Author Topic: Case Study - 24 and just entered the rat race.  (Read 4727 times)

Awitte58

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Case Study - 24 and just entered the rat race.
« on: October 13, 2015, 03:17:52 PM »
Hello, I've posted a few minor questions here and there, but I have never done a full on case study. So here it goes.

Life Situation: Filing Single, 0 dependents, State of Illinois

Gross Salary/Wages: 55,000 annual salary

Pre-tax deductions: 36% of gross into 401k, $3 per check deduction for vision insurance, other insurance is still under my mother (for 1 more year).

Actual Expenses: Mortgage (fixed 4.6%) - $828 per month (escrow insurance taxes)
Living Expenses: $450 per month (Electricity, Heat, Transportation, Food, Waste Management. This is an over estimation in preparation for the winter heat bills)
Cell Phone: $50 per month
Internet: $39 per month
Student loans: $248 (6.8% interest on the 25 year repayment plan, I will be refinancing these through SoFi or other site…the payments start in December. From what I researched so far the monthly payment will be the same, but the interest rate they offer will save 15k over the period of the loan. Just know that the monthly payment won’t change.)

The remainder of my ‘Take-Home’ pay after taking out the 401k deduction and all my ‘necessary’ expenses $375. I am sure I could make cuts in my lifestyle to save more, but let’s just assume these expenses are fixed.

Specific Question(s): Where should I allocate my free cash? My current thoughts/options are listed below:
1.   Roth IRA: The company offers this and will match the funds I put into this account.
2.   Traditional IRA: I would set up externally and fund it so I can deduct it from my taxes at the end of the year.
3.   Student Loans: Guaranteed 6.8% (or whatever the refinanced interest rate is) ROI.
4.   Mortgage Payment: Guaranteed 4.6% ROI
5.   Index Funds: I’d probably do the vanguard route.
6.   Recommendations?

I am open to any criticism or recommendations. I may be getting one roommate which will produce another $350 per month in income. Also, thinking ahead I will enroll in an HDHP that will make me eligible for an HSA, but I won’t do that until I am kicked off my mother’s insurance.

OneCoolCat

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Re: Case Study - 24 and just entered the rat race.
« Reply #1 on: October 13, 2015, 03:27:35 PM »
I recommend the following:
1) Refinance student loans to lower interest rate and pay the minimum.
2) Max HSA Account (you probably dont have this option yet as you are on your mothers policy)
3) Put in just enough to your 401k to get your employer's match.
4) Max Traditional IRA
5) Max 401k
6) Put the rest toward your mortgage (especially if you live in a state that recognizes a homestead).
7) Then open a brokerage account and put everything left over in there.

Mr. Green

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Re: Case Study - 24 and just entered the rat race.
« Reply #2 on: October 13, 2015, 03:34:52 PM »
The Roth IRA is a no brainer if your company will match your contribution. You won't get that kind of return out of any of the other options. I don't know if an employer can have a vesting schedule on a Roth IRA or not but if they do that might be something to consider if you think there's any chance you wouldn't stay there for a while.

MDM

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Re: Case Study - 24 and just entered the rat race.
« Reply #3 on: October 13, 2015, 08:44:03 PM »
Specific Question(s): Where should I allocate my free cash? My current thoughts/options are listed below:
1.   Roth IRA: The company offers this and will match the funds I put into this account.
2.   Traditional IRA: I would set up externally and fund it so I can deduct it from my taxes at the end of the year.
Careful on this.  There is a total $5500/yr limit on all contributions to any traditional or Roth IRA.  Is the company contribution really to a Roth IRA, or is it to a SIMPLE IRA or other deferred compensation plan?  You mention a 401k so maybe the company is that nice about matching Roth IRA money...?  How good are the investment options?

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3.   Student Loans: Guaranteed 6.8% (or whatever the refinanced interest rate is) ROI.
4.   Mortgage Payment: Guaranteed 4.6% ROI
5.   Index Funds: I’d probably do the vanguard route.
If the SL re-fi gets you below 5%, doing the index funds instead of increased loan payments might be better.

Quote
I will enroll in an HDHP that will make me eligible for an HSA, but I won’t do that until I am kicked off my mother’s insurance.
Does your mother have an HDHP?  If so, you are eligible now for your own HSA with the family maximum.

Paul | pdgessler

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Re: Case Study - 24 and just entered the rat race.
« Reply #4 on: October 13, 2015, 08:52:57 PM »
Does your mother have an HDHP?  If so, you are eligible now for your own HSA with the family maximum.

