Hi all,
I've been digesting every morsel of FI and general personal finance information out there over the last month or so. I wanna set myself off on the right foot! So I'm gonna put what I'm doing and why in this post, and hopefully you lovely people can give me your final suggestions and critiques before I decide to stop over analyzing everything!
Info: Age 23, salary is smidge under $60k, have 401k available through work. Effectively zero matching, but decent pick of low cost fund options (my highest ER right now is small-cap index at .13%). No debt. Looking to be FI/maybe semi-retire by 40-50. Not dead set on this cause so much could change in life.
Current savings plan/goals:
- 20% of salary into 401k (about $1000/month)
- An additional ~$500 into a Roth IRA monthly
- Another $200 into "general" savings, for things that have no set time frame such as a home, a car, money to start/invest in a business with, an engagement ring, whatever just anything big in the future with no set date.
- Emergency fund is set
This gives me a pretax savings rate of about 35%, about 44% after tax. Might be able to beef this up a bit. Anyway..
My asset allocation for both retirement accounts right now is 90/10 equities to bonds. Open to opinions on this but I'm trying to split the difference between those who say "you'll wish you had bonds when the next recession hits" and "you will wish you were 100% equities when you see the next 20 years of market data." Of the 90% in equities, 80% is in S&P 500, 10% each in small-cap index and EAFE International index (did some research to come to this but trying to keep it simple...). Bond holdings are just a Bond fund mixing between junk bonds, government, intermediate, etc.
Now I know that being in the 25% marginal bracket, many say I should do a traditional IRA instead of Roth, and mathematically I get why, and have read threads showing why. I know I can always do a Roth laddering in the future, but I'm worried about depending too much on that loophole for getting money out of a t-401k or t-IRA should it be closed before I use it. I'd hate to have enough net worth to be FI, but not actually be truly FI because of a lack of liquidity. For that reason I'd like to at least go about half of my retirement (for now, when I'm maxing 401k it will be less) into a Roth IRA.
Please feel free to convince me otherwise if this is stupid, but I like the idea of having the Roth contributions available if I need them, perhaps to bridge the gap between early retirement and "real" retirement if Roth ladders are disallowed. Even so I need 5 years expenses while I ladder).
What does everyone think? Hopefully all my reading and searching on here, MadFIentist, and MMM has paid off somewhat and I have a decent plan here. Mostly I'm just still unsure of both my asset allocation (bonds to equities, as well as equities allocations) and my savings plan. I just dont want all my retirement money untouchable and I don't want to put all my eggs in the basket of relying on Roth laddering still being available in 20-30 years. And I still want to do some intermediate term savings for large purchases that could come up in maybe 3-5 years.
My sincerest gratitude for the help
You might want a taxable account because of the contribution limit on the Roth IRA, but you can decide on that after you've been maxing out your IRA and 401k for a while.
Mostly I wanted to say good luck!
Agreed with rlbabydoll about considering a taxable account once you've maxed your tax-deferred accounts. About 1/3 of my investments are in taxable accounts and it gives me incredible financial flexibility.
Personally, I think the Roth-conversion ladder will always remain available. Traditional IRA to Roth conversions allow the government to effectively get their tax money early (since the converted amount is subject to taxation) instead of having to wait for the account holder to reach age 59.5 to be eligible for withdrawals. Likewise, there is no incentive for the IRS to lengthen the 5 year waiting period as it will also discourage Roth conversions, which will reduce taxes.
From the info you provided, you are earning about $60k pretax, paying about $12k in taxes, leaving you with about $48k post-tax, of which you are saving about $21k and spending $27k. At the current Roth contribution limit of $5500 per year, it will take you 5 years of maxing Roth contributions to have enough to pay for 1 year of FI. If you plan to be FI in 17 years, this will only give you enough time to accumulate about 3.5 years' worth of expenses that you can withdraw from your Roth, assuming you manage to not inflate your lifestyle costs. This will only take you to age 44, at which point you will still have 15 years to go until you can start withdrawing the earnings from your Roth. You will need to have a sizeable taxable account to sustain you the rest of the way, or at least for another 1.5 years for the Roth conversion ladder to kick in.
