KF's simple rules to achieve FI [Financial Independence]

[KlangFool]

I save 60K per year. So, why would I put 5K into 529?

KlangFool

I think you mentioned you earn about $150k and save about $60k.
I guess it is a matter of priorities, but given those numbers, I would be very comfortable saving 3.3% of income (or 8.3% of my savings) for my kids future.

marcopolo,

Over the last 10+ years. I had to survive quarterly laid for 5+ years (20+ laid off) and annual laid off for the rest. I was unemployed for more than 1 year a few times. I was unemployed for more 1 year when both of my kids went to college. I had to use my taxable account to feed my family besides paying for college.

KlangFool

[marcopolo]

I save 60K per year. So, why would I put 5K into 529?

KlangFool

I think you mentioned you earn about $150k and save about $60k.
I guess it is a matter of priorities, but given those numbers, I would be very comfortable saving 3.3% of income (or 8.3% of my savings) for my kids future.

marcopolo,

Over the last 10+ years. I had to survive quarterly laid for 5+ years (20+ laid off) and annual laid off for the rest. I was unemployed for more than 1 year a few times. I was unemployed for more 1 year when both of my kids went to college. I had to use my taxable account to feed my family besides paying for college.

KlangFool

So much for the plan to cash flow college!

So, you used taxable savings to pay for college when you did not have the income to cash flow it. It would have been more efficient to use a 529 just for this purpose.

[marcopolo]

A) Because if you are planning to pay for some of your kids college expenses, the 529 is the vehicle optimized to save for that.

B) That depends on how much you plan to spend towards college. For, in-state, one kid maybe 5-10k. For Ivy, may be 20k? We did ~10/yer per child while they were young.

marcopolo,

A) Not true. If I am employed, my annual savings is big enough to cover the college education. I do not need to save for college education.

B) Let's go with 20K per year. Why am I doing this?

1) If I am employed long enough, I could pay for the college education from my annual savings. I do not need the 529.

2) If I am unemployed, I need my money from my taxable account. Now, it is down to 10K per year as opposed to 30K per year. 10K = 2 months of expense. 30K = 6 months of expense.

Now, instead of 60K per year for my FI and I could reach my 1 million to 1.5 million number quickly, it is 40K per year. The 529 is not useful to me. In fact, it slows down the pace for me to reach FI and fund the college education through "cash flow"

KlangFool

OK. Let's stop hand-waving this argument and try some actual numbers.

marcopolo,

1) I am "cash flowing" my 2 kid's college education now. Essentially, I am living paycheck to paycheck. But, I max up my 401K, my wife 457, and Roth IRAs. So, I am moving 50K to 60K from my taxable account to the tax-deferred accounts and Roth IRAs. So, the money does not have to stay in the taxable account.

2) When I early retire, I can choose to generate whatever amount of taxable income that I want to generate.

A) The annual distribution from my taxable account is 2%. It is about 10K. It will go down since I move 50K to 60K per year to the tax-deferred accounts and Roth IRA.

B) My Roth IRAs is about 10% of my portfolio and growing at least 13K per year.

C) My tax-deferred account is about 45% now.

So, my portfolio will be between 45/45/10 (Taxable/Tax-deferred/Roth) to 35/45/10.

KlangFool

Why do you use a Roth IRA instead of saving those same dollars in to taxable accounts? I am sure you have good reason to do so.

If you are going to pay at least some of your kids college expenses, a 529 has exactly the same advantage as a Roth.

[KlangFool]

Why do you use a Roth IRA instead of saving those same dollars in to taxable accounts? I am sure you have good reason to do so.

If you are going to pay at least some of your kids college expenses, a 529 has exactly the same advantage as a Roth.

marcopolo,

No. I can use Roth IRA's money for anything. It is not only for college.

KlangFool

[marcopolo]

Why do you use a Roth IRA instead of saving those same dollars in to taxable accounts? I am sure you have good reason to do so.

If you are going to pay at least some of your kids college expenses, a 529 has exactly the same advantage as a Roth.

marcopolo,

No. I can use Roth IRA's money for anything. It is not only for college.

KlangFool

Why ignore the first part of the sentence?

You just mentioned above that despite all the layoffs, you paid for kids college expenses from taxable savings.

[KlangFool]

I save 60K per year. So, why would I put 5K into 529?

