How should I invest for retirement?
December 2, 2008 4:11 PM   Subscribe

I am trying to figure out how to invest money for retirement and otherwise. I am in my late 20s, earn $55,000 annually, have no debt, and about $90,000 in savings. I am currently putting 5% of my salary into a 403(b) which is the maximum amount my employer will match.

I know I should put about $20,000 into an emergency fund. I will probably leave my current city in 3-5 years. At that point I am likely to need to buy a car so I plan to keep another $20,000 in savings. That leaves $50,000. I saw an adviser from Vanguard who said that if I wanted to invest that money the best thing to do would be to max out a Roth IRA account, and then max out my 403(b) contribution and get money for living expenses out of the savings until the amount decreases. This also means I will get some dollar cost averaging through the periodic extra contribution.

The other thing to consider is that when I move I might want to buy a house, and if the money is all locked away in tax-free retirement accounts I may not be able to get to it for a down payment, or only with tax penalties. Knowing this, is it a better idea to invest the money through something

Anonymous because I don't want everyone to know how much money I make or have saved. You can write me at momoney.moproblems.08 on gmail.
posted by anonymous to Work & Money (11 answers total) 5 users marked this as a favorite
You can withdraw your principal from a Roth IRA with no penalty. So maxing out the Roth makes sense.

It sounds like your AGI is low enough that you may also be eligible to contribute to a traditional IRA, which has the advantage of allowing penalty-free withdrawals of up to 10k for down payment on a first time purchase. It may be better to contribute to that before maxing out the 403(b).
posted by phoenixy at 4:30 PM on December 2, 2008

Er, first time home purchase.
posted by phoenixy at 4:30 PM on December 2, 2008

I would disagree slightly with phoenixy- I would always max out the employer 401/403 plan if they offer any matching. Whatever their match is is free money to you. Do they match 25%? That means the money you put in this year automatically grew 25%, right off the bat. That ain't bad.

Also, it's the Roth IRA that has income eligibility limits, not the traditional one.

My advice- load up your retirement accounts as fast as you can as early as you can, especially the ones with extra benefits (tax free, matching).

1 - You have the "spare" money now, let it work for you. Time value of money, etc.

2 - As you get older and (hopefully) make more money, you will have less access to put money into these privileged accounts and you'll be stuck having to use more traditional retirement vehicles. That other money will continue to grow.

3 - I don't know which plans do this, but phoenixy is correct in that some retirement plans have provisions for withdrawing money for home purchases. Investigate this, and load those ones up.

4 - I'm not sure I understand or agree with using savings to live off of. If they can show how it's advantageous, go for it. But if I was in that situation, I'd use that $90k as my own source of "reverse credit". When you need to buy a car, yes, use that cash to do it. But also plan for and feed into that account enough money so that when its time to buy another car, you have paid yourself back for that first car "loan". Always make sure that savings is growing over the long term. I suppose there must be a calculation for how much cash is too much, but it never hurts to have a little extra. Maybe you could convert some of that cash to something else and earn a little more, but you pay for that in losing liquidity. It would hurt pretty bad to have to pay 5% interest on a car loan so you could make a few extra points on the retirement account.

5 - You are in an excellent position for the future, congratulations! I wish I had these kinds of problems...

6 - (General, generic advice- Remember that when you buy your house, it's not an investment like gold or stocks. The investment that a house is is that when you pay it off, you have a free place to live. Pulling money out of a house is no different from carrying a credit card balance, except that it's potentially a cheaper way of borrowing. All these people who refi'd their houses 5 years ago to buy new cars are strarting to feel the hurt- they are realizing that they, in effect, are paying for their cars at 6% over 30 years, instead of the 1.9% for 5 year loan they "paid off"...
posted by gjc at 5:07 PM on December 2, 2008

one small thing regarding buying a house...

its always better to have the least expensive house on the most expensive lot than the most expensive house on the least expensive lot.

land holds value quite well, very rarely is someone going to buy land to move the house - people will however (quite often) buy a lot, tear down the house and build a new one there. (and now is a good time to invest in land for what thats worth)

and if your employer matches, then you should def be contributing to that - whatever it may be

for what its worth my father has been a builder/developer for the last 30+ years and i work in the building industry as well...
posted by knockoutking at 5:21 PM on December 2, 2008

I'm not sure what the adviser meant as far as getting money for living expenses out of your savings; after all you appear to be cash-flow-positive.

