EF nearing 9 months: reduce contributions?

[red92s]

I'm closing in on having 9+ months of expenses socked awain in my Emergency Fund. I just went through a 6 month stint of unemployment and beause I was able to live with family and had no debt, I was able to build it up quite a bit while collecting.

Currently I contribute $250/pay to the EF (14% of my net paycheck). This is done as part of direct deposit to a seperate savings account, so I've grown quite accustomed to simply not having that amount or even seeing it go through my checking account.

I know there are conflicting theories about managing savings accounts. I happen to be on the "compartmentalize" side of the fence. I have 7 savings acocunts under my ING checking (Roth, Short Term, Downpayment, Automotive, Vacation, Grad School, Tax). None of these have more than a couple hundred bucks at the moment, and are funded by automatic transfers the day after pay days (totalling 20% of my net paycheck).

I've been contemplating reducing the EF contribution and bumping up the other savings contributions. Logic here is that I feel like I am nearing the point I'd consider the EF to be getting close to "fully funded", and maybe it's time to start saving more aggressivley towards the other goals that have been more casually considered up to this point.

My real reservation is that, I still have the recent stint of unemployment fresh in my mind. It really, really, sucked . . . so I'm not quite sold on saving minimally for a rainy day.

And yes, I totally realize that in the event of a dire emergency the "other" savings accounts could be used to supplement the EF. But, I find it much easier to save when things are neatly packaged into little "digital envelopes" for particular goals.

[disneysteve]

What percentage of gross income are you currently contributing for retirement? If it is less than 15%, I'd cut out the EF funding and start sending that money to retirement.

[jIM_Ohio]

yes it makes sense to divert... especially if you do not lump all savings into one single account.

[red92s]

What percentage of gross income are you currently contributing for retirement? If it is less than 15%, I'd cut out the EF funding and start sending that money to retirement.

Before the lay-off, I was putting about 14% of gross (before any employer matching) towards retirement, split fairly evenly between a 401k and Roth.

I made minimal, but consistant Roth contributions during the lay-off, just to keep it habitual.

I have not yet become elligible for my new employers 401k plan, so I've only been contributing to the Roth. The amounts have not changed significantly from when I last worked, but on a percentage basis it's probably sligthly higher as my income dropped a bit. Once I become 401k elligible next month, I probably still won't participate until matching kicks in at one year of service.

Current age is 27, with current retirement assets in the $30k range.


Monthly net pay: $3500
-Monthly EF: $500 (14% of net)
-Monthly Retirement: $640 (18% of net)
-Monthly "Other" Savings: $300 (8.5% of net)

Monthly TOTAL savings: $1440 (41% of net)

Monthly Debt Obligations: $0

[disneysteve]

Once I become 401k eligible next month, I probably still won't participate until matching kicks in at one year of service.

Do they not match until 1-year of service or are you not vested in the match until 1-year of service? If they don't match, fund the Roth. If they do match but you aren't vested, contribute anyway.

[red92s]

Do they not match until 1-year of service or are you not vested in the match until 1-year of service? If they don't match, fund the Roth. If they do match but you aren't vested, contribute anyway.

No match for the first year. Quite a change from my previous employer that had immediate, fully-vested matching, AND an additional 2% yearly lump-sum contribution after two years (also immediatley vested).

[disneysteve]

In that case, fund the Roth first. If the $5,000 max doesn't represent a large enough percentage of income, then fund the 401k.

[jIM_Ohio]

Monthly net pay: $3500
-Monthly EF: $500 (14% of net)
-Monthly Retirement: $640 (18% of net)
-Monthly "Other" Savings: $300 (8.5% of net)

Monthly TOTAL savings: $1440 (41% of net)

Monthly Debt Obligations: $0

**note you are saving $17k+ per year already (you knew that, I need that number for reasons below)

The Roth-401k discussion to me is 75% about taxes and 25% about the match.

I have net take home as 42k per year, can I assume you are single and gross pay is about $60k per year?

I am "guessing" that you file taxes in 25% tax bracket.

Here is the math of that guess

60k gross pay
minus std deduction of 5,700
minus personal exemption of $3,650

60k-$9350=50650 taxable income

$82,400 is top side of 25% bracket ... and 34k is bottom side (2010 tax brackets here Reference Room)

so if your gross pay is between $34,950 and $91,750 I would suggest trying to use 401k to get taxable income below $34000 and then fund Roth once you have taxable income in the 15% bracket.

You would be hard pressed to convince me that your spending in retirement will be in 25% bracket because you currently are not spending anywhere near the 15% bracket now. I realize things can change, considering you save so much, I would think you would want some tax efficiency in the deal too.

editing to add tax breakdown:

If 60k is gross pay, and taxable income is $50650 then the tax liability is
4,681.25+(25%*[50650-34000])=$8844

I am suggesting you put $16500 into 401k (this will leave only $150 being taxed at 25%)

that new math is
60k gross pay
minus std deduction of 5,700
minus personal exemption of $3,650
minus 401k deposit of $16,500

60,000-$16500-$5700-$3650=$34150

taxable income is $34,150 ($16,500 less than previous)


$4681.25+25%*[34150-34000])= $4719
Old tax owed: $8844
New tax owed $4719

that difference is $4000 and change
you should see take home pay increase $300/mo for making this move, except that $16500/12=$1375/mo is going to 401k, so the net change of the paycheck is

$3500 net-$1375+300 tax savings=$2425. That $2425 take home already has the retirement contribution you have taken out of it, so you need a budget which has you spend $2425 and saving a little out of that for "other" and Roth IRAs.

