Question: I am 25, with $75k of savings in a money market account. I have $30k in my 401k through work. I have ~5K in debt, in the form of in interest free medical bills I am paying monthly on. My gross income is $94k. I have been reading through the guides on r/personalfinance, and was hoping for some more personalized advice:
Regarding 401K, I currently have 15% contributions split 8% to pre tax and 7% to Roth. Based on what I've been reading, it seems I should stop contributing to the Roth 401K and instead open an IRA. Is that advisable?
Regarding savings, I currently live in an apartment. Next July when my lease is up, my thought was to put a down payment on a house. I believe a house would be a good investment, but is there something I could/should be doing with my savings in the meantime? Should I instead look at continuing to rent at that time and (saving an emergency fund) go ahead invest what I currently have saved?
If I buy a house, saving an emergency fund, should the down payment be the remainder of the savings? Should I make a smaller down payment and invest that in something like index funds?
Answer:
Personalized Financial Planning Advice for Your Retirement and Savings Goals
Hello! It's great to see you're taking proactive steps toward understanding your financial situation and planning for the future. Let's address your questions one by one to help you make informed decisions.
1. 401(k) Contributions vs. Opening an IRA
Current Situation: – 401(k) Contributions: You're contributing 15% of your salary, split as 8% pre-tax (traditional) and 7% Roth. – Goal: Considering stopping Roth 401(k) contributions to open an IRA.
Considerations:
a. Employer-Sponsored Retirement Plans vs. IRAs – Contribution Limits: – 401(k): For 2023, you can contribute up to $22,500 if you're under 50. – IRA: The annual limit is $6,500 if you're under 50. – Employer Match: – Ensure you're contributing enough to your 401(k) to receive the full employer match, as this is essentially free money. – Investment Options: – 401(k): Limited to the plan's offerings. – IRA: Typically offers a broader range of investment choices.
b. Roth vs. Traditional Contributions – Tax Now vs. Tax Later: – Traditional 401(k): Contributions are pre-tax, reducing your taxable income now but taxed upon withdrawal in retirement. – Roth 401(k)/IRA: Contributions are made with after-tax dollars, but withdrawals in retirement are tax-free. – Current Tax Bracket: – With a gross income of $94,000, you are in the 22% federal tax bracket (for single filers in 2023). If you expect to be in a higher tax bracket in retirement, Roth contributions might be advantageous.
Recommendations:
- Maximize 401(k) Contributions:
- If you're not already hitting the annual limit, consider increasing your 401(k) contributions before opening an IRA.
- Evaluate Tax Diversification:
- Having both Roth and traditional accounts provides tax flexibility in retirement.
- Consider Opening an IRA:
- If you wish to diversify your investments or have more control, an IRA could be beneficial.
- Roth IRA Eligibility:
- For single filers in 2023, the ability to contribute to a Roth IRA starts to phase out at a modified adjusted gross income (MAGI) of $138,000.
- If eligible, a Roth IRA could complement your retirement strategy.
Action Steps:
- Review Employer Match: Ensure you're contributing enough to get the full match.
- Assess Contribution Levels: Decide if you can increase your total retirement contributions.
- Research IRA Options: If you choose to open an IRA, compare providers for fees and investment options.
- Consult a Tax Professional: For personalized advice on tax implications.
2. Utilizing Savings and Deciding on Homeownership
Current Situation: – Savings: $75,000 in a money market account. – Goal: Considering buying a house next July or continuing to rent and investing savings.
Considerations:
a. Emergency Fund: – Recommendation: Maintain 3-6 months of living expenses in an easily accessible account. – Purpose: Covers unexpected expenses like medical bills, car repairs, or job loss.
b. Homeownership Pros and Cons:
Pros: – Equity Building: Each mortgage payment increases your ownership in the property. – Stability: Long-term housing stability and the ability to personalize your living space. – Potential Appreciation: Property values may increase over time.
Cons: – Upfront Costs: Down payment, closing costs, moving expenses, and potential renovations. – Ongoing Expenses: Property taxes, insurance, maintenance, and repairs. – Less Flexibility: Harder to relocate compared to renting.
c. Investing Savings:
- Time Horizon:
- Short-Term Goals (<5 years): Keep funds in safe, liquid accounts like high-yield savings or CDs.
- Long-Term Goals (>5 years): Investing in index funds or other equities may be appropriate.
- Risk Tolerance:
- Investing in the stock market carries risk; funds needed in the near future shouldn't be exposed to market volatility.
