Author Topic: Reader Case Study - How to properly allocate?  (Read 2249 times)

typicalmillenial

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Reader Case Study - How to properly allocate?
« on: February 27, 2019, 05:37:27 PM »
Life Situation: Single, 24 y/o male living in HCOL area.

Gross Salary/Wages: Base Salary is $67,000 (started in January 2019). I work in a sales position with a large corp and have a competitive OTE (on target earnings) plan, but for this 6 mo training period (until July 2019) I will not be eligible for commissions. I also received an $8k signing bonus at the end of January 2019.

Individual amounts of each Pre-tax deductions 401k, HSA, FSA, IRA, insurance, etc.- Currently have not set up my 401K contributions (part of the reason why I am here!)

Taxes: $6486 in Federal taxes with a $785 refund. $2657 in State tax with a $96 refund.

Current expenses:
Rent + Utilities- $12,612.93
Car + Insurance- $4070
Gas- $1,473.93
Dining out/Alcohol- $6,170.23
Groceries- $2,169.55
EZ pass/other transportation- $1,548.18
Misc- $3,140.77

This is based off of 2018 spending- fixed things such as rent, car, insurance have remained into 2019. Likely to change in the summertime, but not enough to really matter. I tracked all of this on my own spreadsheets, and I am now utilizing a personal capital and spreadsheet mix.

Assets: $22,000 in my Ally savings account @2.2% interest. $2436 in Roth 401K.

Liabilities: Car loan- $12,682 @ 4%. Opened December 2017, 63 mo long loan. Monthly payment is $276 and insurance is $67. (biggest money mistake thus far, but it is a 2014 Honda Accord, good gas mileage, and I figure it will last forever.) No student debt, no mortgage.

Here is my current concern: I am hovering around a 50% savings rate so far into 2019, but I am continuing to try and make this more efficient. I am wanting to invest all of my cash (current and future, with the exception of keeping $10,000 as emergency fund) into VTSAX. I am in the wealth accumulation phase of my career/life and have the risk tolerance to add my money and sit back, hands off.

I am struggling mainly with whether I should be doing this \through my own Vanguard acct, or through my employer Roth 401k because of tax free growth. While I understand how powerful this is, one of my goals is being able to walk away from corporate life earlier than what is traditional. This could include doing nothing, or a career switch into a space that doesnt offer as much money, or a mix of the two. The point is I want options, and I am concerned that I will not have many options if the majority of my wealth is tied up in a 401K that can't be touched until 59.5 y/o.

I am looking forward to any words of advice, and face punches are more than welcome. Please help me understand where I am going wrong!
« Last Edit: February 28, 2019, 09:29:53 AM by typicalmillenial »

ysette9

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Re: Face punch wanted, investment advice NEEDED
« Reply #1 on: February 27, 2019, 08:34:45 PM »
First, check out the investment order thread and then come back with specific questions. You should be absolutely maxing out your 401k. It is a great gift from the IRS and you can access it early if needed.

Next-work on getting that dining out number  lower. That is a pretty big chunk of your spending and entirely discretionary.

https://forum.mrmoneymustache.com/investor-alley/investment-order/

typicalmillenial

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Re: Face punch wanted, investment advice NEEDED
« Reply #2 on: February 28, 2019, 06:12:26 AM »
@ysette9

Thanks for the reply, the dining out is something that I am working on. It also included things like going out on the weekends, but you're right it is far to high and an area of focus for me.

I guess my main issue/concern/question has to do with liquidity. Tax advantaged is a great wealth growing tool, but what happens when I am laid off and 43 y/o? I suppose my emergency fund would have expanded by then, as well as my contributions to taxable accounts, but having the majority of my net worth tied up does not feel very secure.



ysette9

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Re: Reader Case Study - How to properly allocate?
« Reply #3 on: February 28, 2019, 09:58:02 AM »
Let me mentally break this down a bit and do some thinking out loud. You are correct that if you get laid off you have to have some liquid funds to tap to keep you afloat. The amount is personal. If you are single-income and maybe your particular job niche is not common then you may choose to keep 6-12 months spending in a high-yield checking. If you are a dual-income household savings >50% of household income then you may only have a couple of months buffer in checking (our situation).

Filling up all of the tax-advantaged space ($19k or $55k per year depending on what your 401k plan allows) is definitely a privilege the higher income folks benefit from. If you can do that and have extra left over to invest then you put it in a taxable account which you can touch any time.

If you are 43 and lose your job then you fall back on your emergency fund to tied you over to the next job. If you plan to be FIRE at 43 then 5 years before that you start your Roth conversion ladder so you have access to penalty-free retirement funds once you do quit for good. https://www.madfientist.com/how-to-access-retirement-funds-early/ You continue doing Roth conversions to fund your life of leisure until you hit 59.5.