So my suggestion is take this $17k per year

-Monthly EF: $500 (14% of net)
-Monthly Retirement: $640 (18% of net)
-Monthly "Other" Savings: $300 (8.5% of net)

and change it too
401k $16500/year ($1375/mo)
Other savings $3600/year ($300/mo)
Roth IRA $1000-$3000 per year

Because the retirement savings is pre-tax, you actually have more money "on the table" to work with by order of $1000-$3000 per year.

This will depend on gross salary some. If you have a few more above the line deductions (like an HSA) or itemized deductions exceeding the std deduction, then this becomes even better (because those deductions would push a 60k gross salary into 15% tax bracket for a single filer).

[red92s]

**note you are saving $17k+ per year already (you knew that, I need that number for reasons below)

The Roth-401k discussion to me is 75% about taxes and 25% about the match.

I have net take home as 42k per year, can I assume you are single and gross pay is about $60k per year?

I am "guessing" that you file taxes in 25% tax bracket.

Your assumptions are very close to the actual situation in play. This is a lot of information to digest and I'll have to work through it step by step. I certianly appreciate the effort in running the numbers, and presentation of a contrarian opinon to the others.

[jIM_Ohio]

Your assumptions are very close to the actual situation in play. This is a lot of information to digest and I'll have to work through it step by step. I certianly appreciate the effort in running the numbers, and presentation of a contrarian opinon to the others.

All of us are correct, its simply a matter of do you do 10k to 401k and 5k to Roth, 15k to 401k and 1-3k to Roth... and you need to apply some judgement to situation.


If you are in 25% tax bracket now, and 25% tax bracket in retirement, it makes no difference whether its 401k or Roth.

If you are in 25% bracket now and 15% bracket in retirement, the 401k will beat the Roth, regardless of the match (or lack of match). If you earn 60k now I documented you are paying 8k in taxes, when you withdraw that money, you would pay $4400 in taxes... that savings is clear. If tax bracket will be lower in retirement, choose the 401k.

If you are in 15% bracket now, and will be in 25% bracket in retirement, the Roth will win, under most conditions, after some basic considerations.

The basic considerations are this- everyone is not taxed on the first $X they earn each year. For a single person is $5700+$3650 (std deduction plus personal exemption). This is $9300 per year for a single person. Using 25X rule, this means everyone should have $233k in a 401k or tax deferred vehicle, because that money would "never" get taxed anyway.

So if you believe you are in 15% bracket now (your spending is clearly in this bracket, even if income exceeds the bracket), and think you will be retiring on an income of more than 34k per year, then the Roth will be a good choice, as long as you put "some" money in 401k to use up your tax free withdraw from 401k each year in retirement.


Most of us here (including me) fund the Roth to the max, and use a 401k or 403b (or similar employer plan) for other retirement savings. The best way to look at this is some money is taxed now (the Roth) and most is taxed later (401k, 403b, TSP) or in taxable accounts. Regardless of what future tax law is, some money is penalized, some money is favored.

75% of the workers and people in this country file taxes in the 15% tax bracket (incomes of 34k or less single; 68k or less married). To use the Roth over the 401k means this statistic does not apply to you (you are either in the 25% minority, or have a different political/tax view than I do). I am in the 25% minority and still overfund the 401k beyond the match for many reasons.


The best way to run this for yourself, is find a paycheck calculator
plug your CURRENT numbers in (withholdings, salary)
see if it matches your current paycheck

then plug my 401k numbers in (add $1375/mo to 401k) and see if
a) you have more "savings" on the table to play with
b) you have lower tax withholdings
c) the lower tax withholdings gives you the appropriate savings for the reasons you need

Worst case with using 401k is you change withholdings from $1375/mo to $875/mo and put $500/mo into Roth IMO.

[red92s]

While I agree that contributing enough to the 401k to drop a tax bracket is an appealing thought, funding a home downpayment, potential wedding, car replacement, and grad school on $300 a month is a pretty tall order.

[jIM_Ohio]

While I agree that contributing enough to the 401k to drop a tax bracket is an appealing thought, funding a home downpayment, potential wedding, car replacement, and grad school on $300 a month is a pretty tall order.

LOL
you did not put a timetable on the wedding, car and grad school.

Use the 401k to save on taxes
dropping a tax bracket will be a bonus (if you put $12k into 401k instead of 16k, the tax bill will go up $1000 from what I projected. Still a considerable tax savings relative to current situation.

**Read my signature LOL**

I know there are conflicting theories about managing savings accounts. I happen to be on the "compartmentalize" side of the fence. I have 7 savings acocunts under my ING checking (Roth, Short Term, Downpayment, Automotive, Vacation, Grad School, Tax). None of these have more than a couple hundred bucks at the moment, and are funded by automatic transfers the day after pay days (totalling 20% of my net paycheck).

If you give specific goals for wedding, car payment, car savings, grad school and overall budget, I can give a much better plan.

For example if you are footing bill for grad school, can you qualify for lifetime learning credit?

For every 10k you spend, 2k (20%) comes back to you in cash. This 20% return would be 10X+ higher than a savings account with 10k in it.

Be specific about what you WANT and how much it COSTS and WHEN you want the money.

[wincrasher]

Wow. That all seems like a lot of financial gyrations to figure out the obvious.

You can afford to max out your 401k and Roth. Do it now while it's easy.

As an engineer, you are poised to continue earning more and more money if the economy cooperates and you are savvy about marketing yourself. I'd expect in 5 years time, you will be earning well over $100k.

I think that, while you have no debts or dependants, a 6 month EF is very conservative. Keep your 401k and Roth at max, and put the balance into your other priority savings accounts.