Reader Case Study – Need A Game Plan Towards FIRE

[YoungMustachian]

We discovered MMM in December and are trying to make the appropriate changes to get to early retirement. This is our first year both working full time (done with college – yay!) and having consistent excess funds. We know how to live pretty cheap, but need help building a game plan on where to put our savings.

Life Situation: Married filing jointly. No kids. United States. Ages 25 and 29. This will be our first year with two full time incomes.

Estimated Gross Salary/Wages:
Me: 33,000, take home pay about $2000 per month
SO: 33,000 take home pay about $1900 per month (after TSP match, sometimes has overtime pay)
66,000 combined plus SO’s disability income of $5700 per year

Pre-tax deductions: Standard deduction of $12,600 and had $8000 in exemptions for 2015. I will open an HSA this year. SO has healthcare through Department of Veteran’s Affairs, so no HSA for him.
401k/TSP – Full 5% match with SO’s employer in an after tax Roth TSP. No match at my work.

Qualified Dividends & Long Term Capital Gains: Unknown. First year with taxable account.

Adjusted Gross Income: 45,000 (estimate)

Taxes: Not sure. We paid $140 for 2015 state taxes and got a refund of $2,900 on an AGI of $18,800 this past year (actual was $40,000).

Current monthly expenses:
Rent $685
Utilities $100-200 (high in the area where we live)
Internet $75
Cell phones $25 (2 phones, Republic Wireless, no data)
Groceries $160
Eating Out $60
Personal/Fun Spending $40
Household needs (clothes, medicine, etc.) $40
Car insurance $21 (on one vehicle, borrowing second from family)
Gas $140
Giving $385 (not negotiable)
Misc $100 (Christmas shopping, trip to visit family out of state, baby showers, etc.)
Total Monthly Expenses: $1,831-$1,931
Total Monthly Income: $4,375 (includes disability)
Total Monthly Savings: $2,444

Assets: $60,000 divided evenly between 2 Roth IRAs, $40,000 taxable account ETFs in Betterment, $5000 regular savings account, $3000 money market account (savings and money market are for our $6000 emergency fund), $5432 Series I bond

Liabilities: No debt of any kind.

Specific Question(s): Our original plan was to max out Roth IRAs, use work matches, and then pour everything else into a Betterment taxable account…I now am reconsidering this as a result of reading the MMM forum and website, the MadFientist, and jlcollinsnh’s stocks series, and books by Malkiel, Bogle, & Bernstein. There is so much information out there and I could use some more specific guidance as everything is so new. We specifically need to gain a better understanding of why we should max out our work retirement accounts instead of saving in taxable accounts.

[MDM]

We specifically need to gain a better understanding of why we should max out our work retirement accounts instead of saving in taxable accounts.

YM, welcome to the forum.

The short answer is that the less you pay in taxes, the more you get to keep.

You might find it worthwhile to "prepare" your 2016 taxes now.  E.g., take whatever you used for your 2015 return and do another version using what you expect to have in 2016.  You'll do the real version next year, but better to look ahead now and plan accordingly.

See http://forum.mrmoneymustache.com/ask-a-mustachian/turbo-tax-vs-cpa/ and http://forum.mrmoneymustache.com/taxes/best-way-to-calculate-w-4-exemptions-for-2016/ for some pertinent discussion.

It appears you are doing better than average for your ages, so keep up the good work!  Does seem that tax knowledge and planning could be improved, thus the suggestions above.

[YoungMustachian]

Thanks so much for your response  MDM! I have been reading mostly about investing in the past couple months and have not spent much time learning about taxes. I am looking through the links you posted and will check back in later today or tomorrow with any questions from my reading.

We should have about $30,000 to put towards investments over the course of this year saving $2444/mo. Would a "Mustachian" plan be to put $11,000 in Traditional IRA's (already did our Roths for 2016, so would start in 2017) and put the remaining $19,000 towards my husbands TSP and/or my 401k? Should we be building up the taxable Betterment account at all? And hopefully from my reading, I will know what to expect with taxes if we need to set money aside there...

[Hotstreak]

You're in a great situation.  You have good savings for your age, relatively low expenses, and seem dedicated to saving.  You have lots of savings options.

HSA - Excellent saving vehicle, for medical expenses now and for all expenses when you retire.  If you have good investment options, this is a wonderful place to put money (and at least put enough to cover a few years of medical expenses)

Roth vs Traditional IRA - Since you are already in a low tax bracket (15% it looks like), you may want to keep using the Roth.  This depends on whether you think you will be in a higher or lower tax bracket in retirement though, which is a pretty personal decision (since tax rates may change in that time, or after you retire).

401k type accounts - Get your matching contribution.  After that, max your IRA, then come back and contribute as much as possible for this account.  The tax savings will help!

