The Plan

This guide is laid out as a series of steps. You should start with the first step and only work your way to subsequent steps when you have completely finished the current step. For example, don’t start putting money into your 401k until you have established your emergency fund.

1) 3 month emergency fund

  • Figure out how much money you need to live 3 months and save that first. If you happen to lose your job or total your car or whatever, it is important to have some accessible money so that you are not forced to take on emergency debt at a high interest rate. This money should be put in a checking/savings account where it can be accessed immediately. I’m personally a fan of Ally Bank if you don’t have a bank you are happy with. Moving to an online bank can be slightly more inconvenient for a few things (certified checks, depositing some checks), but it allows you to get a real interest rate for your savings account. I like the combination of a local checking account and an online savings account that are connected.

2) 401k up to match

  • If your company has a 401k match, fund your 401k up to the match. This is free money. For every dollar you put in, you get an additional dollar. That is a 100% return rate. You will not beat that anywhere.

3) Pay off all debt with an interest rate greater than 4%

  • Start with the debt with the largest interest rate and move to the smallest interest rate. It is very important to not move on to any of the later steps until this is done.

4) 6 month emergency fund

  • This is a continuation of the 3 month emergency fund. You want to give yourself a little extra breathing room in case something catastrophic should happen.

5) Max out your HSA

  • An HSA is a health savings account. It was originally designed to help with health expenses for those with high-deductile plans, but many people have started to use them as retirement vehicles.
  • You can only contribute to this if you are in a high-deductible health plan (HDHP) and don’t have an FSA. If you are not currently in an HDHP or have an FSA, it may be worth considering changing that so that you can contribute to an HSA. There is no income limit.
  • We discussed earlier that there are pre-tax (Traditional) and post-tax (Roth) retirement vehicles. An HSA is actually both. Yes, that is as awesome as it sounds. You can use pre-tax money to fund it and when you take the money out you don’t have to pay taxes as long as it is for medical expenses. Now I can already hear you saying, “Yo, I’m healthy. I’m not going to need money for medical expenses”. You may be right, althought it is very likely that you will have some medical expenses in your life and this vehicle provides a great tax efficiency to pay for that.
  • The other great part about an HSA is that if you need to take money out from it after you are 65, you only need to pay normal income tax. In essence, the worst case scenario is that you HSA becomes a Traditional IRA. In the best case scenario, it becomes a tax-free haven for health expenses.
  • There are two ways to fund an HSA: through your company (if they offer it) or on your own. If you fund it through your company, you additionally won’t have to pay Social Security and Medicare tax on it. This is less interesting if your salary is above the Social Security max [1]. You want to make sure to look at options for investment with this. Some HSA options will act as just a holding bank instead of allowing you to put the money into the market. If that is the case, you are probably better funding an HSA on your own.
  • If you fund an HSA on your own, you will have to use post-tax money, but you will get the taxes back when you list the HSA at tax time. Go through HSA Bank and buy one of TD Ameritrade index funds.

6a) Max out your tax-advantaged accounts

  • People that plan to retire before 59 1/2 often fear ‘locking up’ too much money in retirement accouns that they won’t be able to touch. It is not true that you won’t be able to access this money. The two common ways to access this money penalty-free before that age are through a Roth IRA Conversion Ladder and 72t distributions. As a general rule, the amount of money you will save in taxes by utilizing tax-advantaged accounts is well worth the downsides associated with these methods.

  • I’m not going to tell you how much you should save because that is really a lifestyle choice for you to make.

  • Here is the quick math. The amount of time you will need to work until retirement depends on what percent of your income you can save. Assuming an inflation-adjusted 5% return and that you will be able to withdraw 4% per year in retirement, we can derive the following (assuming you just started saving):
    • If you can save 15%, you can retire in about 45 years.
    • If you can save 30%, you can retire in about 30 years.
    • If you can save 40%, you can retire in about 20 years.
    • If you can save 50%, you can retire in about 16 years.

  • Max out your Roth IRA [2]. If you income is above a certain amount [3], you are limited from contributing to a Roth IRA. In this case, you need to perform a backdoor conversion. This involes putting money into a traditional IRA and then immediately converting it to a Roth IRA.

  • Max out your Roth 401k beyond the matching [4].

6b) (Optional) Save up 20% for a house down payment

  • Note that this step is numbered 6b. It is the one step that can be done simultaneously with the step above.
  • There are a lot of discussions about whether or not you should buy vs rent. I’m not going to get into that. Here is a calculator that may be helpful.

7) Finish paying off any debts with interest rates less than 4%

  • If you have any remaining debts with low interest rates, you should pay those down.

8) Save for kids college

  • If you are going to have children and would like to help contribute to their college education, you will want to look into a 529 plan. Almost every state has its own 529 plan. Some plans require that you be a resident of the state, while some do not. For example, even if you live in Oregon, it may be advantageous to put your money into the 529 New York plan.
  • There are two main types of 529 plans: pre-paid tuition and college savings plans. Pre-paid tuition plans allow you to buy tuition credits, locking in current tuition rates. Savings plans are similar to investment accounts in that you invest money through them into various assets. When your child needs money for education expenses, you can then withdraw from the account.
  • The first thing you will want to do is very carefully look into the plan for your home state. Tennessee and New York both have good plans which do not require you to be a resident so you should be comparing the plan from your state to those plans. Look here for some comparisons.

9) Payoff house early

  • At this point, you are in a pretty good position. Depending on the interest rate on your mortgage, you may want to start making more aggressive payments. Alternatively, your last option is to start contributing to taxable accounts.

10) Taxable accounts

  • You’ve hit the end of the line. All that we have left is to put money into taxed accounts. Through Vanguard you can start putting in additional money into a brokerage account.
[1]$118,500 per individual in 2015.
[2]$5,500 per individual in 2015 ($6,500 if you are over 50).
[3]$116,000 if you are single and $183,000 if you are married in 2015. Those are actaully the amounts in which a phaseout starts. In that case, you want to look at the backdoor conversion.
[4]$18,000 per individual in 2015.