The Money Mustache Community
Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: Bookworm on June 23, 2014, 11:48:38 AM
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Hi, Mustachians. I have come for a little help.
I think we are doing fairly well on our journey as far as the things we've tackled already. We still spend more than most here, but we're spending consciously. My husband and I have both started side hustles to bring in some extra money, and our savings rate for the next year should be 35% or a little higher. He has a third interview for a new job this Friday, and that would both bump up our savings rate to over 50% and reduce his insane 240-mile round-trip daily commute to about 70 miles. I've adopted YNAB and, if I do say so myself, my budget is a thing of beauty. I spend quality time with it every day. :) We've eliminated our auto loan and reduced our insurance costs by trading our 2011 Sienna for an older, smaller vehicle. Our electric bill, while still on the high end of those posted on the "Share Your Badassity" board, is down by about a third. So I think we're on the right track. I've started a savings account to build up the $3,000 it takes to start a Vanguard account, and should be there very soon. It's going quickly. BUT...
I don't know what to do with it.
This is what we have so far.
Thrift Savings Plan - $29,857 (his)
Scottrade IRA - $1,205 (his, a rollover from a job he had in the early '90s)
cash in bank - $23,949
We also have some rental real estate with positive cash flow, VA disability payments for conditions that are very unlikely to change even if they are reevaluated (already receiving), and a military reserve retirement that starts when he is 56. He is 49 and I will soon be 42.
There is a 401(k) available at his job, and the company will match up to a certain point after a year, which is in October. I don't know if it's a year after hire, or a year after signing up for the 401(k), but he didn't sign up for it because we didn't think he'd be there for more than a few months. This job got him home from a contract position on the other side of the country, but the commute is horrendous and he's been working on getting another job all along. We needed to build up an emergency fund anyway, which we have.
The potential new company also has a 401(k) with 3% match. So that's the background on where we are. Here is what I understand:
401(k): A retirement account controlled by an employer. That bothers me for some reason. What if the employer mishandles it or goes out of business? How do we know it's in a good place?
IRA: Anyone can get one of these. We could even start one for me. The money goes in pre-tax, but then gets taxed when it's taken out.
Roth IRA: The money is not pre-tax, but doesn't get taxed when it's taken out. Again, we could both have one, right?
Regular taxable account: Obviously inferior because of taxation, but at least it's simple and I understand it!
If you were 49 and 42, which one would you choose? Or maybe more than one type? If it matters, I will probably start working in about a year, and will work until he retires, whenever that is. It won't be a lot of money, probably part time, but I will need a place to invest that money, too.
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Good job so far. I would say that a 70 mile commute is still unacceptable but without knowing details it's just hanging out there as easy pickings.
A 401k is not "controlled" by the employer. It is employer sponsored, as in the employer has worked with a third party financial company to set up and maintain the 401k for the company. If the employer goes out of business the employee is unaffected depending on vesting rules. The employer has no direct handling of the employees 401k beyond setting it up with the third party financial company, or at least they shouldn't and the employee should be dealing directly with the third party financial company.
Whether you utilize an IRA or a Roth IRA they share the same contribution limitations. They only get treated differently for taxation purposes like you have outlined. See the wiki article (http://en.wikipedia.org/wiki/Individual_retirement_account) for basics.
If I were in your shoes I would determine a plan. Then view these items as part of a set of tools that you can use to make your plan come to reality. So make the goal and then outline how you'll get there using these various accounts. If all else fails and it is too overwhelming max out a 401k, IRA, and then put the rest into standard taxable accounts until you are knowledgeable enough to craft a plan for yourself and yours given the basic tools. Keep a focus on minimizing expenses throughout this and you will be fine.
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Roth IRA: The money is not pre-tax, but doesn't get taxed when it's taken out. Again, we could both have one, right?
The I is for individual, so you both must have your own, it can't be joint. Of course you don't have to have one at all though.
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401k - the investment choices are controlled by the company. So far example they may choose Fidelity and not Vanguard. They also choose the funds available to you. However you still choose how to invest the money. So usually there are some low cost index funds in the mix which is what most of us would choose. Also no worries about if the employer goes out of business as the money is not there but held in funds by another company. Those funds own pieces of companies so you really cannot lose your money.
IRA is pretty much the same as a 401k from a tax perspective. Both are pre-tax dollars so your withdrawals are taxed as ordinary income.
