Balancing Retirement and Non-Retirement Savings

Really? That's far from obvious to me. At 30 yrs old, having $95k in retirement plans is a good start, but it's only a good start. You don't say anything about your income levels, retirement expectations, etc, but if you are saving what many of us consider the bare minimum towards retirement - 10% of income - you're on the right track, not oversaving at all - and need to keep it up.

Remember - time is your biggest ally here. The more you put towards retirement *early* the better your likelihood of retiring when you choose and comfortably. And the less - by *far* - you'll have to sacrifice to save later.

That wouldn't be "correcting" it. As I said, we don't have nearly enough information here, but at a glance, I'd say that's more in line with "screwing up what looks like it was probably a good plan".

If you can't keep that up *and* rebuild your after-tax savings (emergency cash, etc), then you need to seriously look at the

*expense* side of your budget.

As I was saying about the expense side. Unless you *need* a new car in 2-4 years, don't buy one, and almost certainly not a new one. Your retirement savings is vastly more important than an new car.

[rant snipped. Note that a proposal for simplifying and unifying govermnent-favored accounts was basically just ignored a couple of years ago. For reference, it was Bush's 2004 budget, and it was completely dead on arrival.]

If any part of your 401(k) contributions are matched by your employer, I hope that you will continue to continue to contribute enough to capture all of the match. Not doing so is just like giving away money.

My wife and I are 65 and 64, and we are glad that we contributed to our retirement accounts years ago. You'll be glad, too, when you retire. In that sense, it probably isn't possible to contribute too much to retirement accounts. Just consider that you are on track to a successful retirement.

I have decided that what I want in a car is reliable transportation with reasonable comfort. To me, a car is not a status symbol, so I pick reliable cars and drive them at least 8 years (we currently drive a Camry and a RAV4). You are right that it is nice to pay cash, so save the equivalent of a car payment every month and accumulate the money in advance.

Just accept the complexity of having multiple retirement accounts with different rules as one of the things you have to accomodate, learn enough about the rules to get along, and go with the flow. Take a couple of aspirin if the headache gets too bad. :-)

Dave

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Bill, I think you'll find the general consensus is that at your age you cannot have saved too much for retirement. You and your wife have done well to this point. One cannot predict the future and, while we always believe things will continue pretty much as they are, life occasionally takes a turn. Be thankful that you have established a good and solid foundation for your older age. Withdrawing any of it now is likely a mistake.

Without more information it is difficult to truly answer your question as to the best way to balance present and future needs. It isn't clear that you should stop all retirement savings, but I agree that cutting back for a time may be prudent so that your emergency fund is built back up and that you have the sort of cushion for non-retirement purchases that you need.

As Dave pointed out, contribute enough to your workplace retirement plan to get any employer match. You can temporarily suspend IRA contributions to build your emergency fund. If one of you has only an IRA and not a workplace plan, however, you should continue those IRA contributions.

Dave suggested that you start making car "payments" now in anticipation of that car purchase. You may need to delay the purchase in order to be able to pay cash, but you thinking of paying cash is wise. You'll have a new house, but houses have a way of eating money in unanticipated ways. Decide on an amount that seems reasonable for home maintenance and start making those "payments" too.

Elizabeth Richardson

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95k at age 30 is good for retirement, but far from excellent or more than needed. That 95k is only 4k in income in retirement (4% withdraw rate). If you make more than 4k per year, you need to have more saved to retire.

Here are the guidelines I think you asked for (which I used for my family):

1) save 10% of gross pay for retirement to 401k 2) max out Roths (for wife and me). 3) keep 3 months expenses in a cash account 4) keep 3 months expenses in a mid term investment 5) contribute to HSA enough to cover estimated yearly medical expenses. 3 and 4 defy some convention- here is my logic: 6 months expenses are suggested in cash. This is to cover emergencies. I have a hard time watching 6 months expenses (25k+ for me) earning 2-4%.

So I took a 3 and 3 approach.

3 months expenses in 90 day CDs (laddered to mature every 30 days) 3 months expenses in a moderate mutual fund (I use PRPFX).

I am working on a new household budget. That budget will add to PRPFX. $500/month for car. $20/month for new roof for house ($5000 every 20 years), $10/month for new hot water heater ($2500 every 10 years). Any money I would use to pay down mortgage (5.75%) will be added to this same account. Money for kids education gets added to this same account.

The account is liquid, grows faster than cash (7% yearly return expected), grows faster than inflation, has little risk (it invests in

4-5 asset classes with low correlation to each other), and can be used for many reasons.

The tough part in your situation is that when you start, you need everything (3 months expenses, money for new car, maybe house repairs). But once you get the system implemented for around 2 years, it will have more than enough liquid cash to fund current expenses.