KlangFool

I think you mentioned you earn about $150k and save about $60k.
I guess it is a matter of priorities, but given those numbers, I would be very comfortable saving 3.3% of income (or 8.3% of my savings) for my kids future.

marcopolo,

Over the last 10+ years. I had to survive quarterly laid for 5+ years (20+ laid off) and annual laid off for the rest. I was unemployed for more than 1 year a few times. I was unemployed for more 1 year when both of my kids went to college. I had to use my taxable account to feed my family besides paying for college.

KlangFool

So much for the plan to cash flow college!

So, you used taxable savings to pay for college when you did not have the income to cash flow it. It would have been more efficient to use a 529 just for this purpose.

marcopolo,

1) Really? What can I use to pay anything else besides the college education? My annual expense plus college for 2 kids = 120K per year.

2) If I save for 529, I would not have 1 million that I am free to use for anything. How would I know how much I can afford for 529? I would have to be extremely lucky to pick the right amount. I am not that lucky.

3) When I am unemployed, I do not need to worry about tax-efficiency.

KlangFool

[KlangFool]

Why do you use a Roth IRA instead of saving those same dollars in to taxable accounts? I am sure you have good reason to do so.

If you are going to pay at least some of your kids college expenses, a 529 has exactly the same advantage as a Roth.

marcopolo,

No. I can use Roth IRA's money for anything. It is not only for college.

KlangFool

Why ignore the first part of the sentence?

You just mentioned above that despite all the layoffs, you paid for kids college expenses from taxable savings.

marcopolo,

A) That was because I have 1 million. And, I have enough money in the taxable account to feed the family beside paying for college.

B) If the unemployment lasts much longer than that, the kids would have to take a student loan.

KlangFool

[SGM]

I like 529s for college education, because the earnings are not taxed and are funded out of taxable accounts. This decreases taxes on investments a little every year the funds are outside of a taxable account. In our state there is a tax credit for investing in 529s as well. I have never had an issue with possible unemployment. If you have to decrease your IRA, 401k or Roth to fund a 529 then it may not be a good idea. Decreasing the taxable account is fine unless you need that money for something else.

I also invested my taxable account 100% in stock until a few years prior to retirement. Maybe I was just lucky, but it was in retrospect the best choice. I continued to invest regardless of market valuations. I was very comfortable investing in the stock market on a monthly basis regardless of valuations.

[bling]

2) If I save for 529, I would not have 1 million that I am free to use for anything. How would I know how much I can afford for 529? I would have to be extremely lucky to pick the right amount. I am not that lucky.

you don't have to be right or lucky. you just need to pick something that's sensible. for me, i chose to save enough for a state college tuition. if they happen to get into an ivy league then i'll cash flow the rest.

worst case scenario you take a 10% penalty on the earnings to use for something else. any principal you contributed can be withdrawn at any time tax/penalty-free.

[KlangFool]

2) If I save for 529, I would not have 1 million that I am free to use for anything. How would I know how much I can afford for 529? I would have to be extremely lucky to pick the right amount. I am not that lucky.

you don't have to be right or lucky. you just need to pick something that's sensible. for me, i chose to save enough for a state college tuition. if they happen to get into an ivy league then i'll cash flow the rest.

worst case scenario you take a 10% penalty on the earnings to use for something else. any principal you contributed can be withdrawn at any time tax/penalty-free.

bling,

<<for me, i chose to save enough for a state college tuition. >>

1) Why does this make sense for you? How much is the annual college saving versus the annual retirement savings?

2) As per my observation, 529 make perfect sense for folks in the 24% and above tax bracket. Aka, household gross income at 200K and above.

KlangFool

[bling]

2) If I save for 529, I would not have 1 million that I am free to use for anything. How would I know how much I can afford for 529? I would have to be extremely lucky to pick the right amount. I am not that lucky.

you don't have to be right or lucky. you just need to pick something that's sensible. for me, i chose to save enough for a state college tuition. if they happen to get into an ivy league then i'll cash flow the rest.

worst case scenario you take a 10% penalty on the earnings to use for something else. any principal you contributed can be withdrawn at any time tax/penalty-free.

bling,

<<for me, i chose to save enough for a state college tuition. >>

1) Why does this make sense for you? How much is the annual college saving versus the annual retirement savings?

2) As per my observation, 529 make perfect sense for folks in the 24% and above tax bracket. Aka, household gross income at 200K and above.