Some people may choose to have a mix of tax-advantages and taxable accounts just to have that flexibility, but since there are a couple of ways of accessing your retirement accounts early the usual advice is to max those out first for the tax advantages before going taxable.

FI45RE

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Re: Reader Case Study - How to properly allocate?
« Reply #4 on: February 28, 2019, 01:23:30 PM »
Two things stand out to me:

1) Cost of food and alcohol...You're spending ~$700 per month on Dining Out/Alcohol + Groceries, and spending almost 3x as much on Dining Out/Alcohol as groceries. Learning to cook at home will save you a TON in the long run. For comparison's sake: we spend ~$650 per month on food for 5: 2 adults, 3 teenagers, and eat especially well.

2) Your miscellaneous spending accounts for ~$260 per month in expenses. Do you know where this money goes? I see you mentioned Personal Capital...I use a mix of Personal Capital and Mint for tracking spending categories.

robartsd

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Re: Reader Case Study - How to properly allocate?
« Reply #5 on: February 28, 2019, 03:08:09 PM »
Current expenses:
Rent + Utilities- $12,612.93
Car + Insurance- $4070
Gas- $1,473.93
Dining out/Alcohol- $6,170.23
Groceries- $2,169.55
EZ pass/other transportation- $1,548.18
Misc- $3,140.77

Liabilities: Car loan- $12,682 @ 4%. Opened December 2017, 63 mo long loan. Monthly payment is $276 and insurance is $67. (biggest money mistake thus far, but it is a 2014 Honda Accord, good gas mileage, and I figure it will last forever.) No student debt, no mortgage.
I think you eating out is a bigger money mistake than your auto purchase (at least if you've been spending at that level for more than a year).

What's up with your overall transportation spending? you've got enough gas to drive over 1000 miles a month, plus as much again (~130/mo) in additional transportation costs. I'm guessing that you have a 20+ mile commute and EZ pass pays for your use of congested roadways. What are the options for not driving?

Check2400

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Re: Reader Case Study - How to properly allocate?
« Reply #6 on: February 28, 2019, 04:39:46 PM »
I always try and break it out so this makes more sense for me on your financials--your setup isn't very intuitive. 

Taxes: $6486  + $2657 in State tax = $9143, refunds treated as a bonus.
--------Does this include Payroll taxes and health insurance?  What is your net income per month?  It looks like it is:
Net Monthly Income:  67,000/12 = $5583, less 762 in taxes = $4821 a month.
Expenses:                 $31,183 total, or $2,598.  Which leaves you with $2222 a month in excess?

 $4821
-$2,599
$2222 excess
Does this seem right to you? It doesn't seem like FICA is included. 

So, what should you do?  If you max all your tax sheltering savings you are looking at:
--Roth 401k is 19,000/yr post tax so 1583 from your net paycheck
--Roth IRA is $6000 total, or $500 a month, this is also post tax.
So $2222-1583-500 = $139 in excess a month without doing any optimization of spending.  Let's give you the benefit of the doubt and say you trim expenses to get you to $400 a month in savings. 

$400 savings a month is kind of scary low.  Except that is the leftovers.  The Turkey Sandwiches.  The cold pizza.  You're socking away $25,000 a year in post tax earnings.  And you're 24.  And you're just starting your career.  And you're commission based.  And you want to earn more. 

That means, to me, three things.  Every single raise you get goes back to you to enjoy your 20s while still dramatically taking care of your post 20s.  You want more fun, earn more money.  You have a career that allows for immediate financial gratification.

Second, it trains you to stay on budget and keep low expenses now while everyone else is seeing how they could be spending the 2 grand you're socking away.

Third, you're getting time on your side now.  In 5 years time, if you don't do any post tax investing on top of this, you're going to be sitting, in an average situation, on $150,000 grand in retirement accounts.  If you don't add another dollar for the rest of your working career, you'll have over 1.2 million dollars waiting for you at age 59, or almost $700,000 in inflation adjusted dollars.  If you do it for 10 years, you're looking at almost 2 mill at age 59.5, or 1.2 million inflation adjusted.  All growing and withdrawable tax free. 

That is factoring in no raise, no other savings, no windfalls, no nothing. 

I get the desire to not tie up funds for distant future you now, but math says otherwise.  Math says to take advantage of the 401k/Roth IRA.  More importantly, don't look at this as tying up funds forever, look at it as financial training on spending.  You want a raise in take home funds, save up and pay off that car loan--now you're got an extra 276/mo.  Want to go on vacation?  Credit card churn and earn it.  Want to buy a house or a ring or a who knows what else?  Good news, you're at the start of your earning potential.  Raises and increased earnings will come, and when they do, future you is already taken care of to the fullest (excluding HSAs) and you can pocket the rest.  $400 in savings is the starting point.

