Author Topic: Advice for a friend - high earner with little retirement savings  (Read 4803 times)

Lis

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I was having a drink with a friend when the discussion of budgets, savings, and retirement came up. We were discussing budgets, and I mentioned how I "pay myself" first by throwing money into my IRA, and how I'm excited that this is the first year I'm maxing out both my IRA and 401k. She confessed that she just has a random percentage contribution to her company's 401k (not maxing), and while she does have a savings account, pretty much whatever she doesn't spend just sits in her checking account. She's comfortable with the amount that she spends (and definitely doesn't spend her whole pay check), but she's was just never sure what to do with extra money, so she didn't do anything with it. I offered to help her set up an IRA, so at least she has something else.

I want to give her basic, easy advice (there's a good chance I'll actually be doing the leg work for her here). Whatever advice I can offer right now is better than nothing, but I want to crowd source and see what you all think as well.

She's a software engineer, high earner but her income will grow, HCOL.

- I had recommended an IRA first. Traditional or Roth? Given that her she's still at the beginning of her career (less than five years in the work force), I'm inclined to say Roth. As an aside, I currently have a Roth IRA with Vanguard with the Target Retirement Date (2055), and when I explained what that was, her response was "just do that." She's all for simplicity and is fairly risk adverse.

- If she has more than $5500 to invest (which she very well might, I don't know her exact numbers), what's the next account she should open (assuming she begins to max out her 401k as well)?

- She *might* be planning an elective surgery* sometime in the future, which is part of the reason she's been hoarding money. My company provides money with an FSA, so I really know nothing about HSAs. Is an HSA (or something similar) a viable option for an elective surgery? (*I am not going to attempt to dissuade her from her choice of surgery, she's on the fence about it and I will support her choice no matter what, so please don't say "tell her not to have the surgery!" If there's nothing out there that can help with savings for an elective surgery, she'll figure something else out.)

Thanks in advance for your advice!

Edited to add: she's debt free, rents with roommates, and is not considering any large purchases (like a house or car) in the immediate (or even distant) future - the possible surgery is the only potential large expense.
« Last Edit: May 12, 2017, 07:52:59 AM by Lis »

Altons Bobs

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Re: Advice for a friend - high earner with little retirement savings
« Reply #1 on: May 11, 2017, 04:40:26 PM »
Check to make sure she can even qualify for tax deduction on ROTH since you said she was a high earner, or if she needs to do backdoor ROTH and if it's easy enough or if she needs to transfer all of her other IRA funds out first before doing a backdoor ROTH. And if it's Traditional IRA, also check on the her income and the income limit on tIRA.  A friend of mine didn't check, and she would not qualify for ROTH, but she did it not knowing there was an income limit.  If she's a high earner, most likely she would not qualify for any tax deduction.  Well, it depends on how "high" you consider high.

MDM

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Re: Advice for a friend - high earner with little retirement savings
« Reply #2 on: May 11, 2017, 04:40:36 PM »
"High earner" usually translates into "traditional is better", even if "higher earner later" is also true.

See Investment Order and links therein for more on this, and on your overall question.

Scortius

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Re: Advice for a friend - high earner with little retirement savings
« Reply #3 on: May 11, 2017, 04:58:32 PM »
Investment Order is the way to go, but you can keep it even more simple to get her started.

Basically, 18k in the traditional 401k is priority number one.  She's a high earner so she should be able to do it, it will guarantee she gets her full match, and she should be prioritizing pre-tax accounts.  If she has the options, HSAs and traditional IRAs are also good.

After that, it doesn't have to get much more complicated.  If that's the level she wants to think about it, she'll probably be find just throwing any excess into a taxable Vanguard target retirement account.  The benefits of Roth accounts are probably overrated:

http://www.gocurrycracker.com/roth-sucks/

So, unless she shows great interest in really going deep, I'd advise you just stick to 1) max pre-tax contributions, 2) automatic deposits into a taxable Vanguard Target Retirement Account.

Laura33

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Re: Advice for a friend - high earner with little retirement savings
« Reply #4 on: May 11, 2017, 05:19:40 PM »
I'd advise you just stick to 1) max pre-tax contributions, 2) automatic deposits into a taxable Vanguard Target Retirement Account.