Of course if I knew when my hot water heater would go, I would stop contributions for a month or two or six, then use the cash to get a new one.

The idea is to have money grow while I wait for something bad to happen.

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Keep up the Roth IRA contributions and 401K up to the level of matching funds.

I don't think that you have enough to build a new house, can you postpone it?

There's nothing wrong with a loan, just don't buy luxury cars or all the options.

You can convert your standard IRA to a Roth IRA, eliminating two of your accounts. When you leave your job, you can convert your 401K accounts to standard IRA accounts.

-- Ron

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I do something similar with dividing my "emergency fund" into layers. I routinely keep enough in my checking account to cover an extra month's expenses, and another $5000 or so in a money market account to cover unexpected home repairs and the like. Beyond that, I have money in a muni bond fund that I could tap into in case of a longer-term emergency. I consider it part of my retirement savings and count it towards the bond part of my asset allocation, but since I know it's there I don't feel like I have to keep huge piles of cash around.

Anyway, I agree with the general advice others have given to the OP: do try to continue to take advantage of any employer match on the 401K, don't cash in existing retirement accounts, do watch expenses until you build up your savings again.

-Sandra

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Yeah, that certainly seems to be the case. It strikes me as unnecessarily extreme. For example, Bread suggested that if you can't contribute the maximum to your retirement accounts ($41K for 2008), you're spending too much. Given that the median household income in the United States is $48K, well... you do the math.

Plus, what's the point of contributing so much to your retirement accounts? Ensuring your children never have to work a day in their lives? Suppose you do invest $41K per year for 30 years with a 6.5% real return. You'll end up with $3.8M. That's enough to generate $255K income per year. Is that really the goal? Is it really worth it to deprive during your working years so that you can have more money that you know what to do with during retirement?

Another thing I'm concerned about with the "all retirement all the time" approach is diversity of investments. What if we want to invest in real estate? Admittedly, it's possible with a self-directed IRA, but I've heard it's a real headache. What if my wife's practice offers to buy her in as a partner? Or she wants to buy a practice or start a new one? Heck, what if >I< want to start a business? If the vast majority of our savings is tied up in retirement accounts, we'll have to pay a hefty premium to invest outside the box, as it were.

--Bill

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Using a 4% withdrawal rate, $3.8M gives an income of $155K. For someone who could save $41K per year, $155K may not be enough for a "comfortable" lifestyle.

Here's another way to look at it: If you want to retire at the same standard of living you had prior to retirement, you will need retirement savings of between 15 and 20 times your final pre- retirement income. Using a 4% withdrawal rate, this savings will replace 60% to 80% of your previous income. Add Social Security to that and you should be able to replace 80% to 100% of your previous income. If you think Social Security will not be around for you, then aim for 20x to 25x your pre-retirement income.

One way to achieve 15 to 20 times final income is to start saving 10% of your income in your mid-20s. If raises average 3% and your investments average 8%, by age 67 you will have accumulated about 15x. If your investments average 9%, you will have about 20x.

Dave

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That's not actually what I said. I did, however, suggest that whatever else you do, you make sure to continue to put at least

10% of your income into your retirement accounts. More's better, sure, but less than 10% makes it awfully difficult to picture one managing to save enough to ever actually retire.

(And not everyone can put the legal max into retirement accounts - even if one can put the full $15.5k into a 401k *and* maxes out an IRA (Roth or Trad), that's still only $20.5k (more for those over 50, though.) The difference would have to come from employer matches + other employer contributions - and most folks' employers are not quite that generous)

Again, you're missing a lot here. I don't expect anyone making less than $200k to reasonably expect to put $41k into retirement accounts.

Now, you've said you'd saved $95k into retirement plans - with your wife - by the time you're both about 30. If we assume that you both started earning enough to really save money at about

25 years and put 10%/yr away, I'll guess that your combined income is on the order of $100k now. Keep putting 10%/yr away and assume your 6.5% return (and if we assume everything is after inflation and that your income goes up at inflation + 2%), then after 30 more years of working, you have a retirement balance of about $1.72 million. Which is enough to draw an annual retirement income of about $69k.

Saving 10% it'll *still* take you 30 years to build up that moderate retirement dream. And at that point you'll be 60 and probably live another 30 years.

So 10%. Do it. Do no less. If you want a safety net, or an earlier retirement, or be able to invest a little less aggressively and with less risk - save more. Assuming a 6.5%

*real* return is very aggressive, and a portfolio which can generate that much is likely to have dips of 20% or more along the way. Can you handle that kind of volatility?

