This year I want to drastically save and invest more money. Since I began working at my company, I’ve only contributed the minimum to my 401k plan to get my company match. My husband has also only contributed the minimum amount to his retirement plan. We already have no credit card debt (while most spending is done on our credit cards, it’s paid off in full every month), own our cars outright and have a healthy cash emergency fund. But if we want to reach financial independence sooner rather than later we need to ramp up our savings/investing plan right away.
Here are our saving & investing goals for 2016 (I won’t get too specific on the concepts; rather this will be a general guide):
Step 1- Max Out My Retirement Plan – $18,000
If you are lucky enough to work for a company that allows you to invest pre-tax dollars into a retirement account, take advantage of it! Especially if they will give you a company match %. Basically, they are giving you free money just for investing in your own future. For example, my company matches up to 4% as long as I contribute a minimum of 5% of my gross pay to the company 401k plan. The more pre-tax money you invest, the fewer taxes you have to pay. Tax avoidance is crucial, especially for middle to high-income earners. Once you reach a certain threshold, the government will tax you more and the less take home pay you will receive. Why give the government your money in taxes when you can take it and invest in your future? The caveat here is, while you put your money away pre-tax, the money will be taxed when you begin to withdraw it in retirement.
For those of you who don’t have access to a pre-tax retirement account through your job, you can invest in a Traditional IRA. It acts the same way as a company 401k Plan but can be done at individual investment companies.
Step 2- Max Husband’s 457 Plan – $18,000
My husband is a teacher and has access to a 403B plan AND a 457 Plan. Both plans are like my 401K plan I described above. He gets to put money away pre-tax before the government can take any of it. The 457 Plan is usually only offered to government employees and is more beneficial to a 403B or 401K plan if you decide to leave your job early (hint: early retirement). In the case of a 457 plan, you can begin to take withdrawals from the account without penalty at any age once you leave the job, whereas, for the 403B and 401K plans, you have to wait until your 59 ½ to withdraw without penalty.
Ideally, I would love to be able to contribute to both the 457 & 403B Plan in order to save more on taxes. Right now, we have decided to focus on fully funding the 457 Plan going forward and if our budget permits in the future, contribute to the 403B plan.
Step 3- Fully Fund My Back Door Roth (for 2015) – $5,500
A Backdoor Roth is a method for contributing to a Roth IRA if your income level exceeds the contribution limit to a Roth IRA. Our plan here is to diversify our retirement income by having streams of taxed income (401k, 403B, 457 Plans) and non-taxed income (Roth IRA accounts).
You fund a Roth IRA with money that is already taxed. For example, your take home pay is $1,200 after taxes, you take $300 of that and put it in a Roth IRA. Since the money you are putting in your Roth IRA is already taxed you won’t get taxed on in when you withdraw it in the future.
Also, the principal portion (the amount you put in) in the Roth IRA can be withdrawn for any purpose at any time without paying a penalty or taxes. Earnings (the return on your principal amount) can only be withdrawn without taxes and penalty until retirement (59 ½). This makes the Roth IRA not only a great savings vehicle for early retirement but a great way to help pay for your children’s college expenses. I love having the option of being able to use the Roth IRA for college expenses in case the 529 Plans funds aren’t enough.
Step 4- Fully Fund Hubby’s Back Door Roth (for 2015) – $5,500
Ideally, I would love to fund one for myself and one for my husband every year going forward. This will be the first year I will attempt a Back Door Roth. We have until April 15th of the current year to contribute to the previous years limit. In our case, I will be taking some of my bonus received in March of this year to fully fund two 2015 Back Door Roth’s. I will document this process for you once I do it.
Step 5- Start/Contribute to kids 529 Plan – Up to $10,000 per year
With one child and another on the way, I would like to set aside money specifically for 529 plans for them. The principal portion can also always be withdrawn tax-free and penalty-free but the earnings must be spent toward qualified higher education expenses. Any leftover funds withdrawn after you are done paying for college will incur income tax and a 10% penalty.
Some people don’t like the restrictions of the 529 Plan because they don’t like the idea of their money being tied up if their child never goes to college or gets scholarships. However, you can still withdraw the principal amount without penalty should your child not need the money. Also, 529 Plans can be transferred from sibling to sibling or to other qualified family members.
Many 529 plans also offer state tax credits or deductions on contributions for residents who invest in their home state’s plan. In our state of NY, up to $10K can be deducted from New York State taxable income hence reducing the taxes you pay to the government. If our budget allows, I would like to contribute to the maximum of $10K per year.
Step 6- Start Index Investing
This is a brand new area for me. I never gave much thought to investing in the stock market, mutual funds, etc. because it seemed too complicated and confusing. However, I have been learning more and more about Index Investing and I am getting comfortable with the idea of diversifying my wealth portfolio by taking the plunge and investing in Index Funds. I will blog and document this process also. In the meantime, check out the following to learn along with me. The plan here is to invest on a monthly basis and as much as our budget allows.
Find More About Index Investing in this Stock Series from JL Colins
Step 7- Pay Extra Principal on Primary Mortgage
Ideally, I rather not have a mortgage once we retire and once the children are in college. Being mortgage free would drastically reduce our monthly expenses and allow us to cash flow other items (ex. college tuition). If we don’t make any extra payments on our mortgage, it will pay off in 2044, this means we would have a mortgage until we are 61. Yikes! While our interest rate is not bad, only 4.375%, I like the thought of not having a primary mortgage sooner rather than later. Depending on how things play out with our budget and how much we contribute to Step 6, I would like to start throwing some extra principal payments to the mortgage so that it can be paid off by our late 40’s to early 50’s.
It’s also important to mention that I do believe the home we live in is our forever home. Unless we win the lottery or our financial circumstances improve immensely, I don’t see a reason for us to move. Therefore, I am more comfortable with the idea of paying off the home more quickly and owning it outright.
How Will We Do It?
In 2015, our savings/investment rate was 15%. In 2016, I would like to reach a 44% savings/investment rate.
So how will I accomplish all these goals? Where will all this “extra” money come from in our budget since we will be saving and investing a lot more than we have in the past?
Well, the first thing is BUDGET BUDGET, BUDGET. I currently use the YNAB app (to be discussed in another post) and it has completely changed the way I look at our money. By cutting out the fluff and unnecessary spending, we should be able to accomplish all if not most of our 2016 goals. This is not to say we won’t be enjoying life in the meantime. Yes, there will be some sacrifices made but it can be done while living a fabulous life. We just have to prioritize what’s important to us. This is what I mean by the phrase “budget fab”.
Whew! I didn’t think this blog post would be so long and if you made it this far, thanks for sticking with it. Don’t be discouraged if some of these concepts are new or if you can’t save/invest as much as the numbers I posted above. Taking the little steps matter more than you think. Rome wasn’t built in a day and it’s nearly impossible to become a millionaire overnight.
P.S. My next blog post will go over how to calculate your savings/investment rate.