This post is less about the "trucks" and more about the "tax-advantaged accounts", which hopefully won't offend too many sensibilities. I just figured it's been a while since I last forayed in my financials, and the several ensuing months have seen some modifications to the plan. The biggest of these modifications is that I added a new tool to my early retirement arsenal: the Mega Backdoor Roth.
The Mega Backdoor what?
The Mega Backdoor Roth. I'm no CPA or CFP, or any other fancy three-letter money-managing acronym for that matter, so check here or the other two links above for a more thorough, accurate explanation. The gist of it is that the IRS overall limit on contributions to retirement accounts is $53,000, meaning you can contribute to more than just a 401k. I've mentioned in the past that I'm putting the maximum $18,000 into my 401k, and I'm being matched an additional $9,000 by my employer. That leaves $53,000 - ($18,000 + $9,000) = $26,000 to contribute to other tax-advantaged accounts. Income limits stop me from contributing directly to a Roth IRA, and even if I could, the max contribution via that regulatory avenue is $5,500. Thus, the process for getting that $26,000 into a Roth IRA is as follows:
- You add a paycheck deduction to contribute after-tax money to a 401k.* This doesn't actually sound all the useful, and on its own it really isn't. You're being taxed on the money before you put it in, and since it's a 401k, you'll be taxed on it when you take it out, so it functions like a non-tax-advantaged contribution at this point. The real magic happens in the next step.
- Every time a paycheck contribution comes in, you roll the after-tax portion over into an out-of-plan Roth IRA.** At this point, you pay taxes on the capital gains you've earned on the contribution, which should be on the order of zero dollars and zero cents since it's only been sitting in there a day or two and the stock market isn't some magical money-printing machine, at least for a plebeian like me.
- Wait for the rollover to go through and clear, then invest it in whatever funds tickle your fancy.
The benefit of doing this is that, because it's a Roth IRA, you don't pay taxes when you take it out. The caveat is that, because this is a Roth IRA, you can't take the money out until you're 59.5 years old, barring a few exceptions like for buying a first home. You can however take out the principal whenever you want, if you find yourself in a pinch. This isn't something I was utilizing last year, partly because my paycheck would have been negative and partly because I had no idea how any of this worked. Luckily, I was clued in by a friend (thanks Mike!), and I've since received a bunch of comments/e-mails with similar tidbits of information. Unfortunately, the backdoor Roth isn't available in everyone's plan (your plan needs to support after-tax 401k contributions, among other things), and Vanguard didn't even support it except over the phone until last year.
Grab a glass of water, because this post is about to get even drier, as we dive into the wonderful and exciting world of paycheck deductions. I've made a few tweaks since last time, because now my contributions are spread out over the full year instead of the six months I worked last year. Doing some hardcore basic algebra:
- 401k - In my infinite wisdom, I forgot to update my 401k contribution from the $1,200/paycheck I was doing last year, and continued to not realize it for a few pay cycles, so my contribution per paycheck is now ($18,000 - $1,200 * 2)/24 = $650/paycheck.
- HSA - My employer still puts $800 into my HSA each year and an additional $200 when I get my physical, so my contribution there is ($3,350 - ($800 + $200))/26 = $90.38/paycheck.
- Roth IRA - I didn't pull my act together and figure out the backdoor Roth stuff until after my first few paychecks of the year, so I'm currently contributing $26,000/24 = $1,083/paycheck.
After all is said and done, my take-home pay is ~$2,000 a month. In the Bay Area, that would hardly cover rent and basic livings expenses…if I had them. It's a nice reminder that my lifestyle really is accelerating my ability to build the future I want, at no (or maybe even a negative) cost to my happiness. I truly am fortunate to be in the position I am.
Balancing the Books
Okay, so we've crunched the numbers and know how much money is going into these accounts, but what happens once it gets there? Well it's at the mercy of the stock market, of course. I'm no day-trader, so the daily/seemingly arbitrary fluctuations in stocks and funds don't have any real impact on me. I'm it it for the long haul, and I'd like to think that the intrinsic value of the companies represented by the funds I invest in will increase over the course of the next ten years. So for now, the change in my investments doesn't mean much to me. That said, I've been doing this eight months or so at this point, which has been enough time to see some small gains. My brokerage account, which I was putting more into before I started utilizing the backdoor Roth, currently has unrealized gains (because I haven't cashed out yet) of ~$350. The Roth IRA, which I've only been contributing to this year, has unrealized gains of ~$200. According to Health Equity, my HSA investments have appreciated 4.2%, which is ~$200 of growth. In the same period of time, my student loans (which are paid ahead until 2019 and I've been more or less ignoring), have only accrued about ~$226 in interest, so the investments are indeed worth paying off the loans ever so slightly more slowly.
Aside from having to roll over the after-tax 401k money into the Roth IRA, my finances are pretty much on auto-pilot. All of the aforementioned accounts are set to reinvest the dividends as they come in, so those earnings will keep compounding as I put in more money and time goes on. This is nice because it means that I don't even have to think about investing or worry about too much money accumulating in my checking account and fighting in a losing battle with inflation (not that that's actually something to "worry" about anyway).
Talking to an actual CFP
One lovely feature of my employer's plan is that we can schedule appointments with a Vanguard Certified Financial Planner. This is great because my background in finance consists entirely of a handful of Google searches and I occasionally worry I have no idea what I'm doing. I'd consider this to be a problem because I'm throwing 90% of my money (and thus time) into what might as well be a black hole of legislation and taxation, with the expectation that my sacrificial offerings will magically generate financial independence ten years from now. So on Friday (aka yesterday) at 7:45 am, I spoke with a pleasant chap named Bob, who pored over my finances and listened to my early retirement goals. After some thoughtful consideration, he gave me a few pointers.
The gist of the conversation was that my current strategy (maxing out the 401k, HSA, and Roth IRA) is good, though as my total investment grows, he'd like to see more investments in small/medium cap businesses and some international funds. Once my stock grant vests (and subsequently sells) sometime next month, I'll be grabbing some combination of VTIAX, VTI, and VO. Bob also suggested converting some (10-20%) of my investments to California Intermediate-Term Tax-Exempt Fund Admiral Shares as I near my early retirement date, which seems pretty reasonable to me. After a discussion about my travel plans, he voiced some concern about my ability to get/pay for health insurance while travelling internationally, though after a bit of research it appears I can actually use my HSA to fund that, which is a nice touch. Having some reassurance from a Professional Adult™ that my future plans are feasible and not totally insane definitely upped my confidence regarding this whole ill-defined "growing up" thing.
*On Vanguard's website, you can change your deductions by going to Employer plans > Manage my money > Change my paycheck deduction.
**On Vanguard's website, you can do this by going to Employer plans > Manage my money > Manage my loans and withdrawals > Withdrawal