Not "all retirement all the time". 10%. After that, non-retirement savings. After *that*, spending. If the spending's too high, there are only two options. Earn more or spend less.

And if by "real estate" you mean directly owning rental property, bear in mind that that's *not* an investment per se, but more the owning and management of a business. I'm all for it, but *not* at the expense of that 10% in the retirement accounts. If you can put 20% of your income away, then 10% in retirement accounts and 10% into the "start a business; buy rental housing; etc" account. But still - 10% into the retirement accounts, unless those accounts are already well funded - the best way to do that is to fund them *early*. If you put more than 10% into the retirement funds early, then sure, at some point, stop. But at $95k at the age of 30, it's not enough.

Anyway, there are plenty of real-estate and other non-stock-assets one can buy in an IRA quite easily, from REITs to RE management companies to other commodity-tied companies which own land and/or other assets.

All well and good. But NOT with the retirement accounts. You may have to stop contributing to them at some point, but the retirement accounts are your safety net.

If you save 20% - half in retirement accounts and half outside of them, then no, the vast majority of your savings won't be "tied up".

I'm not really sure what you're looking for here. If you think anyone's going to tell you "oh, sure, don't worry about saving for retirement in IRAs and 401ks" you might get that advice, but you'd likely be taking a bigger risk with your own future. Even if you invest identically (ie. funds rather than a business or real estate), the tax drag lowers your long-term return and to make up for that you have to either save more or invest in a more risky asset mix.

You really didn't give us enough information about your situation to make fully drawn out advice. Knowing what little I know, though, you clearly haven't made a "mistake" in putting away the $95k you already have, and stopping your contributions to that (rather than, say, cutting down other spending) may be necessary for a short time, but any more than a couple of years would be the real mistake.

The reason it is usually said that you can't have contributed too much at a young age is because something might happen to you at, say age 50, when you could no longer contribute at all. We simply can't predict the future. If you do a good job now while you're able, then you can re-evaluate everything at increments nearer retirement itself.

Most folks don't find they've saved too much for retirement. Most folks wish they'd saved more when they were younger. If you put it off now, when you're in your 50s the amount you'd have to save will be overwhelming.

It is very difficult to balance all the demands on one's finances. Only you can decide which demands should have a priority. It might be a good idea to just write down all those things for which you expect some future expense. Put some real numbers with them, then try to divide up what funds you have available to see how you come out.

Maybe you'll decide to back off retirement savings from 10% to 6% and temporarily forego any IRA contributions in order to build up a cash reserve. Maybe you'll decide that you can't pay cash for a car in 2 years, but that you could do it in 4.

You don't mention children. Will you have some future need to be saving for college? How will that fit into the picture? Will your wife's income be reduced in order to have these children, or the cost of raising them affect your discretionary income? And, Bill, it's these future demands on your finances that tell me your $95k in current retirement savings have been excellently deferred.

Elizabeth Richardson

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Elizabeth Richardson wrote:

It's easy to find data that supports Elizabeth's statement above. Last I read, less than 25% of retirees have saved more than $25,000 for retirement. So, while there are some out there who are fortunate enough to have actually over-saved, there numbers are pretty small.

Bill, there's no magic formula. You seem to be asking a combination of a few questions. There's the risk of 'saving yourself into the next tax bracket." You don't mention any pension plans. A pension replacing a chunk of your income at retirement can make the 401(k) and IRA withdrawals heavily taxed. If no pension, only your own savings and social security, it's a bit tougher to do. Look at Fairmark

and you can see that for a couple, the standard deduction is $10,900, plus 2 exemptions, $3500 each. This totals $17,900 that a retiree can withdraw each year tax free. Using the 4% initial withdrawal rate, that's $447,000 gross pretax savings needed to generate. The next $16,500 is taxed at 10%. Another $412,500 needed to support that withdrawal rate. With about $75K in pretax accounts, you have a way to go, even adding the $31K to the 401(k) and $10K to the IRA. In the dozen years it would take, the brackets will creep up as will the standard deduction and exemptions. I doubt there will be any huge jump that would catch you by surprise. Tied into all this - if you ae in the 28% or higher bracket now, I'd not use Roths, just pretax. If you have a baby and the missus takes some time, you can convert while in a lower bracket. (mixed in to this is the Social Security tax trap that needs to be monitored. When half your social security plus other income exceeds $32K joint, the SS becomes taxable. A high earner, and high saver will blow through this. My study shows that it's only an issue for those straddling the line, where the next $1,000 is taxed at a high phantom rate)

Your real question seems to be how much non-retirement funds need to be available for the high ticket things you mention. I'd suggest that's more a function of how steady your income is and how predictable the expenses are. I'd go back to the 'emergency fund' conversations, so when the furnace fails you don't need to panic to replace it. Of course a homeowner has more potential unexpected repairs than a renter. If you wish to pay cash for the cars, start saving now.

