Calculating Savings Rate

[ardrum]

I have a possibly really dumb question about the calculating of one's savings rate...

Made-up Scenario:
After Tax Income: $50,000
Combined traditional IRA/401k contributions for the year: $20,000  (at first looks like 40% savings rate)

If this person is in the 25% tax bracket for those contributions, they should have $5000 tax savings though right?  For math simplicity, let's just say they invest $5000 in a taxable account.

The total amount they invested that year then is $25,000.  So would this situation actually represent a 50% savings rate?  It seems like an extremely easy way to crank up the savings rate. 



 

[MDM]

I have a possibly really dumb question about the calculating of one's savings rate...

Made-up Scenario:
After Tax Income: $50,000
Combined traditional IRA/401k contributions for the year: $20,000  (at first looks like 40% savings rate)

If this person is in the 25% tax bracket for those contributions, they should have $5000 tax savings though right?  For math simplicity, let's just say they invest $5000 in a taxable account.

The total amount they invested that year then is $25,000.  So would this situation actually represent a 50% savings rate?  It seems like an extremely easy way to crank up the savings rate.

Yes, more savings is indeed a good way to crank up the savings rate.

FWIW, to get $50K after tax (with tax being federal + SS + medicare), and making $20K pre-tax investments, requires gross wages of $86,390.

If that same $20K is made post-tax (either to Roth or taxable), the after-tax income increase from $50K to $65K.

"Savings Rate" can be defined many different ways, none of which are inherently "best".  All depends on what you want to do with the number....

[ardrum]

I have a possibly really dumb question about the calculating of one's savings rate...

Made-up Scenario:
After Tax Income: $50,000
Combined traditional IRA/401k contributions for the year: $20,000  (at first looks like 40% savings rate)

If this person is in the 25% tax bracket for those contributions, they should have $5000 tax savings though right?  For math simplicity, let's just say they invest $5000 in a taxable account.

The total amount they invested that year then is $25,000.  So would this situation actually represent a 50% savings rate?  It seems like an extremely easy way to crank up the savings rate.

Yes, more savings is indeed a good way to crank up the savings rate.

FWIW, to get $50K after tax (with tax being federal + SS + medicare), and making $20K pre-tax investments, requires gross wages of $86,390.

If that same $20K is made post-tax (either to Roth or taxable), the after-tax income increase from $50K to $65K.

"Savings Rate" can be defined many different ways, none of which are inherently "best".  All depends on what you want to do with the number....

Thanks!

[slugline]

Sure, I could go with the OP's premise when it comes to calculating this year's saving percantage. Of course, those tIRA/401K accounts don't let you avoid taxes forever. They're like financial DVRs that let you time-shift the tax expenses to later in life when you may be in a better position to "unpause" them and deal with their impact then.

(Perhaps the most intriguing tax avoidance vehicle is the health savings account. If I understand correctly, if you use the account funds on medical expenses, you really do avoid 100% income tax on both the contributions and investment earnings forever.)

[ardrum]

If I have 5+ years of living expenses from the combination of my Roth IRA contributions and taxable accounts by retirement, I could minimize or eliminate those traditional 401k taxes later though by converting it slowly over time to my Roth IRA when I otherwise have no earned income in that year.  The amounts converted would be categorized as contributions, making them accessible each year after those initial 5 years.

My current living expenses are only about $17k annually at present, so I anticipate a very low future tax rate vs my 25% current marginal rate.

[redcedar]

If you are interested in understanding a couple of different savings rate views and the math behind them, check out this article on Firestarter. It references a few savings rate models used by long term bloggers including MMM. Its a very good read.

http://thefirestarter.co.uk/calculating-savings-rate/

[ardrum]

If you are interested in understanding a couple of different savings rate views and the math behind them, check out this article on Firestarter. It references a few savings rate models used by long term bloggers including MMM. Its a very good read.

http://thefirestarter.co.uk/calculating-savings-rate/

Thanks!  Based on the formula  SR = [total savings / (expenses + total savings)] * 100 , my SR should hit 70% once I move (within walking distance to work) next month!