Roth IRA- Yes you can both have one.
Regardless of age, but especially at your ages, I would suggestion the following order of how much you can afford:
1. Contribute to 401k up until match.
2. Max out your Roth IRA (Currently $5500 per person per year)
3. Max out the 401k (Currently $17500 per person per year)
4. Taxable accounts
If you end up working for a job that does not offer a 401k all you do is take out step 1 and replace 401k with IRA for step 3.
For a much better (and slightly longer) explanation check out http://jlcollinsnh.com/2012/05/30/stocks-part-viii-the-401k-403b-ira-roth-buckets/
Part of his fantastic stock series http://jlcollinsnh.com/stock-series/
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You don't need $3000 to start up a Vanguard IRA account; you need $1795 because you should roll the Scottrade IRA into Vanguard too. (That assumes you're okay with that $1795 going into an account in your husband's name rather than yours, of course.)
If I were you, I'd open two Vanguard IRAs: one in your husband's name funded with $4295 of your cash plus his Scottrade rollover, and one in your name funded with another $5500 of your cash. Your husband's will have to be a traditional IRA because (I assume) that's what the Scottrade one is; yours could be traditional or Roth, but which is better depends on your tax situation.
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An important thing to note:
401(k) is pretax income. That means you're going to pay less taxes when you earn it, as it doesn't count toward your AGI for taxes. The company match is free money you're turning down if you don't contribute to the match.
Traditional IRA you typically contribute to with money that's already been taxed, but then you can claim it on your tax refund so that you won't pay taxes on it IF YOU ARE UNDER A CERTAIN AGI (not sure what that is, because I haven't used a traditional IRA like that).
Roth IRA is money that has already been taxed.
There are Roth 401(k)s too, which goes by the same basic principal as traditional IRA vs. Roth IRA.
So the basic idea is that with the 401k or T. IRA, you'll pay taxes later in life when you take the money out, and with the Roth options, you've already paid the taxes and any gains you get from that investment are NOT taxed in the future.
There are all kinds of different ways to access money in either of these accounts. Personally I like having a 401k and a Roth IRA; I don't know whether my tax bracket will be higher (making the Roth more valuable) or lower (making the 401k more valuable) in retirement, so I'm basically diversified.
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An important thing to note:
401(k) is pretax income. That means you're going to pay less taxes when you earn it, as it doesn't count toward your AGI for taxes. The company match is free money you're turning down if you don't contribute to the match.
Traditional IRA you typically contribute to with money that's already been taxed, but then you can claim it on your tax refund so that you won't pay taxes on it IF YOU ARE UNDER A CERTAIN AGI (not sure what that is, because I haven't used a traditional IRA like that).
Roth IRA is money that has already been taxed.
There are Roth 401(k)s too, which goes by the same basic principal as traditional IRA vs. Roth IRA.
So the basic idea is that with the 401k or T. IRA, you'll pay taxes later in life when you take the money out, and with the Roth options, you've already paid the taxes and any gains you get from that investment are NOT taxed in the future.
There are all kinds of different ways to access money in either of these accounts. Personally I like having a 401k and a Roth IRA; I don't know whether my tax bracket will be higher (making the Roth more valuable) or lower (making the 401k more valuable) in retirement, so I'm basically diversified.
I believe that money you put into your tIRA is pretax regardless of your AGI. If your AGI is too high then you won't be eligible to contribute to your tIRA, but if you are eligible then it will be pre-tax money.
I like the idea of maxing the 401k, then maxing the traditional IRA, then putting money into a regular investment account. Then when you FIRE you can convert your 401k and tIRA into a roth IRA and pay no tax (if you have low enough earned income - which you may if you FIRE before traditional age), then after 5 years you can take those conversions out of your roth IRA (without ever paying tax on that money) and leave the rest in the roth IRA to continue growing tax free.
Also I'M Brian Fellows! Don't listen to that other poster, he is not my doppleganger.
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Thank you all for clearing up my misunderstanding about 401(k)s. We will see what happens with this job on Friday, but then I think either way, he will sign up for one.
A little more:
Taxable income is salary of $65,000 plus about $8,000 for the rental income, with us and three dependents. If this job comes through, it will bump the salary up to $85,000. So I am thinking it is better to have the tax savings now, as opposed to the Roth plan? I am not sure how it balances out between having the extra money now to invest (the tax savings) vs. our lower tax bracket in the future.