But I'll close with this - run the numbers to see if you are on track to your retirement goals. Not knowing your income, I can't guess whether you are on on your way or falling short.

Joe

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I know it's tough to get a handle on somebody's situation based upon a single post, but it seems to me the original poster and his wife were diligent about funding their tax advantaged accounts and built up a nice balance. But now they're building a house and at least thinking about a new car and they realize they don't have enough cash on hand in their taxable account to pay for that and keep up the retirment savings too.

The debate over "save for the future" vs. "live well now" is almost as eternal as "tastes great" vs. "less filling." Just my two cents worth, but building a custom house at age 30 is pretty ambitous. In my value system that's the kind of thing you do later in life. (Unless you're an Internet prodigy or a pro athelete.) Ditto for replacing a perfectly good used car with a new one.

So I'll support the consensus. Max out on the retirement accounts and put off those Viking appliances in the kitchen under construction. Houses are CONSUMPTION, not an investment.

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I agree with the layering approach in taxable accounts. Some money has a general purpose, and watching that general purpose account only return 1-2% before taxes is not a good way to get or stay rich.

When general purpose moves to specific purpose, I would strongly advise raising cash.

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I built a custom house at 27. It was fairly modest, about 1500 sq ft. (Just above median size for the time). It was just over 2x my annual income (also fairly modest). Just because it is custom does not mean it is extravagant.

The appliances were Kenmore.

Absolute truth, but not often told by the real estate industry.

-- Doug

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$15.5K is not the legal max that can be put into a 401K. I see this mistakenly stated in many places. That is the max that can be put in Pre-tax. The total limit for 2008 is $46K combined Employee/Employer.

This year, I will put in $23K, my generous employer matches with $23K, total of $46K goes in to 401K. The amount above the Pre-tax limit of $15.5K is taxed, but grows tax deferred, kind of like contributing to a non-deductible Traditional IRA, plus i get the 100% match.

While this is good to capture all the free money, it can lead to imbalance in the Retirement vs. Non-Retirement savings. Particularly if you plan to retire early, but can not touch the over-weighted "retirement" saving. There is Rule 72t, but that is a discussion for another day.

As an aside, every year i get a piece of these contributions (both mine and employer match) paid back to me out of the 401K because we fail the "fairness" test for HCEs. I am always amazed that people do not take advantage of 100% matching on 10% of income. It is like saying "No Thanks" to a 10% raise! I have jokingly advocated identifying those that do not max out enough to get all the matching, and firing them for excersizing such poor judgement. If they are making such bad financial decisions in their own lives, what kind of decisions are they making regarding company matters?

Best regards, Marco Polo

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"Marco Polo" wrote Re taking the match in 401(k) plans:

Fair point. I will raise you that management likes not having to match and likes even more having an automaton who just takes orders.

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My company started automatically enrolling new employees in the plan at a rate to capture full match. They can opt out, of course.

Brian

It's not as simple as that -- the match often allows that same management to contribute more to their own plans.

This is getting a little far afield for MIFP but it might help people understand why matching percentages are set where they are. 401k plans must pass "nondiscrimination tests," because the plans are supposed to benefit all employees, not just highly compensated ones. Tests look at contributions and balances among all employees, sorted by compensation levels. If only senior executives are contributing it will cause some problems -- perhaps some MIFP readers have encountered this, where they needed to undo a contribution.

By adopting a "safe harbor" 401k plan, an employer can avoid some of these tests. One safe harbor involves offer matching contributions of at least some minimal levels. So this is one reason a plan might offer "3% match on the first 3%," that's part of one of the safe harbor plans.

So to the OP -- in effect this is another benefit to the company for matching, it has to do with IRS rules about nondiscrimination testing and "safe harbor" 401k plans. Without the match the plan could be out of compliance, and the senior execs couldn't contribute as much.

-Tad

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"Default User" wrote E wrote

Automatic enrollment is up not because companies want to look out for their employees. It is up because of pressure from lawmakers.

Notable is that, at the start circa 1980, 401(k)s were intended only for executives. Then 401(k)s became all the rage because companies, suffering the capriciousness of pension budgeting, sought a cheaper way to offer retirement benefits to all. The main reason companies offer 401(k)s is, as has been stated repeatedly here, to stay competitive when hiring employees. Everything else is an afterthought. Tad's explanation denotes the same: If a corporation wants good upper management, then it has to offer a good retirement package, which means it has to follow laws (created for goodness sake not by companies but by Congress) to try to boost 401(k) bennies for lower income employees.

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