Saving With Purpose: Retirement Phase II

This is the fourth post in a series called Saving With Purpose: Living a More Intentional Financial Life. In this series, I plan to highlight a number of specific savings goals my family has identified we would like to achieve over the next few decades.

In the last series post we discussed ways to reach early retirement through a combination of taxable investments and retirement contributions that may be withdrawn before traditional retirement age. This post picks up where the other left off; we’ve now reached that golden age of 59 1/2 and may begin withdrawing from our traditional retirement plans.

Should we invest in both a Roth IRA and a 401(k)? Should I count on social security income, and if so, should we elect to receive early payments? What alternative investments can we make to fund retirement?

Forget Everything You Thought You Knew About Retirement

Our strategy for retirement is different from the more traditional idea of working somewhere 40 years, retiring, and drawing social security for the next two or three decades (hopefully). Our plans for retirement have been influenced by a shift in some of the long-held financial beliefs.

Things like a guaranteed 8% return in the markets may be soon be a distant memory. Sure, some years will be good and some bad, just as it always has. However, I suspect there will be more volatility and negative financial news than anyone my age remembers. So our plans have been molded by life experiences, the political climate, and even larger economic trends that have developed in our lifetimes. Our investments will be more conservative, and we will always lean to being “cash heavy,” because we value preparedness over the chance of hitting it big.

Maximize Roth IRA Contributions

Each year, my wife and I will contribute the maximum amount to a Roth IRA. I’m a big fan of the Roth IRA, for several reasons. First, the earnings in a Roth IRA grow tax free, and since you are using after-tax dollars, contributions can be withdrawn at any time, for any reason (making the Roth sort of a 2nd pseudo-emergency fund).

The Roth IRA also has no mandatory distribution age, meaning if you hit 59 1/2 and don’t want to tap your Roth IRA balance, you don’t have to. Traditional IRAs require distributions at age 70 1/2, meaning you could be forced to reduce the amount you leave to heirs thanks to mandatory distributions.

With about 27 years until we reach that 59 1/2 years-old threshold, my wife and I could save a large amount in our Roth IRAs, assuming we don’t tap contributions early to fund early retirement (something I mentioned as possibility in the last series post). Assuming a 6% average return on our $10,000 yearly investment, we would have nearly $700,000 in Roth IRA savings in 27 years.

Maximize 401(k) Contributions

In Adam’s recent post asking whether or not he should save for retirement or pay off debt, it seemed the consensus in the comments was Adam should contribute through his employer’s match, but use any remaining funds to reduce his debts. I agree; there is nothing like “free” money in the form of matching contributions.

However, there is a larger question here. After becoming debt free, should one continue to increase 401(k) contributions to the maximum yearly amount (currently $16,500), or should they invest that money elsewhere in a more diversified mix of asset classes (paid-for real estate, business ventures, etc.)? I don’t believe there is a right or wrong answer here. but it seems to me that if all you can afford to do is stretch to max out your 401(k), you may do better to spread that money around a bit. On the flip side, if you can afford to save above and beyond the yearly maximum, then you should first fund all tax-advantaged accounts, such as a 401(k).

What did we decide? After much deliberation, we decided to slash a few budget items and go after the max 401(k) contributions, recognizing we may not be able to do this every year going forward. Fortunately, we are now debt free, and through my blogging pursuits, we have what amounts to a second income. I recognize this does not work for everyone, and it certainly didn’t work for us until just recently. In fact, I haven’t even contributed to a 401(k) in the last few years while we whittled away debts and built emergency savings.

If we could find a way to continue maxing out 401(k) contributions until retirement age, we would have $1.1 million, assuming a 6% return. Add in Roth IRA contributions and growth, and we’re approaching $2 million. Of course, as I mentioned in my last post, this is not likely to happen because I want to move away from full-time employment in the next 12-15 years. If we kept up our goal of maxing 401(k) for just 15 years, we could still build a 401(k) nest egg of just over $400,000, and another $250,000 in Roth IRAs. Not bad at all.

Will We Receive a Return On Our Investment In Social Security?

In a word, no. I don’t believe we will. Put another way; don’t count on it. I personally believe social security as we know it today will not exist in another 15-20 years. It can’t, mathematically, as soon there will be many more people receiving benefits than paying in. That sort of upside down pyramid doesn’t work – just ask anyone associated with a failed Ponzi scheme.

Now, I am not as radically anti-social security as some. I just like the idea of controlling my own investment dollar, because I’m confident I can earn more than the U.S. government can. Enough of that, I’m not out to make a political statement. I am simply trying to reinforce the idea that people in their 20′s and 30′s should not expect to be able to live on social security in retirement.