KlangFool

tax-advantaged is tax-advantaged is tax-advantaged. i don't get why being in 24% makes any difference or not, you're still giving up free money. the rule i follow for myself is to max out any tax-advantaged space, in the following order: 401k, roth, 529 (up to the state tax deduction). anything that remains goes into taxable. your income/expenses will naturally determine what you can or cannot do.

[marcopolo]

2) If I save for 529, I would not have 1 million that I am free to use for anything. How would I know how much I can afford for 529? I would have to be extremely lucky to pick the right amount. I am not that lucky.

you don't have to be right or lucky. you just need to pick something that's sensible. for me, i chose to save enough for a state college tuition. if they happen to get into an ivy league then i'll cash flow the rest.

worst case scenario you take a 10% penalty on the earnings to use for something else. any principal you contributed can be withdrawn at any time tax/penalty-free.

bling,

<<for me, i chose to save enough for a state college tuition. >>

1) Why does this make sense for you? How much is the annual college saving versus the annual retirement savings?

2) As per my observation, 529 make perfect sense for folks in the 24% and above tax bracket. Aka, household gross income at 200K and above.

KlangFool

You keep saying that about the 24% bracket without explaining why. Have you actually done the analysis, or is that just a gut feeling?

[KlangFool]

2) If I save for 529, I would not have 1 million that I am free to use for anything. How would I know how much I can afford for 529? I would have to be extremely lucky to pick the right amount. I am not that lucky.

you don't have to be right or lucky. you just need to pick something that's sensible. for me, i chose to save enough for a state college tuition. if they happen to get into an ivy league then i'll cash flow the rest.

worst case scenario you take a 10% penalty on the earnings to use for something else. any principal you contributed can be withdrawn at any time tax/penalty-free.

bling,

<<for me, i chose to save enough for a state college tuition. >>

1) Why does this make sense for you? How much is the annual college saving versus the annual retirement savings?

2) As per my observation, 529 make perfect sense for folks in the 24% and above tax bracket. Aka, household gross income at 200K and above.

KlangFool

You keep saying that about the 24% bracket without explaining why. Have you actually done the analysis, or is that just a gut feeling?

marcopolo,

1) At higher income/saving/tax level, the tax advantage of 529 is significant versus the taxable account.

2) At higher income/saving/tax level, the person could save enough for the college education without affecting retirement/FI.

3) At higher income/saving/annual expense level, there is no hope that the person's kid could qualify for any financial aid even if he is unemployed.

KlangFool

[bling]

marcopolo,

1) At higher income/saving/tax level, the tax advantage of 529 is significant versus the taxable account.

2) At higher income/saving/tax level, the person could save enough for the college education without affecting retirement/FI.

3) At higher income/saving/annual expense level, there is no hope that the person's kid could qualify for any financial aid even if he is unemployed.

KlangFool

1) there is a benefit the moment you pay any income tax. obviously the more taxes you pay you make the more you benefit.

2) just because you can save enough to pay for college doesn't mean you should give up tax benefits of a 529. by that logic you don't need to put anything into a 401k or IRA either.

3) yes, once you get past 200k income your EFC is pretty high. even more reason to put money into a 529 since you're expected to foot a large portion/all of the bill.

[KlangFool]

marcopolo,

1) At higher income/saving/tax level, the tax advantage of 529 is significant versus the taxable account.

2) At higher income/saving/tax level, the person could save enough for the college education without affecting retirement/FI.

3) At higher income/saving/annual expense level, there is no hope that the person's kid could qualify for any financial aid even if he is unemployed.

KlangFool

1) there is a benefit the moment you pay any income tax. obviously the more taxes you pay you make the more you benefit.

2) just because you can save enough to pay for college doesn't mean you should give up tax benefits of a 529. by that logic you don't need to put anything into a 401k or IRA either.

3) yes, once you get past 200k income your EFC is pretty high. even more reason to put money into a 529 since you're expected to foot a large portion/all of the bill.

bling,

<<2) just because you can save enough to pay for college doesn't mean you should give up tax benefits of a 529. by that logic you don't need to put anything into a 401k or IRA either.>>

401K and IRAs are for retirement and FI. They are not limited to college education funding.

The simple fact that is I do not have the money to fund college education until my retirement/FI is funded. Some folks have higher income and saving. They can afford to do both at the same time.