If you do this you're ahead of every conceivable curve.  I did this (albeit much later in life) and it has been great to set a false barrier to spending by not having access to overspend.  It makes those tax return bonuses extra fun.  It makes paying off car loans (for me student loans) great interim goals.  It makes every raise that much more enjoyable because it doesn't have any other place it 'should' go.

You are worried about having your money tied up in non accessible accounts.  If you're like many people here, the most painful thing you could face is to start depleting your taxable accounts before you're completely done.  Do you think that you could start drawing down on taxable accounts in 5 years knowing it won't last forever?  It is hard when facing that sell button, I promise you that. 

Lastly, you said you might want to option out into a lower paying gig later to explore what you want to do.  If you make it five years under this plan, you've learned to live off of a salary of roughly $40,000 since that is all you're seeing.  Just because you don't access the funds til later doesn't it doesn't have an effect.  You'll have set up retirement, and just need to bridge it til you get there. 

No matter what, you're in a good spot making money with an emergency fund.  I would challenge you to do this maximum savings plan for 5 months to see how you live on the budget.  Barring an emergency (That you have a fund for) I think you'll find that your lifestyle isn't changing much except for the fun of watching your personal capital savings amount grow by leaps and bounds.

Either way, congrats on a great start to an early retirement. 

typicalmillenial

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Re: Reader Case Study - How to properly allocate?
« Reply #7 on: March 01, 2019, 07:32:33 AM »
@ysette9 Thanks for breaking that down further. I probably read and reread that madfientist article 10 different times, that is extremely powerful and I had no idea that it was possible. I am thinking that it makes sense for me to max my 401k, followed by maxing a traditional IRA, prior to moving into taxable accounts. Does this make sense? I have left out HSA as I am on my parents healthcare for now and am not eligible.

@FI45RE you're right. What's odd is I actually do a fair amount of cooking, but it is not efficient by any means. Do you have any suggestions on where to find cost effective recipes and ingredients? Out of my friends, I easily spend the least amount of money of food and going out. I am and will continue to fight off lifestyle inflations. As for Misc expenses, a lot of that is from splitting something w/ a friend and venmoing what I owe. When I review my finances, I sometimes forget and they go into this bucket. I have a better strategy for this moving forward.

Personal Capital is great, but I consistently volunteer to pay for meals when out with a large group to collect the points and venmo everyone their amount due after. The issue is my dining out numbers are skewed and I have not found a way to edit appropriately. Any ideas?

@Check2400
Thank you for such a detailed response. The income and tax info were based off by 2018 returns, as I mentioned I changed jobs and things are different. My total monthly gross pay is $5612 ( higher than the $67,000 because of a $30/mo healthcare opt out). I take home $4109/mo before any overtime/per diem/commissions. But still, your message remains true and valuable.

You mention Roth 401K and Roth IRA, is there a reason for this over traditional for both? I feel as though it would be more beneficial for me to take the tax advantage now and look into roth conversions if it came to that down the line. Thoughts? Does it make more sense to max out a traditional IRA or a Roth IRA after my 401K?

Again, thank you very much for your well thought out response, the advice is greatly appreciated.

typicalmillenial

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Re: Reader Case Study - How to properly allocate?
« Reply #8 on: March 01, 2019, 08:04:18 AM »
Also, a question on Roth conversions for anyone.

Say for instance I know that I will be retiring in 5 years and I would like to start the conversion while I am still receiving a w2 income. Is the amount per year that I convert ADDED to my w2 income and taxed as such in whatever bucket I fall into?

If so, it would make no sense to begin a conversion while still receiving a w2 income. I am understanding this correctly or totally off base?

@ysette9 @Check2400

ysette9

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Re: Reader Case Study - How to properly allocate?
« Reply #9 on: March 01, 2019, 09:41:53 AM »
You are understanding it correctly that you would have to pay tax on the Roth conversion, which would be higher if you are working and bringing in income. If you ever have an opportunity to convert at a lower tax rate (go back to school for a year, take off part of the year to travel the world or have a baby or whatever) then be sure to do Roth conversions when your income is temporarily low. The alternative is to save in a taxable account just enough to have five years’ expenses to cover you initially in retirement while you start that Roth pipeline.

ysette9

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Re: Reader Case Study - How to properly allocate?
« Reply #10 on: March 01, 2019, 10:03:34 AM »
@ysette9 Thanks for breaking that down further. I probably read and reread that madfientist article 10 different times, that is extremely powerful and I had no idea that it was possible. I am thinking that it makes sense for me to max my 401k, followed by maxing a traditional IRA, prior to moving into taxable accounts. Does this make sense? I have left out HSA as I am on my parents healthcare for now and am not eligible.

