How should I be saving for retirement?
October 14, 2013 8:11 AM Subscribe
As a lower income person, I feel like my retirement planning should be simple, but it still fills me with anxiety and uncertainty. Tell me what, if anything, I should be doing differently.
I don't want to bias the responses by being too specific about my concerns, but I worry that I should obviously be saving more, or handling my student loans differently--specifically, I wonder if favoring retirement savings over loan payments will bite me in the ass if, for instance, my income becomes too high to qualify for the IBR plan before I reach 25 years of payments (and forgiveness). Otherwise, if you were in my shoes, what would you change?
Facts:
1. I gross $27,000/year at my primary job, and can sometimes scrape together an extra $2,000 working part-time seasonal gigs. I get an annual cost-of-living adjustment of ~2% (but maybe not every year?), and I'm not eligible for other raises, or promotions.
2. I have $45,000 of student loans at 6.8%. They're all federal. I currently pay $165/month, which is the lowest possible payment under the IBR plan. Only about $150 per year goes toward the principal, so I am essentially only making interest payments.
3. I currently put 18% of my gross into a tax-deferred retirement account. My employer matches 3%. (And even this much, which is fairly painful, seems like a pitifully small amount.)
4. I'm in my mid-late 30s, and have approximately $11,000 in a couple of retirement accounts. Most of it is in the tax-deffered account provided by my employer, so I can't really do anything with the money without risking penalties.
5. I don't have more than a few hundred dollars of credit card debt at any time, but I occasionally owe $300-800 at 12%-16%. I only really carry a balance when an unexpected expense empties out my (small, $300-500) emergency fund.
6. The amount of money that actually makes it into my bank account (after taxes/health insurance/retirement) is <$19,000/year, so I don't have a lot of room to, for instance, make higher student loan payments without directly stealing from my retirement.
I don't want to bias the responses by being too specific about my concerns, but I worry that I should obviously be saving more, or handling my student loans differently--specifically, I wonder if favoring retirement savings over loan payments will bite me in the ass if, for instance, my income becomes too high to qualify for the IBR plan before I reach 25 years of payments (and forgiveness). Otherwise, if you were in my shoes, what would you change?
Facts:
1. I gross $27,000/year at my primary job, and can sometimes scrape together an extra $2,000 working part-time seasonal gigs. I get an annual cost-of-living adjustment of ~2% (but maybe not every year?), and I'm not eligible for other raises, or promotions.
2. I have $45,000 of student loans at 6.8%. They're all federal. I currently pay $165/month, which is the lowest possible payment under the IBR plan. Only about $150 per year goes toward the principal, so I am essentially only making interest payments.
3. I currently put 18% of my gross into a tax-deferred retirement account. My employer matches 3%. (And even this much, which is fairly painful, seems like a pitifully small amount.)
4. I'm in my mid-late 30s, and have approximately $11,000 in a couple of retirement accounts. Most of it is in the tax-deffered account provided by my employer, so I can't really do anything with the money without risking penalties.
5. I don't have more than a few hundred dollars of credit card debt at any time, but I occasionally owe $300-800 at 12%-16%. I only really carry a balance when an unexpected expense empties out my (small, $300-500) emergency fund.
6. The amount of money that actually makes it into my bank account (after taxes/health insurance/retirement) is <$19,000/year, so I don't have a lot of room to, for instance, make higher student loan payments without directly stealing from my retirement.
I would only put up to my employer's match amount into my employer's fund. You can put the rest in a Roth IRA or your own IRA and make your own decisions about what fund in which to invest.
But first make more aggressive payments to your student loan debt. Also, look for a higher paying job!
If you have no hope of getting raises that will elevate your wages, then you'll never get ahead. you take a low paying job if you can AFFORD it. Or to get experience.
But you can't afford to keep this job. You can't.
I think that once you've contributed your employer match, you should put all the rest of your money toward your student loan debt. Once it's gone, you'll no longer have anything to worry about!
But really dude, you need a new job. You can't afford this one.
posted by Ruthless Bunny at 8:37 AM on October 14, 2013 [4 favorites]
But first make more aggressive payments to your student loan debt. Also, look for a higher paying job!
If you have no hope of getting raises that will elevate your wages, then you'll never get ahead. you take a low paying job if you can AFFORD it. Or to get experience.
But you can't afford to keep this job. You can't.
I think that once you've contributed your employer match, you should put all the rest of your money toward your student loan debt. Once it's gone, you'll no longer have anything to worry about!
But really dude, you need a new job. You can't afford this one.
posted by Ruthless Bunny at 8:37 AM on October 14, 2013 [4 favorites]
I agree with Ruthless Bunny that at this point, you should only be putting in what your employer will match for your company's 401(k). With your income and the student loans hanging over your head, I would concentrate on eliminating those loans first, and then start putting more money into your retirement account.