I may be mistaken, but I think that would only be true if the mother or her employer were not contributing anything to her own (the mother's) HSA. For family coverage, the sum total contributions to any associated HSAs cannot exceed the family maximum.

MDM

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Re: Case Study - 24 and just entered the rat race.
« Reply #5 on: October 13, 2015, 09:06:18 PM »
I may be mistaken, but I think that would only be true if the mother or her employer were not contributing anything to her own (the mother's) HSA. For family coverage, the sum total contributions to any associated HSAs cannot exceed the family maximum.
It does seem reasonable to think that, but the law doesn't always make sense, and sometimes that can be favorable to you - as in the case of a non-dependent adult child covered by a family HDHP. 

See http://forum.mrmoneymustache.com/taxes/hsa-for-an-adult-child-great-benefit-if-one-qualifies/ for more details.

Paul | pdgessler

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Re: Case Study - 24 and just entered the rat race.
« Reply #6 on: October 13, 2015, 09:11:45 PM »
Wow, I did not know this! Thanks for the references, and sorry for the noise. :-)

MDM

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Re: Case Study - 24 and just entered the rat race.
« Reply #7 on: October 13, 2015, 09:26:30 PM »
Wow, I did not know this! Thanks for the references, and sorry for the noise. :-)

Not noise at all.  It was a very good question.  "Wow" seems to be a near-universal reaction when one learns about this - it was for me also.

Awitte58

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Re: Case Study - 24 and just entered the rat race.
« Reply #8 on: October 14, 2015, 06:31:56 AM »
Thank you all for the responses.

My mothers plan does NOT qualify for an HSA so all of that discussion is out; however, I will be 25 in January so I will have to try and convince her to change to HDHP for next year so I can get those two years of family contributions. That thread was very interesting!

As for the other stuff: 
My employer will match $0.15 for every $1.00 I contribute to BOTH my 401k and Roth IRA. That being said.... all of the matched contributions go into the 401k and not the Roth IRA.
So if I were to focus all of my extra money and max the Roth IRA at $5500, then the company would put an extra $825 into my 401k.

I suppose taking full advantage of the company match makes the most sense. I guess I got caught up in trying to reduce my taxable income, but even with the reduction I still get more money out of the company match.

I will refi the loans, pay minimum, pay minimum on the house, and continue to try and reduce waste in other areas of my life.



ShoulderThingThatGoesUp

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Re: Case Study - 24 and just entered the rat race.
« Reply #9 on: October 14, 2015, 06:44:48 AM »
Are you sure it's not a Roth 401k that your employer would match? The $18,000 limit applies to both Roth and pretax 401k plans combined. I accidentally contributed to my company's Roth 401k option for part of this year because I didn't realize this.

Fishindude

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Re: Case Study - 24 and just entered the rat race.
« Reply #10 on: October 14, 2015, 07:12:47 AM »
For starters, I'd just get a nice amount of cash saved up in a savings account to have readily available in event of auto troubles, home repairs, or other surprises. (Dave Ramsey emergency fund)

After you've lived with that for a while and know you have plenty of excess, invest the excess but always maintain a cash emergency fund of some type.

Awitte58

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Re: Case Study - 24 and just entered the rat race.
« Reply #11 on: October 14, 2015, 07:46:38 AM »
Are you sure it's not a Roth 401k that your employer would match? The $18,000 limit applies to both Roth and pretax 401k plans combined. I accidentally contributed to my company's Roth 401k option for part of this year because I didn't realize this.
How does a Roth 401k differ from a Roth IRA? I know that the money I was contributing to Roth was post-tax because my taxable income didn't change whether or not I was contributing to the Roth account, so I assumed it was a Roth IRA... Am I wrong? On the web portal where I can check account balances etc It has the account balance breakdown listed as:
Company Match: $XXXX
Roth Salary Deferral: $XXX
Deferred Salary: $XXXX

And at the top of the page it says "Roth account started: 2015"
Now I am confused. Going to chat with HR later.
For starters, I'd just get a nice amount of cash saved up in a savings account to have readily available in event of auto troubles, home repairs, or other surprises. (Dave Ramsey emergency fund)

After you've lived with that for a while and know you have plenty of excess, invest the excess but always maintain a cash emergency fund of some type.
I have 6 months worth of living expenses in my checking account, so we're good there. Thanks for the advice!

Awitte58

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Re: Case Study - 24 and just entered the rat race.
« Reply #12 on: October 14, 2015, 09:00:57 AM »
Went back and talked with HR. And read some stuff online: http://www.bankrate.com/finance/retirement/roth-ira-401-k-what-s-the-difference.aspx

I have a Roth 401k that I was contributing to. So I can only contribute the IRS 18000 between my two 401k accounts and the company will match 15 cents on the dollar of that.
I suppose the best option now is to open a traditional IRA and max that out so it can be deducted on my taxes.