Recommendations:
- If Planning to Buy Next Year:
- Keep Savings Accessible: Maintain your savings in a safe, liquid account for the down payment and closing costs.
- Avoid High-Risk Investments: Market fluctuations could reduce your savings when you need them.
- If Considering Renting Longer:
- Assess Housing Market: Determine if delaying homeownership might offer financial advantages.
- Invest a Portion of Savings:
- After setting aside an emergency fund and any planned expenses, consider investing surplus funds with a long-term perspective.
Action Steps:
- Calculate Homeownership Costs:
- Estimate all expenses related to buying and maintaining a home.
- Review Your Budget:
- Ensure mortgage payments wouldn't strain your finances.
- Market Research:
- Investigate local real estate trends and forecasts.
- Consult a Financial Advisor:
- Get personalized advice on whether to buy now or invest and wait.
3. Determining the Down Payment Amount and Investment Options
Current Situation: – Down Payment Options: Using the majority of your savings or making a smaller down payment and investing the rest.
Considerations:
a. Larger Down Payment:
Pros: – Avoid Private Mortgage Insurance (PMI): – Putting down at least 20% eliminates the need for PMI, saving you money. – Lower Monthly Payments: – A larger down payment reduces the loan amount, decreasing monthly obligations. – Better Loan Terms: – May qualify for lower interest rates.
Cons: – Reduced Liquidity: – Ties up a significant portion of your cash in the property. – Less Available for Investments: – Opportunity cost of not investing that money elsewhere.
b. Smaller Down Payment with Investments:
Pros: – Maintain Liquidity: – Keeps cash available for emergencies or investment opportunities. – Potential Investment Growth: – Money invested in the market could yield higher returns over time.
Cons: – PMI Costs: – Required if down payment is less than 20%, increasing monthly expenses. – Market Risk: – Investments can lose value, especially in the short term. – Higher Monthly Payments: – A larger loan amount results in higher mortgage payments.
c. Balancing Both Approaches:
- Hybrid Strategy:
- Make a down payment that allows you to avoid PMI but retains some savings for investments and emergencies.
- Investment Diversification:
- If you choose to invest, consider a diversified portfolio to mitigate risk.
Recommendations:
- Aim for a 20% Down Payment:
- On a $300,000 home, that's $60,000, leaving you with $15,000 from your savings.
- Maintain an Emergency Fund:
- Ensure you have sufficient funds after the down payment for unexpected expenses.
- Be Cautious with Investments:
- If investing leftover funds, focus on long-term growth and avoid speculative assets.
Action Steps:
- Determine Home Price Range:
- Based on what you can afford while meeting the 20% down payment threshold.
- Consult a Mortgage Professional:
- Understand different loan options and their implications.
- Assess Investment Options:
- If investing, consider low-cost index funds or retirement accounts for long-term growth.
- Review Insurance Needs:
- Homeowners insurance, life insurance, and possibly disability insurance to protect your assets and income.
4. Additional Considerations for Early Retirement and Starting a Family
a. Early Retirement (Financial Independence Retire Early – FIRE):
- High Savings Rate:
- Requires a significant portion of income to be saved and invested.
- Investment Strategy:
- Focus on investments that offer long-term growth.
- Lifestyle Adjustments:
- May need to limit expenses and live frugally.
b. Starting a Family:
- Increased Expenses:
- Childcare, education, healthcare, and general living costs.
- Financial Planning:
- Consider starting a college savings plan (e.g., 529 plan).
- Insurance Coverage:
- Life and health insurance become even more critical.
c. Balancing Both Goals:
- Prioritize and Plan:
- Determine which goal is more important or how to achieve both over time.
- Flexible Strategies:
- You might adjust your early retirement age to accommodate family expenses.
- Income Growth:
- Focus on career development to increase earning potential.
Action Steps:
- Set Clear Financial Goals:
- Define what early retirement means to you and when you’d like to achieve it.
- Create a Comprehensive Financial Plan:
- Include retirement savings, housing, family planning, and emergency funds.
- Monitor and Adjust:
- Regularly review your financial plan and adjust as your situation changes.
Conclusion
You're in a strong financial position with significant savings and a good income at a young age. By carefully planning your retirement contributions, housing decisions, and investment strategies, you can set yourself up for long-term financial success.
Next Steps:
- Educate Yourself:
- Continue learning about personal finance through reputable sources.
- Stay Flexible:
- Life circumstances change, so be prepared to adapt your financial plan as needed.