KlangFool

[marcopolo]

You keep saying that about the 24% bracket without explaining why. Have you actually done the analysis, or is that just a gut feeling?

marcopolo,

1) At higher income/saving/tax level, the tax advantage of 529 is significant versus the taxable account.

2) At higher income/saving/tax level, the person could save enough for the college education without affecting retirement/FI.

3) At higher income/saving/annual expense level, there is no hope that the person's kid could qualify for any financial aid even if he is unemployed.

KlangFool

I will take that as a "no".

[marcopolo]

The simple fact that is I do not have the money to fund college education until my retirement/FI is funded. Some folks have higher income and saving. They can afford to do both at the same time.

KlangFool

Your description of your situation seems to be all over the place depending on what argument you are trying to make.

You have stated that you are not FI yet.
You have stated that you have cash flowed your kids college expenses for several years.
You now state you would not have money to fund college education until retirement/FI is funded

Which is it?

[KlangFool]

The simple fact that is I do not have the money to fund college education until my retirement/FI is funded. Some folks have higher income and saving. They can afford to do both at the same time.

KlangFool

Your description of your situation seems to be all over the place depending on what argument you are trying to make.

You have stated that you are not FI yet.
You have stated that you have cash flowed your kids college expenses for several years.
You now state you would not have money to fund college education until retirement/FI is funded

Which is it?

marcopolo,

1) My number is around 1.5 million.

2) I am at 1.2 million now.

3) I save nothing at this moment. All my annual savings go towards the college education.

4) I can reach my numbers in a few years with zero additional contribution.

5) I could retire/FI if I choose to downsize.

viewtopic.php?t=220234&start=150

6) You can read about the complete detail at the above thread.

KlangFool

[LadyGeek]

Before this escalates further, see: General Etiquette

We expect this forum to be a place where people can feel comfortable asking questions and where debates and discussions are conducted in civil tones.

Please state your concerns in a civil, factual manner.

[bling]

bling,

<<2) just because you can save enough to pay for college doesn't mean you should give up tax benefits of a 529. by that logic you don't need to put anything into a 401k or IRA either.>>

401K and IRAs are for retirement and FI. They are not limited to college education funding.

The simple fact that is I do not have the money to fund college education until my retirement/FI is funded. Some folks have higher income and saving. They can afford to do both at the same time.

KlangFool

taxable accounts don't have any restrictions either. why does that make a difference? at the end of the day, it's all inter-connected. money comes in, money comes out. it doesn't matter whether it's in a 401k, IRA, 529, or whatever vehicle -- you should take advantage of anything that nets you more money to spend. if you know that there's a high certainty you will be funding your kids' college fees in any form, then you should contribute extra savings into a 529.

even now it makes sense for you to do it. you stated you're saving 20k less, so tuition/board is that much per year. assuming 7% return, 20k contribution each year for 4 years, you'd have almost $89k at the end of it. under these assumptions, you have an extra (9k * .22) = $1980 in your pocket. if the market went down instead, you'd still be in the same spot because there's no penalty for withdrawing your principal.

only upside, no downside. why not take it?

[indexonlyplease]

I used Rule 3 and 4 for my 30 year career and then retired. But I bought multiple houses and always 15 year mortgage. I was then able to pay the finale house I am living in now in half the time. Which means I had no mortgages way before I retired. Made saving even easier.

Now I am able to pay cash for everything beacuse of no debt.

[KlangFool]

bling,

<<2) just because you can save enough to pay for college doesn't mean you should give up tax benefits of a 529. by that logic you don't need to put anything into a 401k or IRA either.>>

401K and IRAs are for retirement and FI. They are not limited to college education funding.

The simple fact that is I do not have the money to fund college education until my retirement/FI is funded. Some folks have higher income and saving. They can afford to do both at the same time.

KlangFool

taxable accounts don't have any restrictions either. why does that make a difference? at the end of the day, it's all inter-connected. money comes in, money comes out. it doesn't matter whether it's in a 401k, IRA, 529, or whatever vehicle -- you should take advantage of anything that nets you more money to spend. if you know that there's a high certainty you will be funding your kids' college fees in any form, then you should contribute extra savings into a 529.

even now it makes sense for you to do it. you stated you're saving 20k less, so tuition/board is that much per year. assuming 7% return, 20k contribution each year for 4 years, you'd have almost $89k at the end of it. under these assumptions, you have an extra (9k * .22) = $1980 in your pocket. if the market went down instead, you'd still be in the same spot because there's no penalty for withdrawing your principal.

only upside, no downside. why not take it?

bling,

<<even now it makes sense for you to do it. you stated you're saving 20k less, so tuition/board is that much per year.>>

1) I am saving nothing now. All my annual savings go towards the college education.