Easye418

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Re: Case Study - 24 and just entered the rat race.
« Reply #13 on: October 14, 2015, 09:27:40 AM »
I recommend the following:
1) Refinance student loans to lower interest rate and pay the minimum.
2) Max HSA Account (you probably dont have this option yet as you are on your mothers policy)
3) Put in just enough to your 401k to get your employer's match.
4) Max Traditional IRA
5) Max 401k
6) Put the rest toward your mortgage (especially if you live in a state that recognizes a homestead).
7) Then open a brokerage account and put everything left over in there.

Some variation of this.  You can probably juggle around 2-5. 

ShoulderThingThatGoesUp

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Re: Case Study - 24 and just entered the rat race.
« Reply #14 on: October 14, 2015, 11:08:00 AM »
Do you then pay taxes on the 15% match if they put it in the Roth? Or is this some amazing workaround where you put untaxed money in a Roth?

nereo

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Re: Case Study - 24 and just entered the rat race.
« Reply #15 on: October 14, 2015, 11:19:11 AM »
Do you then pay taxes on the 15% match if they put it in the Roth? Or is this some amazing workaround where you put untaxed money in a Roth?

According to the OP, the company puts all the contributions into the 401(k).  Not sure how they verify that money went into the ROTH...


OP - if what you said about your company matching is indeed true, I think it is a no-brainer to put all of your extra cash into maxing out your IRA.  You simply won't get a better return on your money.  Later on you can transfer and 401(k) contributions into a tIRA at Vanguard or other similar low-cost investment company, so don't worry too much about what options are available.

For you, gradually building up an emergency fund until you have a couple thousand dollars in there might not be a bad idea either.  It does irk me when people say "Dave Ramsey Emergency Fund" though... as if somehow he was the first to come up with the concept (or even popularize it)... sorry fishindude...

In the meantime, work your butt off and hopefully your income will start to skyrocket in the next 5-10 years.  Then you can keep increasing your contributions and be FI by the time you are in your mid-30s, and choose what you want to do with the remaining half-century+ of your life.

MDM

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Re: Case Study - 24 and just entered the rat race.
« Reply #16 on: October 14, 2015, 11:36:04 AM »
Do you then pay taxes on the 15% match if they put it in the Roth? Or is this some amazing workaround where you put untaxed money in a Roth?
Any employer match, regardless of whether the employee contributed to the traditional or Roth 401k, must go into the traditional 401k.  The IRS gets its cut eventually - whatever that cut may be when the money is withdrawn.

MDM

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Re: Case Study - 24 and just entered the rat race.
« Reply #17 on: October 14, 2015, 11:41:28 AM »
I suppose the best option now is to open a traditional IRA and max that out so it can be deducted on my taxes.

In the lists below, thinking "first your 457 (if you have one), then your 401k and/or 403b" wherever "401k" appears is likely correct.   
Differences of a few tenths of a percent are not important when applicable for only a few years (in other words, these are guidelines not rules).   
   
WHAT   
0. Establish an emergency fund to your satisfaction   
1. Contribute to 401k up to any company match   
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.   
3. Max HSA    
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level   
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)   
6. Fund mega backdoor Roth if applicable   
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.   
8. Invest in a taxable account with any extra.   
   
WHY   
0. Give yourself at least enough buffer to avoid worries about bouncing checks   
1. Company match rates are likely the highest percent return you can get on your money   
2. When the guaranteed return is this high, take it.   
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs.   
4. Rule of thumb: traditional if current marginal rate is 25% or higher; Roth if 10% or lower; flip a coin in between (or see   
   http://forum.mrmoneymustache.com/investor-alley/deciding-between-roth-and-traditional-ira-based-on-marginal-tax-rate/
   if you want even more details on that topic.)
5. See #4 for choice of traditional or Roth for 401k   
6. Applicability depends on the rules for the specific 401k   
7. Again, take the risk-free return if high enough   
8. Because earnings, even if taxed, are beneficial   
   
The emergency fund is your "no risk" money.  You might consider one of these online banks: http://www.magnifymoney.com/blog/earning-interest/best-online-savings-accounts275921001   
      
If your 401k options are poor (i.e., high fund fees) you can check http://forum.mrmoneymustache.com/investor-alley/to-401k-or-not-to-401k-that-is-the-question-43459/ for some thoughts on "how high is too high?"