Author Topic: 23 y/o w/ retirment account/investment strategy questions  (Read 3799 times)

bertrandhustle

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23 y/o w/ retirment account/investment strategy questions
« on: February 13, 2014, 12:30:19 PM »
Hi,

I just turned 23 and am currently deferring law school while I work to grow money. I would like to know what the appropriate investment strategy for my situation is.

I net ~$2,800/month. I currently put $1800/month in Vanguard Total Stock Index, $250/m in company 401k to max the 100% yearly match up to $3000, and used my tax refund to max my 2013 Roth IRA. All told I currently have $21,500 in investments and a 25k net worth. I start law school in 2015. By then I'll own ~$30k (at today's stock price) worth of vested company equity too. I live in the most expensive city in America, so rent disallows me from investing more :(.

My question is, should I stop contributing to my taxable account to take full advantage of my company's 401k matching policy? My company matches 50% on anything I contribute over $6000. So, if I max it out at $17500, they add $8250, which is over $5k more than they contribute in my current strategy. The reason I've hesitated to max it so far is because I might want to use the money I'm saving to help service my future educational debt and am concerned about having it tied up in my 401k.

I'd like to be FI by 40 or younger. I currently have a girlfriend who I have every intention of marrying who will make over 100k/yr within the next 4 years FWIW.

Thanks!

P.S. I know law school can be a risky venture but it is the only way to achieve my professional goal of becoming a law prof to combine tenure with FI. I've minimized my risk by accepting an offer from a top school (think Harvard, Yale, Stanford), building work experience first, and saving as much as possible. I'm also applying for fellowships to help cover tuition. In other words, I'm not looking for reasons why I shouldn't attend law school.

FrugalSpendthrift

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Re: 23 y/o w/ retirment account/investment strategy questions
« Reply #1 on: February 13, 2014, 12:57:25 PM »
That's a big match, I wouldn't turn that down!  Read this and do the math: http://www.welcome-to-the-woods.com/8/post/2014/02/get-rich-with-employer-401k-plans.html

beltim

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Re: 23 y/o w/ retirment account/investment strategy questions
« Reply #2 on: February 13, 2014, 01:01:44 PM »
First, that is an awesome user name.  Well done!

Second, I think the answer to your initial question — should you contribute to your taxable account or your 401k — is a slam dunk in favor of contributing to the 401k.  First, every dollar you put in isn't taxes, saving you perhaps 15% or more right off the bat.  And then you've got company matching of 50%, which means you can sock away upwards of 75% more in your 401k than you can in a taxable account.

Third, you don't have to worry about not being able to use the money in your 401k for educational expenses!  As soon as you leave your job to go to school, you can roll over your 401k into an IRA.  Once you do that, you're allowed to withdraw money from an IRA for educational expenses (http://www.irs.gov/publications/p970/ch09.html) without paying a penalty tax!  Plus, you'll likely be in a lower tax bracket while you're a student (although if you get married while you're a student, that could change—but not enough to negate the extra money thrown in by your employer).

In conclusion, max out that 401k to take advantage of that sweet, sweet employer contribution.  Any tax benefits could be a really nice icing.  When you get to school, you can decide if you want to take more loans to avoid drawing down your 401k—but that's a bridge you can cross when you get there, knowing that by contributing the max to your 401k now, you've put yourself in the best possible financial position.

Cromacster

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Re: 23 y/o w/ retirment account/investment strategy questions
« Reply #3 on: February 13, 2014, 01:35:34 PM »
I might be reading this wrong but....

used my tax refund to max my 2013 Roth IRA.

Was your tax refund 5500?  You might want to get that sorted out.

Yes, I would take full advantage of that 401(k).  You are leaving free money on the table.
« Last Edit: February 13, 2014, 02:28:37 PM by Cromacster »

Olórin

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Re: 23 y/o w/ retirment account/investment strategy questions
« Reply #4 on: February 13, 2014, 02:24:14 PM »
I have a very similar question to the original poster.  I'm about to punch myself in the face if what I think is true actually is, because it means I've wasted thousands of dollars over the past few years. 

I'm a medical student with 2 yrs of school left, and we've had significant reserves that we've been keeping out of the market in order to ensure the money was still available to pay for school and avoid going into debt. 

beltim above mentioned that you can withdraw from an IRA to pay for school without paying a penalty.  Is there any reason I shouldn't contribute the maximum to a Traditional IRA this year (tax year 2013) and then use that untaxed money the following year to pay for tuition?  The earliest we would be withdrawing IRA money to pay tuition would be in the year 2015.

Does this question make sense?  It seems that we could lower our taxable income significantly this year ($5500 to a traditional IRA for my wife who has a salary of ~$60,000, and $4000 to an IRA for me from the $4000 i made during a summer job this past year).  Then we could turn around next year and use that money for tuition without ever paying tax on the money.

Am I missing something, or is this free money I've been missing out on?

Any and all help appreciated trying to wrap my mind around this!

beltim

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Re: 23 y/o w/ retirment account/investment strategy questions
« Reply #5 on: February 13, 2014, 02:35:20 PM »
I have a very similar question to the original poster.  I'm about to punch myself in the face if what I think is true actually is, because it means I've wasted thousands of dollars over the past few years. 