2) Because of my 401K and my wife's 457, I am contributing about 44K to the tax-deferred accounts. Then, another 13K to Roth IRAs. I do not need the 529 for any additional tax-advantaged space.

3) Yes, they are connected. I can pay the college education with my taxable account while contributing to the 401K, 457, and Roth IRAs.

<<if you know that there's a high certainty you will be funding your kids' college fees in any form, then you should contribute extra savings into a 529.>>

I don't. In fact, if my unemployment that lasted for more than 1 year went a bit longer, I would not be paying for college education. It is 120K per year. I cannot afford to pay for my annual expense and college education while unemployed much longer.

KlangFool

[hale2]

It might be to your benefit to give some thought to some of the recommendations that people have given you. Spend a little time analyzing their recommendations for your particular situation. You might decide that making a few changes or thinking about a few things differently may make your financial position stronger.

[Snowjob]

[RE 529]
.....

Our situation explains it.

If you save diligently for years, and lose your job, your kids are now more likely to receive financial aid if your savings are all in retirement accounts and not 529 accounts. Low earned income + little "available assets" = low EFC. Save in 529 accounts and you have high "available assets" for college, but pay a price to release those funds for living expenses if needed. Lose-lose situation for us.

We are saving over 50% of our modest wages in retirement accounts, and are in the zero bracket, actually negative taxes, precisely because of our high savings to retirement. This also helps with our EFC. Those negative taxes are also saved, to Roth IRAs. It took some time for us to ramp up to our current level of savings, partially because of low income, partially because of our high rate mortgage plus student loans (small, but again high rate), and partially because of lack of knowledge about FI when we started out. KlangFool's rules might not be possible for everyone who likes to spend freely, but somehow I've come to a remarkably similar set of rules to shoot for, even on a family income that's just broken $60k. Looking back we broke some of his rules (like the housing guidelines), so we pushed harder to fix the error once we realized it - paid off that mortgage in less than 15 years, increased retirement savings rate incrementally.

OK, so having a 529 and low income still says you have a high ability to pay, they dont look at retirement accounts. What about a brokerage account (taxable account)

Just curious

[Snowjob]

Why do you use a Roth IRA instead of saving those same dollars in to taxable accounts? I am sure you have good reason to do so.

If you are going to pay at least some of your kids college expenses, a 529 has exactly the same advantage as a Roth.

marcopolo,

No. I can use Roth IRA's money for anything. It is not only for college.

KlangFool

Why ignore the first part of the sentence?

You just mentioned above that despite all the layoffs, you paid for kids college expenses from taxable savings.

marcopolo,

A) That was because I have 1 million. And, I have enough money in the taxable account to feed the family beside paying for college.

B) If the unemployment lasts much longer than that, the kids would have to take a student loan.

KlangFool

Marcopolo does not believe the risk in being under/unemployed is real,. Klangfool does. Until there is some reconciliation I see this argument continuing... now on to page 4 haha!

[doss]

This has been an interesting thread. I never thought about the idea of funding college via cash flow once my retirement goals have been met -- always thought you had to do it through 529s from the start. KF's method makes sense, I am just not sure yet if it's the best method for me (still searching). We have a 2 year old and plan to have another kid in the next year or so and I like to see that I am not crazy with the thought that priority for me is to ensure a secure retirement for my spouse and I first and then look for ways to fund college education. I thought that was a selfish thought (my parents put education first before their own retirement and I guess that's why I felt a little uneasy with prioritizing my own retirement). Turns out, I never did graduate from college (wasted my parent's money for 4.5 years!) but I now have a great job and salary where we are able to save 45k a year (single income earner). Once my wife returns to work we will be able to cash flow college even easier. I can see how redirecting the cash flow from retirement savings to college funding (we of course will keep funding 401k, etc) makes sense, but we are assuming that college tuition will not quadruple by then and become even further out of reach?

I just don't like the idea of the lack of flexibility of a 529 (there is a lot of support out there for college funding -- scholarships, GI bill, aid, employer tuition assistance, etc). My wife and her siblings all got scholarships to a major university for cross country athletics.

[ks289]

I agree with KF's rules for the most part. However, I do think that being conservative is wise but has a cost as well.

