals from a traditional IRA are indeed subject to tax, but if the marginal tax rate is 0% then they won't be taxed.

The standard deduction and personal exemption not only applies now, but in retirement as well, making the first ~$10K/yr of ordinary income tax free.  The whole advantage of traditional accounts is to save a higher marginal rate now and pay a lower marginal rate later.

Does that make sense?

Laura33

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Re: Case Study: Starting from Scratch at 32.
« Reply #7 on: October 08, 2017, 06:43:39 PM »
I do sit within that 15% tax bracket so I will definitely look into that $10k exemption and totally going with a Roth.
At some point, if you have no pension - even if you stay in the 15% bracket - it would be good to contribute to traditional accounts (IRA or, if you get the opportunity, 401k etc.) so you have at least a $250K traditional balance at retirement.

That's because withdrawing from the $250K at 4%/yr would be $10K/yr, on which you would pay $0 federal tax.

Rules of thumb for traditional vs. Roth assume a marginal withdrawal tax rate of 15% or more.  Without sufficient taxable income, however, one will not reach that 15% marginal withdrawal tax rate, making the rules of thumb inoperative.

I think you might have flipped this:  the traditional IRA gives you the tax break now, but you pay taxes on withdrawal, whereas the Roth is the one that you contribute post-tax $ to and then have tax-free withdrawals later.  So if you want $10k/yr tax-free, you want that $250k in a Roth IRA, not a traditional one.*  Unless I missed some more subtle strategy?
Withdrawals from a traditional IRA are indeed subject to tax, but if the marginal tax rate is 0% then they won't be taxed.

The standard deduction and personal exemption not only applies now, but in retirement as well, making the first ~$10K/yr of ordinary income tax free.  The whole advantage of traditional accounts is to save a higher marginal rate now and pay a lower marginal rate later.

Does that make sense?

Ahh, yes, I follow you now, thanks.
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Laura33

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Gronnie

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Re: Case Study: Starting from Scratch at 32.
« Reply #9 on: October 08, 2017, 08:17:47 PM »
1.) Bitcoins - that's $700 that I stored in an old merchant account that blew up to $3,500. I didn't earn the money so my brain won't think I "lost" it - so it's kind of there as a fun experiment. I sort of have plans to use it for LASIK (it would be life changing) once it hits a certain amount, but I will think about this a bit more.

If you had $3500 in cash right now in your bank account, would you use it to speculate on Bitcoin? If not, you should sell it right now, it's the same thing.