If we do receive some form of payment from social security, just consider it a bonus, but certainly don’t count on it for financial survival. If the program is still solvent when I reach the age eligible to receive early payments, I’ll likely sign up. After all, nothing is guaranteed – neither my health or the continued viability of the program. Unfortunately, several people close to me paid in their whole lives and never received any benefits, or received very limited benefits through disability before dying young.

Alternative Investments for Retirement

In addition to the traditional types of investments I’ve listed here (and in earlier series posts), we are also interested in things like paid-for real estate. Specifically, we’d like to pay off our own home well before contemplating an early retirement. I have always thought living mortgage-debt free must be the ultimate in financial freedom.

Just imagine no credit card debt, no car payments, and no mortgage payments. Imagine the options available to someone in that position. Imagine the freedom they must feel with the only income requirement to earn enough to cover basic living expenses, and save for future ones. That’s it.

In addition to real estate, I will always have a side hustle or two going, and in the future may elect to invest more money to grow a current hustle, or develop a new one, without introducing too much risk into our lives. I started Frugal Dad over two years ago on less than $50, so it might be tough start something even more frugal!

In the final post in this series, we’ll look at one last topic: giving. Yes, part of our saving strategy is to give a lot away. I’ll share a few ideas I have on the subject, and as usual, try to put some specific numbers to our giving goals going forward.

Comments

  1. Our investments will be more conservative, and we will always lean to being “cash heavy,” because we value preparedness over the chance of hitting it big.

    I think you are making a bad choice, Jason. But I respect the fact that you are indeed making a choice, not just going along with the conventional “wisdom.” That’s certainly a step in the right direction.

    If you are not aware of the work of Zvi Bodie (it sounds to me as though you are) you should check him out. He advocates an approach much along the lines of what you describe (avoiding stocks in favor of certainty of investment results).

    My view is that your approach will pay off big-time over the next few years as the odds are high that we will be seeing at least one more huge stock crash. But once stocks get down to low price levels again (and they will — they always do!), stocks will offer a far better long-term value proposition than any other asset class out there.

    It greatly saddens me that most middle-class investors go along with what The Stock Selling Industry tells them and buy stocks heavily when they are selling at prices at which a good long-term return are just about zero and then respond to the devastating losses by moving out of stocks just when they are again selling at prices that pay out a long-term annualized return of 15 percent real or so. There’s obviously a small group of super-wealthy investors earning a return far in excess of the 6.5 percent real return that is the average for U.S. stocks when the vast majority of middle-class investors have locked themselves in to long-term stock returns far less than that by putting their faith in The Stock Selling Industry to shoot straight with them.

    I think you are making your path to financial freedom longer than it needs to be by ruling out the possibility of investing in stocks in an informed way (that is, ignoring the advice of the Stock Selling Industry to buy stocks at any price whatsoever, no matter how dangerous). But I also am confident that you are going to achieve your goals because of the determination and intelligence I see coming through in just about all of your posts. Best of luck with the path you have chosen!

    Rob

  2. “Just imagine no credit card debt, no car payments, and no mortgage payments.” Paying off our CC bills monthly, having paid cash for both cars, and having just paid off our mortgage, I must say it’s a wonderful feeling! It makes the cost of raising children a little more bearable…just have to start a 529 for them now ;-)

  3. As a parent of four college aged students. My frugal advice regarding kids and college.

    #1. Think of your retirement first!
    #2. Any college aged student who has ever called his folks for cash “with the sky is falling” only needs about 1/3 of what they are asking for.
    #3. Save some for them dole it out to them in tiny trickles know that regardless of how much you save for them it will never be enough.
    Let them try to figure out some of the financial stuff on their own (this is the only way they learn about the real world)
    #4.If you let them know after the first degree they are on their own they will waste less of your hard earned money.
    #5. I have watched many of my friends children select majors they can not get jobs with (only because the classes were easier) If they realize they are on their own after school I do mean right after school you would be surprised how many start thinking Engineer degrees look really great!
    Set some rules for college early on (like when your kid is 10 or 12 then you can not have nearly as many surprises)
    Also I started giving them Christmas gifts for their dorm rooms when they were 10 and 12 in this way they see themselves at college and they don’t mess around getting there. (another additonal cost many of my friends had to shell out for extra year of studies at getting the kids up to speed)

  4. We are also paying our house off early. I think that will give us more flexibility in the future, along with greatly decreasing the amount needed for our monthly living expenses. Unless we then decide to go rent a place in Kauai (which we might) that means we could in theory retire earlier on less money.

  5. Jason, it’s great to hear that you have a plan, which is key. However, I highly recommend that you revisit this plan at least every 6 months as your situation, goals and expectations will change.

    Good luck and I look forward to talking to you when we both retired early :)

  6. @MoneyNing: Absolutely, nothing here set in stone. I plan to revisit often and make tweaks along the way.

    @Jackie: Having a minimal amount of monthly bills seems to be the best way to get to an early retirement. After all, with no debt, it wouldn’t take much income to take care of our needs (and a few wants).