Also, use some of what you're not adding to your 401(k) after making this change to beef up your emergency fund. You should have a bigger buffer than the few hundred bucks you currently have in there.
posted by xingcat at 8:42 AM on October 14, 2013 [5 favorites]
Also, use some of what you're not adding to your 401(k) after making this change to beef up your emergency fund. You should have a bigger buffer than the few hundred bucks you currently have in there.
posted by xingcat at 8:42 AM on October 14, 2013 [5 favorites]
I would only put up to my employer's match amount into my employer's fund. You can put the rest in a Roth IRA or your own IRA and make your own decisions about what fund in which to invest.
Double check this - I put this question to my CPA the other day and was told in no uncertain terms that just the fact that I was contributing to a 401K (Roth 401K) meant I could not contribute to any other IRA fund this fiscal year.
posted by tilde at 8:57 AM on October 14, 2013
Double check this - I put this question to my CPA the other day and was told in no uncertain terms that just the fact that I was contributing to a 401K (Roth 401K) meant I could not contribute to any other IRA fund this fiscal year.
posted by tilde at 8:57 AM on October 14, 2013
That seems like a high interest rate for student loans. Are they consolidated? Have you considered consolidating? How many years into the IBR are you? What happens if you pay the IBR for 20 years and then bump out because of salary - do you still not get any forgiveness? Because I really don't see any reason to increase paying student loans unless you think you're going to suddenly make so much that you don't qualify for IBR.
I would either keep doing what you're doing (because the 401K is automatic and you're not likely to touch it), or switch to a Roth (which to my understanding you can remove principle from if necessary without penalty. So it could serve as an emergency fund in a pinch).
posted by dpx.mfx at 9:18 AM on October 14, 2013
I would either keep doing what you're doing (because the 401K is automatic and you're not likely to touch it), or switch to a Roth (which to my understanding you can remove principle from if necessary without penalty. So it could serve as an emergency fund in a pinch).
posted by dpx.mfx at 9:18 AM on October 14, 2013
Tilde, your CPA is, in no uncertain terms, wrong. See this IRS FAQ page. At certain income levels, there are limits to the deductibility of a contribution to a traditional IRA, and above certain income levels, a Roth IRA is not available directly (but there are no limits to conversions, so there are "backdoor" contributions some make). These limitations are available through that FAQ link.
OP--is it possible to consolidate those federal loans to get a lower rate than 6.8%? I'm not on any sort of IBR plan, and I'm paying 1.8% or so on my consolidated loans, and my wife is paying 3.8% on hers. You might be able to chip away at the principal that way. Good luck--it sounds like you're doing a hell of a lot with limited resources.
I am not anyone's financial, tax, or legal advisor. Anyone reading this should consult their own financial, tax, or legal advisors for advice specific to their situation.
posted by Admiral Haddock at 9:36 AM on October 14, 2013 [1 favorite]
OP--is it possible to consolidate those federal loans to get a lower rate than 6.8%? I'm not on any sort of IBR plan, and I'm paying 1.8% or so on my consolidated loans, and my wife is paying 3.8% on hers. You might be able to chip away at the principal that way. Good luck--it sounds like you're doing a hell of a lot with limited resources.
I am not anyone's financial, tax, or legal advisor. Anyone reading this should consult their own financial, tax, or legal advisors for advice specific to their situation.
posted by Admiral Haddock at 9:36 AM on October 14, 2013 [1 favorite]
tilde, you might need a new CPA, or maybe there was a misunderstanding. You can contribute to a Roth 401k and a Roth IRA at the same time. However, if the OP has a Roth 401k, unless the investment options are bad I don't know that it would be worth starting a Roth IRA as well.
On preview, agreed with the esteemed Admiral.
posted by treehorn+bunny at 9:37 AM on October 14, 2013
On preview, agreed with the esteemed Admiral.
posted by treehorn+bunny at 9:37 AM on October 14, 2013
OP, just wanted to add, one rule of thumb on emergency funds is that it's a good idea to have 2 to 6 months of expenses in there in case you lose your job. If you're emptying yours out on a semi-routine basis and carrying a balance on your credit card at 12-16%, you're wasting money and you definitely need more than that saved up. What good is putting an extra $100 into retirement or loan payments (getting either 6.8% on the loan payments or maybe 5-10% on the retirement savings) if you've got money losing 12-16% on your credit card balance?