This.  It sounds like she is easily overwhelmed and not that interested.  So don't let the perfect be the enemy of the good -- at this point, her success or failure will be driven far more by how much she invests than by the specific vehicle or fund that she choose to invest in.  Because just about any fund in any account will do better than a bank account paying 0.1% interest. 

So max the 401(k) first -- put it in a generic target-date retirement fund. 

Then sit at her computer with her and walk her through opening a regular taxable account at Vanguard.  Set it up to take automatic transfers from her bank account every month -- even if it is just for a token amount.  Put it in the same basic target-date retirement account.  The point here is to get the "hard" stuff done now, so if she decides to increase the amount later, she can just hop online and click a button.

Note:  since she is saving for the surgery, she might not want to max out the 401(k), because then she wouldn't have access to that money.  So if she needs to for now, limit the amount going to the 401(k) and put the difference in Vanguard until she has enough saved for the surgery.  But then have her sign up to automatically increase her 401(k) contributions every year by 1% until she maxes out.

In terms of HSAs and FSAs for the surgery, I believe you have to set those up at benefits enrollment time, so she probably can't do that until next year anyway.  I also don't know whether all elective surgeries are covered (e.g., cosmetic) -- so do a little research before you steer her in that direction. 

Lis

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Re: Advice for a friend - high earner with little retirement savings
« Reply #5 on: May 12, 2017, 07:49:28 AM »
Thank you all!

She definitely gets overwhelmed easily when it comes to financials... last year I tried to have a similar conversation (I was excited about financial things in my own life and wanted to share, then she started asking questions), but her eyes just glazed over.

For "high earner" - she did confirm last year she was under the Roth contribution limit, but that was a year ago and she just accepted a new job that offered "a hell of a lot" more money. I don't know if that makes her hit $117k (I don't think so), but it sounds like Traditional is the way to go anyway.

Since she's switching jobs and hasn't maxed out her 401k, I mentioned she should check with her HR about having 100% (or as much as possible) of her pay check thrown to her 401k (she said she could comfortably do that). I also want to encourage her to contributed max, or at least up her 401k contribution at her new job. Right now she says she's contributing 8%, but when I asked her if she knew how much that was, she didn't know. Assuming she gets paid twice a month, I'm going to advise she just contributes $750 per pay check (or as much as she feels comfortable with).

Then sit at her computer with her and walk her through opening a regular taxable account at Vanguard.  Set it up to take automatic transfers from her bank account every month -- even if it is just for a token amount.  Put it in the same basic target-date retirement account.

So I do not have a taxable account yet - hoping to be able to do that by next year. This might sound like a silly question, but can you still invest in a target retirement fund in a taxable account? She won't be interested in doing anymore then just sending $X every paycheck to Vanguard, and is putting pretty much complete trust in me to set her up. Or is one of the guides I've seen floating around the forums a good source for this?

Thank you for your HSA help - I won't overwhelm her with that. I

Lis

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Re: Advice for a friend - high earner with little retirement savings
« Reply #6 on: May 12, 2017, 07:58:02 AM »
The benefits of Roth accounts are probably overrated:

http://www.gocurrycracker.com/roth-sucks/


Sooo.... should I switch my Roth IRA to a Traditional (can you do that?)? Should I open a new Traditional IRA and stop contributing to my Roth? Because that math is scary.

MDM

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Re: Advice for a friend - high earner with little retirement savings
« Reply #7 on: May 12, 2017, 07:58:15 AM »
...can you still invest in a target retirement fund in a taxable account?
Yes.

Any of Vanguard's (or Fidelity's, Schwab's, etc.) mutual funds may be used in traditional, Roth, and taxable accounts.

MDM

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Re: Advice for a friend - high earner with little retirement savings
« Reply #8 on: May 12, 2017, 08:07:53 AM »
The benefits of Roth accounts are probably overrated:

http://www.gocurrycracker.com/roth-sucks/

Sooo.... should I switch my Roth IRA to a Traditional (can you do that?)?
Not the amounts you already have from previous years.  At some point the withdrawals from the Roth will eventually be tax free, so just leave them alone.