    @Janet: Excellent advice – particularly #4. It wasn’t until I returned to school paying my own way that I really took matriculation seriously. I declared a major, met with advisors and planned out every single semester to get me there in the most efficient way possible.

    @Rob: I am not shying away from stocks, even single stocks, in fact. I just meant that we will always have a “larger than normal” cash emergency fund because of the experiences we have been through. I don’t want too much tied up in investments, retirement or otherwise, that can lose significant value in a short time. That said, we plan to have more than a modest amount in both stocks and mutual funds. Thanks for your comments!

  7. First of all – great website!! But I had a quick question about the Roth IRA vs the 401K retirement investing options. I know that the Roth is funded by post tax dollars, the 401K by pre-tax dollars … but my question is which one should I put my money into if I can only afford to do one (no employer match)? I’d think the 401K would have more growth potential (investing a larger sum over the course of years with the benefit of compounding interest). Even with the tax upon withdrawal I’d think the earning potential would be larger than the Roth (less money going in since it’s after tax and hence less money growing over 20 or 30 years). Am I wrong? I certainly haven’t done the math and am in a position of having to choose either to fund a 401K or a Roth IRA. I’m a total novice at this whole personal finance thing and am trying to chronicle the learning process with my own blog http://thedebtmarch.wordpress.com/. Anyways, I am looking for the wisdom of folks that have much more knowledge on these subjects than I do. Again … great site you’ve got here!

  8. I agree that us young people will not see a dime out of Social Security. When the program was first started, there were something like twenty workers per person getting payments. Today, that is around four. Soon it will be less than that. It is a very wise decision to max out those IRAs and 401(k)s as young as possible.

  9. I disagree that SS will not be there for you. If it is not there for you- it will not be there for the millions who depend on it now. If it goes away, I think you will see a major restructure of the government (because old people vote)
    Saying that, I am preparing for the worst- with a decent flow into savings. I gave up on IRAs since we are so close(52/59). Does it really matter that stocks grow tax free- when you are still taxed at the end? I don’t want to be tied up in another government accounting program where taxes could be out of control.
    Sounding like a pessimist?
    Oh well, we saved so we can be that way;>0
    I have the house paid off- the question is will I be able to pay the taxes on the house in twenty years……
    Yowy- I bought enough land so the “kids” can always move back!

  10. Janette makes a good point about taxes. The big question mark I still have about Roth’s is: what if the govt decides to change tax law? The nice thing about traditional IRAs is you get your deduction now. True, Roths are supposed to be tax free at withdrawl time, but what’s to keep Congress from passing a new law to take that advantage away? Is the old ‘bird in the hand (tax deductible traditional IRA) worth two in the bush (Roth IRA tax free deductions years from now)’?
    I’m still sticking with the Roth for future contributions, but I’m not rolling over my traditional IRA anytime soon.
    I also believe SS will be around in some form for people in their 20′s and 30′s now, but the benefits will probably be greatly reduced or the age to qualify for benefits will increase, possibly up into the late 60′s early 70′s. It’s either that or taxes are going sky high.
    Another old saying: only two things are sure – death and taxes.
    I believe the best one can do is to take advantage to pay off debt as quickly as possible and stockpile enough cash to keep you liquid as the rules change. Stocks/mutual fund are still a best bet for most people. And if you’re feeling particularly ambitious, some income real estate is a great way to go, though certainly it takes a bit more ‘hands-on’ approach than setting up an automatic debit to your retirement account.

  11. My hubby and I (26 and 27 respectively) are also planning for early retirement. We are also not expecting to get much if anything from Social Security.

    If we’re wrong, woot! More cruises for us! If we’re right, I’ll be angry at being taken for 30 years, but we will have a nice retirement anyway.

    Our planning includes my husband’s pension from teaching, my 401k that is matched 100% up to 6%, a Roth IRA we started in 2008, a Roth IRA we’re starting this year, our Scottrade account, and several savings accounts for emergencies and regular expenses. We may also have a rental property as early as 2012.

    It just seems smarter to me to plan for the worst…we want to retire comfortably at age 52 whether the government comes through for us or not.

  12. Remember Crystal- teacher’s pensions are also a part of the government (unless he is a private school teacher).
    I know, both my husband’s and my pensions are dependent on a good government return!

  13. Couple thoughts:

    If long-term capital-gains taxes stay lower than expected retirement-time income taxes, there can be a real benefit to holding growth stocks in normal, taxable accounts. Awesome tax treatment for charitable giving, can borrow against them (margin), step-up basis for estates, etc.

    I doubt the government can renege on the tax-free nature of Roth IRAs completely, but they could “means-test” the tax-freeness or just enact a big VAT tax and have the last laugh on everyone who thought they were avoiding the IRS (this is my expectation).

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