That makes sense to me. The one other thing I’d look into is whether your 401k plan allows post-tax contributions and either what will be called a post-taxRoth conversion or a mega backdoor Roth conversion. The idea there is after you hit the $19k limit for tax-deductible contributions, you can continue to contribute post-tax money into the 401k that you then immediately convert to Roth. The total sum that can be put into your 401k each year between you and your employer together is $55k. Not many people have this option but if you do, it is a fantastic way to build up a ton of Roth-flavored money which is so tasty.

Check2400

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Re: Reader Case Study - How to properly allocate?
« Reply #11 on: March 01, 2019, 10:32:23 AM »
I am struggling mainly with whether I should be doing this \through my own Vanguard acct, or through my employer Roth 401k because of tax free growth.

It sounds like you have a little confusion regarding your options, which is understandable.  You said your employer has a Roth 401K, but in your response to me you said a traditional 401k.  I've never had the opportunity to do a Roth 401K, but as I understand it they exist. 

Forum, please correct me if I'm wrong:

Traditional 401K--you put aside retirement funds after payroll taxes, but before Federal Taxes.  Growth is tax free.  When you withdraw upon retirement you are taxed on that withdrawal as income. 
Roth 401k--you put aside retirement funds after all taxes, but growth and withdrawals are tax free. 
Note--I believe you get an either or on the 401k.  You can't contribute to both.  So a total of $19,000 plus employer match.
Roth IRA--you can contribute up to $6000 a year to a Roth IRA (not through your employer) that is tax free on both growth and withdrawal. 
--You can do a Roth IRA in addition to your 401k so long as you don't earn more than $137,000 in adjusted income.
Roth Conversion ladder--Man, I know it exists, MadFientist has probably the best explanation, but I still don't get it.  It seems really applicable to people who were only able to save in 401ks with no 'bridge' taxable savings.  It takes five years to implement, but I think that I earn too much now to do the conversion efficiently, so I've put it off.  I would say that you can cross that learning bridge when you have a few years under your belt, taking comfort in knowing that it is an option. 

If you've mixed up what 401k you have, and it is a traditional 401k, then congrats, you just got an extra $348 or so in spending cash or so a month since your contributions are not taxed.  i.e. the $19000 you save isn't taxed at 22%, lowering your taxable income, hence the benefit of a traditional 401k. 


ysette9

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Re: Reader Case Study - How to properly allocate?
« Reply #12 on: March 01, 2019, 10:43:48 AM »
So that is pretty close to right. I think Roth 401ks are becoming more common. Usually they make sense for people in the lower income brackets, just like a Roth IRA. See the Investment Order thread for more on that.

It depends on your 401k plan what options you have. I have contribute some money to a Roth and some to a traditional 401k in the same plan because that is how mine is set up. Yes, you get $19k a year of tax-advantaged space and that is the sum of what you put into Roth and traditional 401k if you decide to do both. If you plan allows it, you may be able to do post-tax contributions which are above and beyond the $19k. I believe plans offering that kick-ass feature are more rare.

typicalmillenial

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Re: Reader Case Study - How to properly allocate?
« Reply #13 on: March 01, 2019, 01:23:06 PM »
I originally made a mistake, or rather I did not clarify. The 401k from my previous job was Roth, but I will have it in traditional for this current employer. Very solid plans with low fees.

Otherwise, @ysette9 and @Check2400, I greatly appreciate your help!

robartsd

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Re: Reader Case Study - How to properly allocate?
« Reply #14 on: March 01, 2019, 01:37:17 PM »
Roth Conversion ladder--Man, I know it exists, MadFientist has probably the best explanation, but I still don't get it.  It seems really applicable to people who were only able to save in 401ks with no 'bridge' taxable savings.  It takes five years to implement, but I think that I earn too much now to do the conversion efficiently, so I've put it off.  I would say that you can cross that learning bridge when you have a few years under your belt, taking comfort in knowing that it is an option. 
A Roth Conversion ladder is not an account type. It is usually implemented in IRAs (it may be possible to also do them in a 401k) by moving assets from a Traditional IRA to a Roth IRA. The dollar amount converted from traditional accounts to a Roth IRA is taxed as income for the year in which the conversion happened. After five years the converted dollar amount is available for withdraw without penalty (note earnings after the conversion are not available for withdraw without penalty until age 59.5). If you don't have enough to start up the conversion ladder, you could consider a strategy utilizing SEPP (substantially equal periodic payments).

I originally made a mistake, or rather I did not clarify. The 401k from my previous job was Roth, but I will have it in traditional for this current employer. Very solid plans with low fees.

Otherwise, @ysette9 and @Check2400, I greatly appreciate your help!
Since you've separated from employment at your previous job, you can rollover the Roth 401k to a Roth IRA if that would provide better investments/fees for that money.

DenCo

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Re: Reader Case Study - How to properly allocate?
« Reply #15 on: March 21, 2019, 09:45:45 PM »
How the h3ll are your taxes so low, and you're still getting a refund? On my gross of $6520 I pay just over $1500 in taxes...