Quote
Should I open a new Traditional IRA and stop contributing to my Roth? Because that math is scary.
Maybe.  While GCC's intent is good, his math in that article is wrong.  You don't compare your marginal rate now with your effective rate later, you compare your marginal rate now with your marginal rate later.

Sorry if that isn't significantly less scary... ;)

In general, if you are in the 25% (or higher) bracket now, use traditional.  If you are in the 10% (or lower) bracket now, use Roth.  The 15% bracket can be closer to a coin flip, but unless you have a large guaranteed pension in hand, traditional will usually be better.

There are, however, many exceptions to that rule of thumb, particularly when your marginal rate is not the same as your tax bracket.  See https://www.bogleheads.org/wiki/Traditional_versus_Roth for more.

Lis

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Re: Advice for a friend - high earner with little retirement savings
« Reply #9 on: May 12, 2017, 08:26:17 AM »
...can you still invest in a target retirement fund in a taxable account?
Yes.

Any of Vanguard's (or Fidelity's, Schwab's, etc.) mutual funds may be used in traditional, Roth, and taxable accounts.

Thank you!

Maybe.  While GCC's intent is good, his math in that article is wrong.  You don't compare your marginal rate now with your effective rate later, you compare your marginal rate now with your marginal rate later.

Sorry if that isn't significantly less scary... ;)

In general, if you are in the 25% (or higher) bracket now, use traditional.  If you are in the 10% (or lower) bracket now, use Roth.  The 15% bracket can be closer to a coin flip, but unless you have a large guaranteed pension in hand, traditional will usually be better.

There are, however, many exceptions to that rule of thumb, particularly when your marginal rate is not the same as your tax bracket.  See https://www.bogleheads.org/wiki/Traditional_versus_Roth for more.

Got it. I'm in the 25% right now (and friend is in either the 25% or 28%), so I'll be opening a Traditional myself, and one for her as well.

Thanks for your help!!

Laura33

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Re: Advice for a friend - high earner with little retirement savings
« Reply #10 on: May 12, 2017, 08:57:32 AM »
Since she's switching jobs and hasn't maxed out her 401k, I mentioned she should check with her HR about having 100% (or as much as possible) of her pay check thrown to her 401k (she said she could comfortably do that). I also want to encourage her to contributed max, or at least up her 401k contribution at her new job. Right now she says she's contributing 8%, but when I asked her if she knew how much that was, she didn't know. Assuming she gets paid twice a month, I'm going to advise she just contributes $750 per pay check (or as much as she feels comfortable with).

I want to clarify one thing:  the 401(k) limit is per year, not per employer.  I am not quite sure, but it sounds like you might be telling her to max out her 401(k) at her prior employer ($18K), and then put enough towards the 401(k) at her new employer to max out there as well (another $18K)?  If that is what you are suggesting, she can't do that -- she needs to make sure that she maxes out at $18K total from both jobs. 

She should be able to figure out from her paychecks at the old job how much she has put toward the 401(k) so far this year.  So all you have to do is subtract that from $18K to figure out how much she will be eligible to contribute while at the new job, and divide that by the number of pay periods she will have between when she is first eligible at the new job and the end of the year.

SHARP_00

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Re: Advice for a friend - high earner with little retirement savings
« Reply #11 on: May 12, 2017, 09:01:39 AM »
Note, there is one more wrinkle to this. If you are contributing to a workplace retirement plan (and you are with your 401k), there are limits on how much of a traditional IRA contribution is tax deductible . See the linked article for the ranges:
http://www.bankrate.com/finance/taxes/retirement-plan-contribution-limits.aspx

If you are single, with an AGI above 72,000, you wont be able to deduct the tIRA contributions. While it is certainly true that at higher marginal rates, tIRA beats Roth, if the tIRA is not deductible, Roth wins.

Assuming you are over 72,000 (and single, rules and limits are different depending on filing status), anything over the 401k max should be going either to Roth for tax advantages, or taxable if you value the flexibility to withdraw gains without incurring penalties.

Lis

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Re: Advice for a friend - high earner with little retirement savings
« Reply #12 on: May 12, 2017, 10:45:36 AM »
I want to clarify one thing:  the 401(k) limit is per year, not per employer.  I am not quite sure, but it sounds like you might be telling her to max out her 401(k) at her prior employer ($18K), and then put enough towards the 401(k) at her new employer to max out there as well (another $18K)?  If that is what you are suggesting, she can't do that -- she needs to make sure that she maxes out at $18K total from both jobs. 

