Author Topic: Better to pay for expenses from savings or income?  (Read 211 times)

jhrobbin

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Better to pay for expenses from savings or income?
« on: March 04, 2021, 01:15:01 PM »
Hi folks.  Probably the 'subject' of this post is not clear.  Let me try to briefly explain:
  • I am considering leaving work and taking a mini-retirement soon.  My current income from employment will go to $0
  • My spouse is a teacher and eligible for both a 401k and 457 plan.  She will turn 50 this calendar year and therefore can contribute up to $52,000.  $26,000 [19,500 + 6,500] for 401k + $26,000 [19,500 + 6,500] for 457.  This would account for most of her income.
  • We have a large enough emergency fund to cover living expenses.  Probably too large a fund considering the emergency fund is in money market :)

Is it a no-brainer to put the max into tax deferred savings and use emergency fund for day-to-day living expenses? To be clear, the emergency fund is not the entirety of our long-term savings.  The other $ is in index finds which I want to hold onto (although I could use them in case of a true emergency)

I am a tax noob so I'm wondering if I'm missing something.  Are there other aspects I should be considering?

Thanks for your patience and advice.
« Last Edit: March 04, 2021, 01:23:12 PM by jhrobbin »

phildonnia

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Re: Better to pay for expenses from savings or income?
« Reply #1 on: March 04, 2021, 03:23:48 PM »
I find it helpful to look at it this way:

If you are spending "from your income", then you are essentially really paying from your tax-deferred accounts (by not funding them fully).  Conversely, if you are spending from your non-qualified accounts, then you are essentially transferring money from those accounts to your retirement accounts (by spending faster than your savings accounts can accumulate).

So your decision can be framed more simply as: How much do you need in savings?  If you have more than you need, "transfer" it to a 401(k) by funding the 401(k) and living off your savings.  If you have less than you need, "transfer" it from your 401(k) by living from your income, and shorting your 401(k).  Once you have your savings balance at the ideal level, put the amount into your 401(k) that will keep your take-home pay equal to your expenses.

The fundamental question "How much do you need in savings?" is, of course very personal and depends on your own plans, predictions, and risk tolerance.

A note on the subject of emergency funds:  Ultimately, an "emergency fund" is nothing but a label on a number.  You have savings, and some amount of it is "emergency fund" and some of it is "expenses".  Some people like to have separate accounts, to keep track of what is what.  Some people are able to just keep track of the number.  In either case, if you use it for regular and predictable expenses, it's not part of the emergency fund.  Psychologically, to avoid using your emergency fund for non-emergencies, stop using that term for your savings in general.





seattlecyclone

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Re: Better to pay for expenses from savings or income?
« Reply #2 on: March 04, 2021, 03:36:50 PM »
Yes, loading up your tax advantaged accounts can be a great idea, especially with a 457 available (no early withdrawal tax). If you're having a lower income year you may want to consider switching some of your contributions to Roth.