Roths you can take out up to 10k for a home-mortgage too, I think that's no different from the traditional IRA. (I actually didn't know you could with a traditional one.)

But if I were you, I would not put money in a traditional IRA, I'd put it in a Roth. Why? Well, Roth you pay taxes on the money now. Traditional is tax-deferred; you pay taxes when you take it out (in 4 decades when you retire). I think it's a safe bet that your personal tax rate is lower now that it will be in 4 decades. Both forms have early withdrawal penalties.

I think Roth maximum contribution is 5k/year for your income and age, so that will take time for you to contribute a significant part of your savings. I think that amount is set to change for next year though.

The market, you may have noticed, is currently rather volatile. There's nothing wrong with holding on to some extra cash especially if you're planning a huge purchase (house) in the near term.
posted by nat at 5:57 PM on December 2, 2008

Yes, use a Roth. As a beginning wage earner, you will retire (almost certainly) in a higher tax bracket than you are in now, meaning you'll save by paying the taxes now rather than later.

Next: max it out. 15.5% I believe is the current limit. I know that sounds painful, but do it. Really. I mean it.

I wouldn't even consider buying a house, unless you were already maxed out in your tax-sheltered retirement fund. You can always use it towards the purchase of your first house (although I strongly advise against that!), so it doesn't even preclude doing both, as long as you max out your retirement fund first.
posted by IAmBroom at 7:00 PM on December 2, 2008

Max out the 401k/403b plan for now, and I don't just mean "get all of the employer match". I mean MAX IT OUT, which is probably a 15% contribution. You need to get more money in there sooner, especially in this depressed economic cycle. You can afford to do that AND the other savings options discussed above.
posted by intermod at 7:21 PM on December 2, 2008

Nthing to max out your contributions to the 403b. Do it now while you can afford it, while you are young (so the money works for longer) and while the stock market is in a state where its good to be buying. If you decide to buy a house at some point in the future you can always ease back on the contributions, but right now, maxing out makes so much sense for you.
posted by Joh at 8:08 PM on December 2, 2008

gjc--the traditional IRA has income eligibility limits if you also have access to a employer-sponsored retirement savings fund, which the OP does. In fact, the limits are much lower than for a Roth (phase out starts somewhere in the 50-60k salary range, versus around 100k for a Roth). Also, the OP has indicated that he is already maxing out the matching portion of the contribution--many employers with a retirement savings plan match will not match on the entire contribution.
posted by phoenixy at 6:12 AM on December 3, 2008

Depends on when you want to retire!

You don't have to work once all your living expenses can be covered by about 4% of your income generating assets (on average you can make about 7% return, you lose 3% for inflation, so if you take 4% out per year your capital stays the same value in real dollars.) Van Tharp has a good section in his excellent book about it. If you cut down your living expenses you will be amazed at how little money you actually need to not have to go to work!

Once you can do that you don't HAVE to work - you can do what you want, take a year out, live in another country. Why wait until you are 65 to do what you want? And if you contract for a few months of the year you can do it on even less.

I don't live in the US so I have no idea what a Roth or 401/3 is - but most of those schemes do not allow you to get to your money until you are 60-65. You could be dead by then. I am all for placing a large amount in there (and getting the maximum employer matching sounds like a good idea and it acts as a fall-back plan,) but I would put most of my money into assets that you have control over, and retire (or take mini breaks) when you want to.

You should have an even spread of property, cash/bonds, and shares. And re-distribute it evenly every 6-12 months.

Good luck.

Oh, and don't get divorced. It really stuffs the retirement planning!
posted by lamby at 9:00 AM on December 3, 2008

phoenixy: the traditional IRA has income eligibility limits if you also have access to a employer-sponsored retirement savings fund, which the OP does.

All earners are eligible for a traditional IRA regardless of income or employer sponsored plan. The income limits and employer plan only determine whether the contribution is tax deductible. However, in most cases a Roth IRA is preferable to a non-deductible traditional IRA.
posted by JackFlash at 9:16 AM on December 3, 2008

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