Author Topic: Reader Case Study - 27 wants to retire asap, 401k vs taxable investments  (Read 4365 times)

FruGal

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Life Situation:
27 y.o. female. Files "Single", no dependents. Engineer, living in Oakland, CA

Gross Salary/Wages:
$55,000
($3202 / mo. after taxes and 401k contribution)

Pre-tax deductions:
401k w/ 4% match: contributing 4%

Other Ordinary Income:
No other income. (Wealthy parent owns my car (1998 Jetta) and pays my car insurance ($10/mo.), but gives me no other income).

Taxes:
Federal: (25%), state/local: (9.3%)

Current expenses:
All on a per month basis and are MY cut of expenses. Boyfriend's income and expenses not included. (Side note: we split everything 50/50 except I pay slightly less for food).

Rent for studio (including utilities): $335 (After split with bf, crazy good deal)
Gym membership: $70 (No start up fees, $5/ mo. discount. I had a hard time justifying this at first, but my health has definitely benefited from belonging to a gym that I enjoy going to (and actually use). Price includes: yoga classes, rock climbing, crossfit, cardio boxing, TRX, full set of cardio and weight machines. I go there 3 - 4 times a week.)
Cell Phone: $28 (Republic Wireless)
Food/Groceries: $200 (After split with bf, mostly from Costco) 
Food/Drinks Out/Movies/Etc.: $100
Internet: $20 (Split with bf)
Car: $20 (This is an OVER estimate. I bike to work/gym/bars/movies or take BART (I stocked up on commuter credits (pre-tax) and have $240 left. Technically, it's my dad's car and he also pays insurance (see 'Other Income'). I drive it to the grocery store about 2 times / month and across the street for street cleaning. I've filled my tank 2 times in 2015).
Clothes/Furniture/House Shopping/Trips/Misc: $400 (This has been crazy high since I moved to Oakland 9 months ago without furniture, bought a bike, re-vamped my wardrobe (although all highly discounted or 2nd hand), and went on a few trips.)
Medical/Dental/Vision Insurance: $0 (My company pays for everything for medical and up to $1500/yr for Dental and Vision)
Total: $1173

Assets:
$10,000 in a betterment account (Since Jan, 2015 (when student loans were payed off), I've saved about 2k / mo.)

Debt:
None. Finished paying off my student loans!

As the sole heir to a wealthy parent, what is the best way for me to plan for retirement? What I'm doing is putting 4% into my 401k and, after living expenses, investing the rest of my monthly paycheck in taxed investments (betterment.com). That's $2,200 per year in my 401k ($4,400 once I have full matching - after 5 years) and $20k per year invested in betterment. I could easily max out the $18,000 yearly limit for my 401k, which would put be in a lower federal tax bracket however...

If I maxed out my 401k every year, I wouldn't be able to touch it without penalty until I'm 59.5. With such a low cost of living, I expect to retire within the next 10 years (37) and then live off a combination of dividends and side jobs. Also, at age 59.5, I will probably have inherited more money than I know what to do with. My wealthy parent also lives an MMM lifestyle (although I'm sure he's never heard of the blog). He's made it repeatedly clear that I will inherit everything (he recently got engaged and has gone over all the details of the prenup with me. She's independently wealthy and will get nothing).

I know that nothing is certain, and I definitely would like to have a contingency plan, however I just don't think it makes sense for me to max out my 401k and not be able to use my money for over 20 years after my planned retirement age. However, it pains me that the majority of my savings has been taxed at 25% and gains from my investments will also be taxed. Any suggestions?

BTW: my income is for a first year engineer (no master's degree, no P.E. yet). I estimate that if all goes well, it should increase by about 10% every year for at least 7 years.

seattlecyclone

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If I maxed out my 401k every year, I wouldn't be able to touch it without penalty until I'm 59.5.

False. See https://seattlecyclone.com/accessing-your-retirement-accounts-early-yes-you-can/ for more info. Contribute to the 401(k), save on taxes now, get the money out when you retire.

kpd905

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As SeattleCyclone said, there are multiple ways to access your 401k without penalty at any age.  Roth IRA conversion ladder and 72t (SEPP).

I would contribute to your 401k at least until you get out of the 25% bracket, then maybe go to a Roth IRA at that point.  If you have a wealthy parent leaving you a bunch of money, your tax rate might get pretty high after that.

With $55,000 income, you'll have $44,700 taxable income before 401k contributions.  $7250 worth of 401k or traditional IRA contributions get you into the 15% bracket.
« Last Edit: June 05, 2015, 06:07:50 PM by kpd905 »

MDM

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As the sole heir to a wealthy parent, what is the best way for me to plan for retirement?
As SC already noted, the inaccessibility of a 401k is a myth.

Contribute as much as you can to tax-advantaged plans.  You'll have to predict whether your marginal rate will be higher (in which case do Roth) or lower (in which case do traditional) in retirement than it is now.

Eventually, if your income projection holds and you can restrain spending, you will be "forced" to contribute to taxable accounts because you will the IRS maximums on the tax-advantaged plans.  A good problem to have....

ShoulderThingThatGoesUp

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You can make more money than that. I got offered that right out of college in 2010 in Texas. Certainly after you pass the FE exam.

MDM

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You can make more money than that. I got offered that right out of college in 2010 in Texas. Certainly after you pass the FE exam.

I had similar thoughts.  The particular engineering discipline does however make a difference.  Appears the OP is not in a low cost of living location, so that's another reason to think the salary might be low - again, depending on the type of engineering.

ShoulderThingThatGoesUp

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It makes a difference, but I am pretty sure environmental is on the low end so what I got offered five years ago seems much too low for somebody older than me in the Bay Area.

Ricky

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If I maxed out my 401k every year, I wouldn't be able to touch it without penalty until I'm 59.5.

False. See https://seattlecyclone.com/accessing-your-retirement-accounts-early-yes-you-can/ for more info. Contribute to the 401(k), save on taxes now, get the money out when you retire.

Also, accessing your money with a penalty isn't the end of the world. Say you kept your income low when you withdraw, the 10% penalty + taxes would probably still be less than the taxes you'd pay today on that money. Thankfully, the penalty is plenty avoidable.

Expenses wise, I think you're doing great. I don't think anyone could nitpick there. As others have said, time to focus on income.