Taxable Betterment account - Since you don't currently have enough income to max both your 401k type accounts + both your IRA's, I would sell off your taxable accounts in order to fund IRA's, and put your monthly cash flow in to your 401k.  This account is a large amount of savings though.  If you have plans to purchase a home in the next few years, consider hanging on to it for that purpose.

[YoungMustachian]

RobbyJ, thanks for the clear action steps. We will stick with the Roth then, since I think we will likely be in the 15% tax bracket in retirement as well.

I just want to know that when we are putting our savings into our 401k type accounts that we will be able to access those savings in early retirement. From reading, it sounds like once we quit our jobs, we can convert the 401k accounts to a Roth and then after 5 years, make withdrawals...I just hesitate because that's 5 years that we will still need income. That's why I'm having difficulty putting all our savings into tax-sheltered accounts - I want to make sure we have access to some funds in the first few years of early retirement.

[nereo]

We know how to live pretty cheap, but need help building a game plan on where to put our savings.

Others have covered the "what" to do pretty well - if you contribute more to your tax-advantaged accounts you will pay less in taxes and have more money in the long run.  Now let's focus on the longer 'game plan'.  This is entirely up to you guys, but a few questions to consider

1) what are your long-term goals?  Specifically, do you want to retire as quickly as possible or do you see yourself staying in your current occupations for 10+ years.  If you become "FI" in ~10 years (roughly your current pace) will you quit your jobs or keep working in some capacity?

2) do you want to stay in your current area?

3) what about home ownership and kids?

4) what things do you want to do in your 30s, 40s and 50s that you might not want to do now.  Examples - travel more, start a business, devote yourself entirely to a hobby, raise kids, build a house etc. etc.

[YoungMustachian]

Great questions nereo! They really get at the big "whys" and reasons behind aiming for FI.

1) I think we primarily like the flexibility and freedom FI offers so I see us working at least part-time if not full time at points beyond FI.

2) We don't need to stay in our current area, in fact we would like to move when the timing is right for our careers (in the next 1-2 years).

3) I doubt we will buy a house in the next five years as we are anticipating multiple moves. We are very happy renters and don't need to buy at all unless it's financially advantageous. We also don't plan on having kids in the next 5 years, and beyond that point in time we aren't sure. Depending on what we decide in these areas our "game plan" may need to change.

4) After FI, I would consider starting a business and would like to do some traveling, but these wouldn't need to be necessities. Our big goals in this area aren't well defined yet. I am just looking forward to the flexibility to spend time with people, do more volunteer work, and pursue hobbies.

Would certainly appreciate any further thoughts you have as we are figuring out what the future might look like for us!

[nereo]

Great questions nereo! They really get at the big "whys" and reasons behind aiming for FI.

1) I think we primarily like the flexibility and freedom FI offers so I see us working at least part-time if not full time at points beyond FI.

2) We don't need to stay in our current area, in fact we would like to move when the timing is right for our careers (in the next 1-2 years).

3) I doubt we will buy a house in the next five years as we are anticipating multiple moves. We are very happy renters and don't need to buy at all unless it's financially advantageous. We also don't plan on having kids in the next 5 years, and beyond that point in time we aren't sure. Depending on what we decide in these areas our "game plan" may need to change.

4) After FI, I would consider starting a business and would like to do some traveling, but these wouldn't need to be necessities. Our big goals in this area aren't well defined yet. I am just looking forward to the flexibility to spend time with people, do more volunteer work, and pursue hobbies.

Would certainly appreciate any further thoughts you have as we are figuring out what the future might look like for us!

Thanks for taking the time to give some further detail.  From what you've said, you don't seem to have any pressing need to build short term savings (like you might do if you were saving for the down-payment of a house, for example).  You are also willing to stay flexible (working part time, moving, etc) which is good.  People who are inflexible generally need more secure savings in order to make sure they don't deplete their portfolio.

So what does this all mean right now?  In short - I'd keep putting everything you have into low-cost index funds, maxing out your tax-advantaged (IRA, 401(k), HSA) plans first.  As MDM mentioned you'll save a lot in taxes this way, which will increase your total savings.  You don't have a need for this money in the next 5+ years, so there's ample time for compounding to work its magic.    You already have $8000 in your MMA and savings account, which serve as a very good emergency fund.  I'd keep those but I wouldn't add more to them unless you have children and/or your job security gets very shaky.
Avoid the temptation to micro-check your porfolio and just dump money into your accounts every month regardless of what the market is doing.  WHen it's down you will purchase shares "on sale" and when it's up you've made money on the shares you have already bought.

Do this continuously at your current rate (about $2,440/mo) and in 10 years you shoud have about $600k saved up including your current assets (adjusted for inflation - the real number will be even higher).  You should have enough saved to consider yourself completely FI in ~12-15 years depending on market returns.  If you increase your savings somewhat (either by pay raises or by shaving costs) you could hit the big $1MM in about 12 years.

[YoungMustachian]

Thank you all for all the guidance! I feel like we are headed in the right direction with our plan.