Also wanted to applaud you for taking your financial situation and retirement seriously. Good for you!
posted by treehorn+bunny at 9:43 AM on October 14, 2013 [1 favorite]
Also wanted to applaud you for taking your financial situation and retirement seriously. Good for you!
posted by treehorn+bunny at 9:43 AM on October 14, 2013 [1 favorite]
You seem to be doing fine, based on the "save 20% of your salary" rule. In fact you seem to be saving too much... Lower your contribution to 15% and take the extra 3% and throw it on your debt, first pay off the high interest credit and then add an extra $100.00 /month to the student loan. If you keep these proportions as your salary increases you'll be way ahead of most people.
posted by Gungho at 9:59 AM on October 14, 2013
posted by Gungho at 9:59 AM on October 14, 2013
Is your retirement fund paying you more than 6.8% interest? If no, then you should be working on your student loans aggressively until they're gone.
posted by corn_bread at 10:00 AM on October 14, 2013 [1 favorite]
posted by corn_bread at 10:00 AM on October 14, 2013 [1 favorite]
Nthing the suggestion to drop your retirement contributions down to just the match. I would then take the extra money and first get at least $1K into an emergency fund (while making the minimum payments on your credit card and student loan). Then, get rid of the credit card debt, and then, start paying down that loan. The sooner you can get rid of that, the better. I also have debt at 6.8% and choose to put my extra income towards that rather than put money in retirement. After all - it is a guaranteed 6.8% return, which you cannot always get from the market.
posted by emily37 at 11:38 AM on October 14, 2013
posted by emily37 at 11:38 AM on October 14, 2013
Mod note: This is a followup from the asker.
You can put the rest in a Roth IRA or your own IRA and make your own decisions about what fund in which to invest.posted by cortex (staff) at 2:37 PM on October 14, 2013
How is this better than selecting investments through my employer's account (Vanguard, for what it's worth)? I don't feel like I know enough about investing to do anything other than cost myself money in the long run, and I don't really have much to play with anyway. Remember that I'm only saving $4800/year.
Is your retirement fund paying you more than 6.8% interest? If no, then you should be working on your student loans aggressively until they're gone.
It is, but historically only by 1% (maybe 2% or 3% in the short term), and I have no idea if I can expect it to keep even that that up in the long run. Since I'm young-ish I have a fairly aggressive (pre-selected) portfolio--one of those "target 2050" funds), so I imagine that as the mix shifts the return will drop over the long run.
But first make more aggressive payments to your student loan debt [...] I agree with Ruthless Bunny that at this point, you should only be putting in what your employer will match for your company's 401(k). With your income and the student loans hanging over your head, I would concentrate on eliminating those loans first, and then start putting more money into your retirement account.
What happens if you pay the IBR for 20 years and then bump out because of salary - do you still not get any forgiveness? Because I really don't see any reason to increase paying student loans unless you think you're going to suddenly make so much that you don't qualify for IBR.
well, that's kind of my question. Actually making a run at paying them off on the original 10 year schedule would mean diverting 100% of what I'm saving for retirement to the loans for a decade, and then starting to save for retirement at 46. Even paying them off in 25 years (rather than counting on forgiveness) would mean stealing a significant amount of money from my retirement savings (maybe 40-50%). How can I determine the optimal speed with which to pay them off? At what income will I become ineligible for IBR (How does/will inflation affect this--how can I anticipate what it will be in, for instance, 2028, 6 years or so before I've made 25 years of payments?), and when I do, do I become liable for the full amount remaining? Is the IBR forgiveness just a red herring?
To those stressing that I should handle he consumer debt: I usually don't carry much of a balance. Right now I'm not carrying a balance at all--that paragraph was intended to say that I actually don't generally overuse consumer debt, and pay it off fairly quickly when I do.
To answer your update:
The standard advice about '401K to the match, then choose your own investments in a Roth IRA' is good advice if your 401K plan is bad (high fees, not enough choices) or if you want tax diversification (if you want some of your money to be tax-deferred at retirement age and some of your money to be tax-free). Unless you're expecting to be in a much higher tax bracket when you actually take that money out, I don't think it's necessary for your circumstances.
A Roth IRA does have certain advantages over a 401(k) (you can take out the principal without penalties/taxes in certain circumstances, such as buying a home; everything is tax-free when you start making withdrawals at retirement age) so it might be worth looking into, but it's certainly not something you have to do.
Saving 18% of your income is great! It looks to me like you're doing everything more or less right, just keep at it.
posted by matcha action at 7:11 PM on October 14, 2013
The standard advice about '401K to the match, then choose your own investments in a Roth IRA' is good advice if your 401K plan is bad (high fees, not enough choices) or if you want tax diversification (if you want some of your money to be tax-deferred at retirement age and some of your money to be tax-free). Unless you're expecting to be in a much higher tax bracket when you actually take that money out, I don't think it's necessary for your circumstances.
