January 26 Savings Rate Post - So Confused...

[LalsConstant]

I am so confused.  I must be a very simple person missing a very simple point.

For fun I wanted to calculate my savings rate MMM style per the 1/26/2015 methodology.

Now for the record, this is something I'm still working on, I'm not at my target rate yet.  I don't expect to rate MMM approval!

But I am baffled.

Per his logic, I have a savings rate of exactly 0% because I have opted to tax defer the amount I save and invest because at this point in the process, that's what makes sense for me to do.

I've arrived at this conclusion to put all investments into my 401k at the moment by figuring out how much "old man money" I need at age 60 (at that age the funds should be freely available to me) and discounting that back to its net present value at 5, 10, 15 etc. years before age 60, and I also ran a calculation projecting the 401k balance assuming the same 5% rate return, with assumptions plugged in.  I did this last year to arrive at my plans for this year and plan to make new and better assumptions as information improves.

It's hard to explain concisely but the idea is to keep tweaking things such that I'm contributing to the 401k through each working year to avoide the highest marginal tax rates I might pay, but the balance in the pre tax account has to grow to a very healthy level before it mathematically works out that I have "enough" in there.

But theroetically I should be richer and richer the closer I get to this point yes?

Yet by following the exercise, since I spend exactly every take home dollar this means I'm not saving anything at all?

This also implies that if I meet my goal of increasing my 401k contribution to include another 5% of salary this year, my rate will not move from zero.

But if I were to be contributing it to a Roth IRA instead of a 401k, I'd have a rate above zero.  Why?

I am so confused.  This doesn't seem right.  I must be doing this wrong.

[tarheeldan]

Ah. MMM is including 401(k) contributions as part of "take home" pay:

"The MMM Take Home Pay calculation would thus be:
Gross Pay + Employer 401(k) match – taxes and fees
= $8620 gross pay + $300 employer 401(k) match – $1724 federal tax – $689 state tax
= $6507 biweekly or $14,055 per month"

See how the "401(k) plan deduction: $692" isn't subtracted out?

Hope that helps!

[Cromacster]

He wasn't very clear about it, but he did differentiate between "take home pay" and "money that shows up in the bank"

But this is where many people get confused, because this paycheck he takes home is not really his take-home pay. You need to add back in the money that he is actually using – including to pay off loans –  or will get to use – including all retirement and savings account deposits.

He was trying to clarify here, but the way he stated it was pretty confusing.

So you include any retirement savings into your take home pay, as well as any employer contributions to retirement accounts.

[MDM]

From the blog:

You need to deeply understanding your spending needs and wants in order to know if you can afford to retire. Instead of taking random guesses at the factors above, I prefer to think of everything in terms of after-tax dollars. Take-home income instead of gross income.

A couple of things on the quote above:
-  When you calculate spending needs in retirement for the purpose of "Once the total value of all your investments reaches 25-30 times your annual spending, paid work is now entirely at your discretion," that spending must include the taxes you will be paying.  Yes, your tax rate is likely to be lower than when working, for all the reasons MMM mentions, but unless you know the rate will be zero you should not ignore it.
-  Using take-home income does simplify some things.  Just make sure you appreciate the difference among "take home", "adjusted gross", and "taxable" (not to mention "modified adjusted gross", etc.) because different IRS regulations (e.g., choice of traditional vs. Roth) depend on things other than take home pay.

[deborah]

Also, including your house in your net worth IMO is not realistic. You need to live somewhere, and you are probably not going to be paid to do it. If you end up staying there, you have done your calculations right. If you retire to caravan, or other cheaper accommodation you have a little bit extra.

[LalsConstant]

Ah okay I think I see now.  I may try this again sometime with corrections.  I agree with the sentiment you have to tweak your personal approach and I use a different methodology myself but doing it MMM style seemed like an interesting way to try.

Thanks everyone! =D

[sabertooth3]

As a US federal gov. employee, should FERS contributions and matching be counted in savings as well? I equate the TSP to 401(k)s, and I know that FERS is basically a pension, but since it's inaccessible until at least age 57, does that count?

[deborah]

As a US federal gov. employee, should FERS contributions and matching be counted in savings as well? I equate the TSP to 401(k)s, and I know that FERS is basically a pension, but since it's inaccessible until at least age 57, does that count?