For this reason, Roth IRAs usually don't make sense for aspiring early retirees. A traditional IRA will not only give you an immediate tax break (assuming your salary isn't high enough to make you ineligible), the contributions AND the earnings will be accessible to you penalty-free (not tax-free, but taxed at a substantially lower rate) before age 59.5 via the Roth conversion ladder method.
Full disclosure: I am doing a Roth IRA this year for myself because I am in the 15% tax bracket (started my first job halfway through the year), but I intend to do traditional IRA contributions starting next year until I am FI.
Rule 72(t) allows you to take premature distributions from IRA's without penalty.
I'm actually in the 15% bracket this year as well due to starting my job mid year. I'm probably going to take my starting bonus and just about max a Roth IRA with it this year.
Thank you for your additional input on my plan!
You have probably seen http://www.mrmoneymustache.com/2012/01/13/the-shockingly-simple-math-behind-early-retirement/[1]already. I provided this link as your current savings rate fits you into your goal FI age.
I fully understand the reasoning for using a Roth. Just a little useless note: I think the fact that you not only understand the differences but that you actually get both sides of why to/not to use a Roth and your ability to clearly state these things shows that you probably do not need any beginner advice.
On your allocations, I see nothing "wrong" with what you have. There are clear arguments as to why more should be put into international and other stating that the S&P 500 by itself already has massive international exposure and blah blah blah. You have stated that you have done research on this already so I see no reason to try to argue about that part. I will state that you could consider looking into mid-cap instead of small-cap because it tends to be better in every way, but the reality is the actual expected difference is minimal so shrug. On the bond fund I do think that you may be making a mistake. The bond fund should not hold junk bonds in my opinion. An overall bond fund has 0 correlation (actually it is ever so slightly positive) with the stock market, however a government bond fund has a negative correlation with the stock market. As such, if you are holding the bond fund to help with volatility or re-balancing then a government bond fund suits your needs much better, although at a slightly lower yield I suspect.
A comment about Roth to consider: if you possibly change jobs in the future you can always consider moving part of your 401K into a Roth fund pre-retirement. Yes, there would be a (probably) massive tax hit on the conversion, but it would allow you to have a larger % of your portfolio in a Roth fund.
One more comment which is likely to be hotly debated if anyone reads this... If you have long-term savings in mind you could consider taxable investments. Yes, the tax drag on your account would be highly noticeable, however for something like saving for an unknown wedding ring, house, or something big and unknown which is then likely to be far in the future it may make sense to consider taxable investments for that particular savings instead of a savings account. I personally use taxable investments despite not maxing out my 401K (I do max my IRA). I fully understand the implications, however it has come in handy: I changed my career path which required several months of full-time training which I had to pay for along with being unemployed for an extended period of time and being able to withdraw from taxable investments paid for much of that.
Overall, I think you seem to have things well under control and now all you have to do is follow your plan and enjoy life :)
Your asset allocation is fine, although I don't see the point in holding any junk bonds. Just stick with muni bonds and perhaps some corporate bonds as well that aren't in the "junk" category.
Some at your age would not have any bonds at all, I personally think this is unwise. Think of your bonds as being an additional "buying opportunity" if the market tanks, because you have some additional funds you can sell to buy equities if you want to. And if you don't choose to go that route then I think the diversification is always a good thing.
Asset allocation is really always a personal choice based on what you are comfortable with. At your age I think 20% would be about the max you should hold in bonds, 10% is probably about right.
Your personal savings rate matters more than anything at your age and yours is fairly high. I would set some goals over the years to slowly increase your contributions, but you are doing plenty well at the moment.
Allocation looks fine. Possible a little light on international. 90% vs 100% equity at your age hardly matters. My preference is 100% equity at your age, but your choice is good too. If it makes a difference in how you stay the course in the next big correction, then it's all to the good. The important thing is when a big downturn shows up (in a month, or in 3 years, or in a decade) you don't abandon equities. If you can stomach that big drop, then your allocation is working.
A Roth conversion ladder isn't really a loophole. Normally, you pay taxes on money before you put it in a Roth IRA. The rollover part is perfectly legitimate and not a loophole. When you roll over from a traditional IRA, you pay taxes on the money before it goes into the Roth account. You're not avoiding any taxes (unless you're legally in a different tax bracket). All you are doing is delaying the payment of the taxes.