A Roth IRA does have certain advantages over a 401(k) (you can take out the principal without penalties/taxes in certain circumstances, such as buying a home; everything is tax-free when you start making withdrawals at retirement age) so it might be worth looking into, but it's certainly not something you have to do.
Saving 18% of your income is great! It looks to me like you're doing everything more or less right, just keep at it.
posted by matcha action at 7:11 PM on October 14, 2013
I have never understood the internet's obsession with paying off student loans early. Sure, paying interest stinks, but that's the price you pay! Sacrificing 40-50% of your retirement savings to pay off an unsecured loan early? I think that would be incredibly foolish. You can't borrow money to fund your retirement!
posted by ThePinkSuperhero at 7:49 AM on October 15, 2013 [1 favorite]
posted by ThePinkSuperhero at 7:49 AM on October 15, 2013 [1 favorite]
@ThePinkSuperhero: it is illogical to carry a large amount of debt with a high interest rate if you can't get your money into savings/retirement funding that beats that interest rate. TLDR: it is illogical to carry a large amount of debt.
posted by corn_bread at 9:01 AM on October 15, 2013
posted by corn_bread at 9:01 AM on October 15, 2013
But personal finance is about more than making logical decisions based on interest rates and such. Sure, it might make more sense from a purely financial perspective to pay off high interst loans before you start putting money in a low yielding savings account for an emergency fund, but there's a psychological aspect to it as well. I am personally currently aggressively putting money into a savings account to build up my emergency fund instead of making big payments towards my debt. But that's because having an emergency cushion is super important to me, I know I can get something good built up within six months or so and then I'll turn towards my debt. This is going to be different for every person.
The one thing I will say is that the time value of money is a real thing that you shouldn't discount. This page gives a good illustration but basically putting away a small amount of money earlier almost always trumps putting away a larger amount of money later. This is due to the magic of compounding.
The last thing is if you're unsure about which funds to use or whether to put more in a a Roth IRA or a 401k, there are a couple of variables to consider. Matcha action covers it above but 401k contributions are from pre-tax income and Roth contributions are from post-tax income. So when you take money from your 401k it will be taxed as income and when you take it from a Roth, it won't. There are lots of considerations but I think it's good to have a mix of both in most cases.
And I know a lot of 401ks have crappy investment choices but this isn't universal. If you don't want to think about or pay much attention to your investments, probably the best choice is to put them in low-fee index funds or ETFs. If you have these options in your 401k (as I do, and I'm guessing you do too, if your employer uses Vanguard), then just pick a US total stock market fund, a broad international fund, a bond fund and if you feel like being a little more specialized maybe a real estate fund or emerging markets fund (or whatever else you like). There are lots of tools out there to help you determine what would be a good asset allocation mix for your circumstances. Beyond that, look at every fund you use and find the annual charges, i.e. the expense ratio. If you're using index funds, this should be very low - like 50 basis points (0.50%) or less. I just took a quick look at my index funds and they ranged from 0.13% to 0.28%.
Good luck, feel free to message me with any questions.
posted by young sister beacon at 6:49 AM on October 18, 2013
The one thing I will say is that the time value of money is a real thing that you shouldn't discount. This page gives a good illustration but basically putting away a small amount of money earlier almost always trumps putting away a larger amount of money later. This is due to the magic of compounding.
The last thing is if you're unsure about which funds to use or whether to put more in a a Roth IRA or a 401k, there are a couple of variables to consider. Matcha action covers it above but 401k contributions are from pre-tax income and Roth contributions are from post-tax income. So when you take money from your 401k it will be taxed as income and when you take it from a Roth, it won't. There are lots of considerations but I think it's good to have a mix of both in most cases.
And I know a lot of 401ks have crappy investment choices but this isn't universal. If you don't want to think about or pay much attention to your investments, probably the best choice is to put them in low-fee index funds or ETFs. If you have these options in your 401k (as I do, and I'm guessing you do too, if your employer uses Vanguard), then just pick a US total stock market fund, a broad international fund, a bond fund and if you feel like being a little more specialized maybe a real estate fund or emerging markets fund (or whatever else you like). There are lots of tools out there to help you determine what would be a good asset allocation mix for your circumstances. Beyond that, look at every fund you use and find the annual charges, i.e. the expense ratio. If you're using index funds, this should be very low - like 50 basis points (0.50%) or less. I just took a quick look at my index funds and they ranged from 0.13% to 0.28%.
Good luck, feel free to message me with any questions.
posted by young sister beacon at 6:49 AM on October 18, 2013
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posted by ThePinkSuperhero at 8:20 AM on October 14, 2013 [3 favorites]