I'm a medical student with 2 yrs of school left, and we've had significant reserves that we've been keeping out of the market in order to ensure the money was still available to pay for school and avoid going into debt. 

beltim above mentioned that you can withdraw from an IRA to pay for school without paying a penalty.  Is there any reason I shouldn't contribute the maximum to a Traditional IRA this year (tax year 2013) and then use that untaxed money the following year to pay for tuition?  The earliest we would be withdrawing IRA money to pay tuition would be in the year 2015.

Does this question make sense?  It seems that we could lower our taxable income significantly this year ($5500 to a traditional IRA for my wife who has a salary of ~$60,000, and $4000 to an IRA for me from the $4000 i made during a summer job this past year).  Then we could turn around next year and use that money for tuition without ever paying tax on the money.

Am I missing something, or is this free money I've been missing out on?

Any and all help appreciated trying to wrap my mind around this!

Your question makes sense.  I think that the distributions from an IRA for educational expenses are still taxed—there just isn't an additional penalty for withdrawing money early.  Assuming the money you contribute this year would be at the same tax rate as the money you withdraw in 2015, then you won't get any tax benefits.  You could save money if you'll be at a lower rate when you take the distribution, but you can't get it tax-free. 

You may be able to use a 529 plan to avoid state income taxes on money that you're saving for tuition, but don't make a difference for federal income taxes.

Did that answer your questions?

bertrandhustle

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Re: 23 y/o w/ retirment account/investment strategy questions
« Reply #6 on: February 13, 2014, 02:52:29 PM »
Thank you all for these responses. Looks like I'll switch up my strategy.

First, that is an awesome user name.  Well done!

Thanks, I'm glad someone caught on!

I might be reading this wrong correctly but....
This is my first job out of school so I didn't claim any dependents just to be safe. I've changed it so I will start withholding less beginning next pay cycle.

One more question: My company also offers a Roth 401k. Would it make more sense to convert to this instead of contributing to the traditional 401k considering my plan to use the funds toward educational expenses?

beltim

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Re: 23 y/o w/ retirment account/investment strategy questions
« Reply #7 on: February 13, 2014, 03:03:57 PM »
One more question: My company also offers a Roth 401k. Would it make more sense to convert to this instead of contributing to the traditional 401k considering my plan to use the funds toward educational expenses?

Probably not, but this depends on the relative tax rates.  If your contributions now are in a higher tax bracket than when you're in law school, the regular 401k is better (most likely scenario).  If the brackets are unchanged, it doesn't matter.  And if you're in a higher tax bracket when you're in law school (which is possible if you get married and your wife is making 100k) then the Roth would be better.

Olórin

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Re: 23 y/o w/ retirment account/investment strategy questions
« Reply #8 on: February 13, 2014, 04:59:55 PM »
Thanks beltim!  That answered my question.  I wanted that to be true so badly that I wasn't thinking quite clearly, so thanks for straightening me out.

GlassStash

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Re: 23 y/o w/ retirment account/investment strategy questions
« Reply #9 on: February 13, 2014, 06:35:36 PM »
I have a very similar question to the original poster.  I'm about to punch myself in the face if what I think is true actually is, because it means I've wasted thousands of dollars over the past few years. 

I'm a medical student with 2 yrs of school left, and we've had significant reserves that we've been keeping out of the market in order to ensure the money was still available to pay for school and avoid going into debt. 

beltim above mentioned that you can withdraw from an IRA to pay for school without paying a penalty.  Is there any reason I shouldn't contribute the maximum to a Traditional IRA this year (tax year 2013) and then use that untaxed money the following year to pay for tuition?  The earliest we would be withdrawing IRA money to pay tuition would be in the year 2015.

Does this question make sense?  It seems that we could lower our taxable income significantly this year ($5500 to a traditional IRA for my wife who has a salary of ~$60,000, and $4000 to an IRA for me from the $4000 i made during a summer job this past year).  Then we could turn around next year and use that money for tuition without ever paying tax on the money.

Am I missing something, or is this free money I've been missing out on?

Any and all help appreciated trying to wrap my mind around this!

Your question makes sense.  I think that the distributions from an IRA for educational expenses are still taxed—there just isn't an additional penalty for withdrawing money early.  Assuming the money you contribute this year would be at the same tax rate as the money you withdraw in 2015, then you won't get any tax benefits.  You could save money if you'll be at a lower rate when you take the distribution, but you can't get it tax-free. 

You may be able to use a 529 plan to avoid state income taxes on money that you're saving for tuition, but don't make a difference for federal income taxes.

Did that answer your questions?

It's also important to note that when you put the money in the IRA for later withdrawal, you are incurring risk. Unlike the OP, who has a great employer match to help mitigate some of this risk, you are risking the $9,500 to avoid some (minor) taxes. The market could go up or down in the year or two between your contribution and withdrawal. I'm not sure this is worth the risk for minor tax avoidance.

beltim

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Re: 23 y/o w/ retirment account/investment strategy questions
« Reply #10 on: February 13, 2014, 07:07:47 PM »

It's also important to note that when you put the money in the IRA for later withdrawal, you are incurring risk. Unlike the OP, who has a great employer match to help mitigate some of this risk, you are risking the $9,500 to avoid some (minor) taxes. The market could go up or down in the year or two between your contribution and withdrawal. I'm not sure this is worth the risk for minor tax avoidance.

This is a common misconception.  You can invest in almost anything you want in an IRA. Indeed, you can simply leave it in cash and be guaranteed that you can withdraw everything you contribute.  Of course, if you new when you wanted to withdraw it you could put it in something safe but with a bit of interest -CDs may be a good choice for a two year timeframe.