It depends when you are retiring, and how much it is. If you are 39, and the FERS starts at 57, you have 18 years until it starts. If it is a defined benefit pension, it probably won't return terribly much if you retired tomorrow, but would return a lot more if you retired in 10 years. If it is going to give you as much as you need during retirement, you may only need to save enough money to live on between when you retire and 57. On the other hand, it may end up looking like pocket money.

[FFA]

Also, including your house in your net worth IMO is not realistic. You need to live somewhere, and you are probably not going to be paid to do it. If you end up staying there, you have done your calculations right. If you retire to caravan, or other cheaper accommodation you have a little bit extra.

Yes Exactly. I'm a recent MMM convert and devouring the blog in recent weeks and now the forum. I find myself agreeing with 99.9% of everything he says but this is one point in the latest blog post that I just didn't get.

[oldmannickels]

Also, including your house in your net worth IMO is not realistic. You need to live somewhere, and you are probably not going to be paid to do it. If you end up staying there, you have done your calculations right. If you retire to caravan, or other cheaper accommodation you have a little bit extra.

Yes Exactly. I'm a recent MMM convert and devouring the blog in recent weeks and now the forum. I find myself agreeing with 99.9% of everything he says but this is one point in the latest blog post that I just didn't get.

Think about it the other way. If you have one person who has a paid for house and $100k in investments, would they have the same net worth as someone who has a house with a mortgage and $100k in investments?

[FFA]

Also, including your house in your net worth IMO is not realistic. You need to live somewhere, and you are probably not going to be paid to do it. If you end up staying there, you have done your calculations right. If you retire to caravan, or other cheaper accommodation you have a little bit extra.

Yes Exactly. I'm a recent MMM convert and devouring the blog in recent weeks and now the forum. I find myself agreeing with 99.9% of everything he says but this is one point in the latest blog post that I just didn't get.

Think about it the other way. If you have one person who has a paid for house and $100k in investments, would they have the same net worth as someone who has a house with a mortgage and $100k in investments?

nope, of course person 2 net worth is lower by the amount of the mortgage.

The bit I don't get is if youre using this net worth for a retirement calc, then my approach would be :

person 1 has 100k x SWR say 4% = $4k.

person 2 has (100k minus mortgage) x 4%. Or if you like person 2 can take $100k too but then clearly must include the mortgage repayments in current annual spending.

Either way person 1 is closer to retirement than person 2. But neither of them is as close as they would appear to be if they add the home value onto their net worth and end up with a much bigger apparant retirement income.

Hope the above makes sense. I don't dispute your own home is an asset and part of net worth, but it's not one that I personally would include in the specific case of a retirement income calc.

[sabertooth3]

It depends when you are retiring, and how much it is. If you are 39, and the FERS starts at 57, you have 18 years until it starts. If it is a defined benefit pension, it probably won't return terribly much if you retired tomorrow, but would return a lot more if you retired in 10 years. If it is going to give you as much as you need during retirement, you may only need to save enough money to live on between when you retire and 57. On the other hand, it may end up looking like pocket money.

I'm in my mid-20s, so I have about 30 years before I could even touch that money. Basically, if I count it my household's saving rate goes to about 55%; if I don't then it's more like 45%. I'm fine with either, but trying to get a sense of what it is.

[LalsConstant]

As a US federal gov. employee, should FERS contributions and matching be counted in savings as well? I equate the TSP to 401(k)s, and I know that FERS is basically a pension, but since it's inaccessible until at least age 57, does that count?

I too am involved with a pension, and while the rules of our pensions won't be the same maybe the principal of this argument might help.

Since I cannot be sure of the future payout for three reasons:

1.  The legislature can change it at any time.
2.  The fund is insolvent.
3.  I might not work there long enough to qualify for the annuity

I instead count only the part of the pension that I'm considered "vested" in, because that amount is mine even if I quit the very next day, as in I can literally roll it over into an IRA.

I also do a differential projection, one in which the pension annuity is received, one in which it is not.  That doesn't tell me the future, but it does let me analyze how well prepared I would be for different possibilities and informs my decision making.

It's one of those things like Social Security, objectively it's probably going to be worth SOMETHING but  when you can't possibly predict what that might be exactly, it's prudent to make a conservative planning assumption.