Disclaimer is off to the right. I’m not a financial planner– I’m just sharing how I’m managing my money, not telling you how to manage yours. Everyone’s situation, needs, and goals are different!
Now, my goals are pretty aggressive– if you don’t know what FIRE is, it’s Financial Independence Retire Early. I’m trying to accumulate about $1.8m in liquid assets by age 50 so my life can be “work optional.” If it happens before that, I won’t be mad at it.
I’m a federal employee (married, no kids), and the benefits are pretty good. If you have a job with benefits, do your homework and make sure you’re not missing out on some major perks! Federal benefits are really good, but there are plenty of companies out there that offer benefits similar to these.
This is in order of priority, and this is the first year we’re maxing out so many accounts. It’s been a good year, and if you can only hit one or two of these, I think you’re still setting yourself up for success. It doesn’t need to be crazy intense at first, just do what you can!
- Thrift Savings Plan (TSP)/401(k) to the match. The TSP is essentially the federal employee’s 401(k). It’s pretty much the same thing. If your employer offers a match, and you’re not taking it, you’re missing out on free money. The way it works is you put money in (a dollar amount or % of your income), and your employer matches to a certain %. As an example, I’ll use the numbers I saw most in my private industry career:
- Your employer will match 100% of the first 3% of your salary that you contribute, and then 50% of the next 2%. WAT?
- Let’s use numbers. Let’s say you make $50,000 per year. If you contribute 3% ($1,500), your employer will also contribute $1,500. If you go up to the full 5% of your salary, that remaining 2% ($1,000) will be matched by your employer at 50% ($500).
- So you add $2,500 for the year (5%), and your employer will add $2,000 (full 3% = $1,500, half 2% = ($1,000*.5) = $500)
- So for the year, $4,500 gets put in that account.
- THEN YOU CAN PICK INVESTMENTS! TSPs, 401(k)s, and the like usually have a fairly limited selection, but it’s better than cash. Just make sure you look at the fees to make sure they’re not scraping away at your gains.
- Health Savings Account (HSA) to the maximum contribution limit ($3,600 individual/$7,200 family). This doesn’t make sense for everyone, and you shouldn’t feel bad about it if it doesn’t for you. If you have chronic illness, are more senior, or have kids that need lots of visits to the doctor, it might not be best for you. It works for us and has become one of my absolute favorite accounts for investing because of its triple tax benefit– but it does require your enrollment in a High Deductible Health Plan (HDHP). The HSA allows you to contribute pre-tax money to an account that you (usually) can invest in a variety of funds. Some companies will even kick in a contribution too (the government adds $150/month to my account!). The triple tax benefit that works like this:
- Money you contribute is pre-tax. This reduces your overall tax bill compared to what you make/keep overall.
- Money grows tax-free. You can usually invest the money in your HSA, and you’re not going to pay capital gains tax on it.
- When used for eligible medical expenses, IT IS NEVER TAXED. Think about this. Let’s say you and your spouse contribute the maximum each year (we’ll go with the 2021 max of $7,200/year) during your careers. Maybe you end up with $100,000 over the years from contributions and capital gains. Think about that— that could be a full year’s salary for the two of you that won’t ever get taxed, as long as it’s for eligible expenses.
We try not to use this account now to let it grow and plan to use it for medical expenses in our later years. If we’re healthy, we could also use it as a retirement account when we’re of age (we’ll just have to pay income tax on it).
3. Roth Individual Retirement Account (IRA) to the maximum contribution limit ($6,000). The Roth IRA has income limits, but we’re nowhere near them. We try to max mine out every year. My husband just opened one in March, and we contributed the full $6,000 maximum 2021 contribution…. and THEN, because it was before tax day, we we back and contributed another $6,000 for 2020. Don’t forget you can do this (and if you’re over 50, the contribution limits are higher)! Roth IRAs are great because they’re funded with after-tax money and grow tax-free. That means when you’re of eligible age, you take out money and pay no additional taxes. You can always take out amounts from the principal at any time (just not any gains you made).
4. TSP to the maximum contribution limit ($19,500). Coming back to the TSP (or 401(k)), once we filled up the Roth IRAs, I changed my paycheck contributions to my TSP so that I will meet the maximum contribution limit for 2021 by the end of the year. This applies to 401(k)s too. There’s no additional company match here, but since this is pre-tax money that I’m contributing, it reduces our tax bill now (we’ll pay income tax later when we’re of the age to live off the money). This is helpful if you’re a high income earner.
5. Individual brokerage account. We will live off of this account in the early years of retirement as we start working through the Roth conversion ladder (that’s more advanced, and I’ll cover it in the future). I also do some trading in here because I genuinely enjoy that. We will contribute pretty much all additional surplus funds, as long as our emergency fund is full and after we’ve added to our sinking funds. It’s funded with after-tax money, and is subject to capital gains tax. Not ideal, but it’s flexible, and I could see investments and take any money I need out of it pretty much at any time.
Bonus round! I also throw a few extra dollars at the mortgage principal when we have them. It’s nice to see that principal balance go down, but the list above takes priority because I can get a better rate of return in the market than I lose through mortgage interest. This is a really personal decision– I totally support either method as long as it’s getting you to your own goals!
How does your strategy compare? Have you started investing yet?
-K