She should be able to figure out from her paychecks at the old job how much she has put toward the 401(k) so far this year.  So all you have to do is subtract that from $18K to figure out how much she will be eligible to contribute while at the new job, and divide that by the number of pay periods she will have between when she is first eligible at the new job and the end of the year.

Sorry, didn't make that clear. I'm trying to put down my thought process and having difficulty actually making it coherent (yay cold meds). I knew that. Basically (assuming you're paid 24 times a year), to keep it simple, you would need to contribute $750 per pay check to max out your 401k by the end of the year (you could do so earlier, but then we're making it less simple). If you do that, you should have contributed $6000 by now. She hasn't done that yet, but might be able to hit that (still increasing) target if she contributes her whole pay check. It makes sense in my head lol. But I think trying to figure that out would be too complicated and scary for her, so I'll just stick with recommending she start with $750 per pay check at her new job. She might not max this year, BUT she's set up to max next year and will still contribute a fair amount this year.

Speaking of scary...
Note, there is one more wrinkle to this. If you are contributing to a workplace retirement plan (and you are with your 401k), there are limits on how much of a traditional IRA contribution is tax deductible . See the linked article for the ranges:
http://www.bankrate.com/finance/taxes/retirement-plan-contribution-limits.aspx

If you are single, with an AGI above 72,000, you wont be able to deduct the tIRA contributions. While it is certainly true that at higher marginal rates, tIRA beats Roth, if the tIRA is not deductible, Roth wins.

Assuming you are over 72,000 (and single, rules and limits are different depending on filing status), anything over the 401k max should be going either to Roth for tax advantages, or taxable if you value the flexibility to withdraw gains without incurring penalties.


Now my head is starting to hurt haha. Ok, I am not over $72k (though there's a good chance I'll be within the $62-$72 range for 2017). Friend almost certainly is. So, assuming she does make $72k+, does that mean she wouldn't be able to deduct tIRA contributions? And since I fall in the range, does that mean I'd only be able to deduct partial?

Feel free to advise an 'investing for dummies' book.

MDM

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Re: Advice for a friend - high earner with little retirement savings
« Reply #13 on: May 12, 2017, 10:55:19 AM »
Now my head is starting to hurt haha. Ok, I am not over $72k (though there's a good chance I'll be within the $62-$72 range for 2017). Friend almost certainly is. So, assuming she does make $72k+, does that mean she wouldn't be able to deduct tIRA contributions? And since I fall in the range, does that mean I'd only be able to deduct partial?
Yes and yes.

Some "investment" starters:
https://www.bogleheads.org/wiki/Getting_started
http://jlcollinsnh.com/stock-series/
www.etf.com/docs/IfYouCan.pdf

Don't know of any "tax code" starters, other than working through your latest Form 1040 by hand.  It's actually not too bad to do so, and can help you plan for this and future years better than merely answering TurboTax's questions and taking the results on faith.

Scortius

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Re: Advice for a friend - high earner with little retirement savings
« Reply #14 on: May 12, 2017, 09:56:58 PM »
Note, there is one more wrinkle to this. If you are contributing to a workplace retirement plan (and you are with your 401k), there are limits on how much of a traditional IRA contribution is tax deductible . See the linked article for the ranges:
http://www.bankrate.com/finance/taxes/retirement-plan-contribution-limits.aspx

If you are single, with an AGI above 72,000, you wont be able to deduct the tIRA contributions. While it is certainly true that at higher marginal rates, tIRA beats Roth, if the tIRA is not deductible, Roth wins.

Assuming you are over 72,000 (and single, rules and limits are different depending on filing status), anything over the 401k max should be going either to Roth for tax advantages, or taxable if you value the flexibility to withdraw gains without incurring penalties.

Yeah, this is why I suggested to 'keep it simple' and stick to the two rules 1) max traditional 401k, and 2) just throw the rest into taxable.

If you want to go deeper, go through the Investment Order sticky, but it does get pretty complicated when you start calculating what you're eligible for. 

And yes, Lis, in general you will want to be maxing traditional contributions rather than Roth contributions as well!