The idea of cash flowing college expenses has clear advantages over 529 in one main respect: flexibility.
This allows money to be available for other purposes for whatever reason (job loss, child does not attend college, child earns scholarship, etc) and avoids the potential for a 10% penalty on gains.

The clear disadvantage/cost for not utilizing the 529 is the loss of tax exempt space. The cost of this flexibility varies depending on returns, duration, tax bracket, etc. One can look at the returns for any investment and compare it to the returns after taxes/capital gains to have a rough idea (not taking into account tax loss harvesting and other methods). For our children, holding an aggressive stock heavy 529 over the past 10-13 years has resulted in an extra $40,000 over holding the same investments in a taxable account. We do not have enough losses to offset these kinds of capital gains.

[teen persuasion]

[RE 529]
.....

Our situation explains it.

If you save diligently for years, and lose your job, your kids are now more likely to receive financial aid if your savings are all in retirement accounts and not 529 accounts. Low earned income + little "available assets" = low EFC. Save in 529 accounts and you have high "available assets" for college, but pay a price to release those funds for living expenses if needed. Lose-lose situation for us.

We are saving over 50% of our modest wages in retirement accounts, and are in the zero bracket, actually negative taxes, precisely because of our high savings to retirement. This also helps with our EFC. Those negative taxes are also saved, to Roth IRAs. It took some time for us to ramp up to our current level of savings, partially because of low income, partially because of our high rate mortgage plus student loans (small, but again high rate), and partially because of lack of knowledge about FI when we started out. KlangFool's rules might not be possible for everyone who likes to spend freely, but somehow I've come to a remarkably similar set of rules to shoot for, even on a family income that's just broken $60k. Looking back we broke some of his rules (like the housing guidelines), so we pushed harder to fix the error once we realized it - paid off that mortgage in less than 15 years, increased retirement savings rate incrementally.

OK, so having a 529 and low income still says you have a high ability to pay, they dont look at retirement accounts. What about a brokerage account (taxable account)

Just curious

As far as FAFSA is concerned, a 529 is the same as taxable accounts: available assets.

There's a small Asset Protection Amount, based on age of older parent, but it's ridiculously small and shrinking. When we first filed a FAFSA for DD1 in 2008, it was ~$30k, and it is scaled higher for older parents. A few years ago it was scaled back, way back, to something like $6k. Then it was 'corrected', but it has only reached $20k for us now, 10 years older than that first FAFSA.

After subtracting the Asset Protection Amount, 12% of Available Assets are combined with Available Income, and a progressive rate is applied, with a top rate of 47%.

[Snowjob]

OK, so having a 529 and low income still says you have a high ability to pay, they don't look at retirement accounts. What about a brokerage account (taxable account)

Just curious

As far as FAFSA is concerned, a 529 is the same as taxable accounts: available assets.

There's a small Asset Protection Amount, based on age of older parent, but it's ridiculously small and shrinking. When we first filed a FAFSA for DD1 in 2008, it was ~$30k, and it is scaled higher for older parents. A few years ago it was scaled back, way back, to something like $6k. Then it was 'corrected', but it has only reached $20k for us now, 10 years older than that first FAFSA.

After subtracting the Asset Protection Amount, 12% of Available Assets are combined with Available Income, and a progressive rate is applied, with a top rate of 47%.
[/quote]

Hmm, all the more reason KF's decision to ignore the 529 makes sense from a risk avoidance perspective given the assumptions he's laid out. I suspect if I end up going down the marriage / kids path at some point I'll be in a similar situation and will probably follow this advice

[KlangFool]

This has been an interesting thread. I never thought about the idea of funding college via cash flow once my retirement goals have been met -- always thought you had to do it through 529s from the start. KF's method makes sense, I am just not sure yet if it's the best method for me (still searching). We have a 2 year old and plan to have another kid in the next year or so and I like to see that I am not crazy with the thought that priority for me is to ensure a secure retirement for my spouse and I first and then look for ways to fund college education. I thought that was a selfish thought (my parents put education first before their own retirement and I guess that's why I felt a little uneasy with prioritizing my own retirement). Turns out, I never did graduate from college (wasted my parent's money for 4.5 years!) but I now have a great job and salary where we are able to save 45k a year (single income earner). Once my wife returns to work we will be able to cash flow college even easier. I can see how redirecting the cash flow from retirement savings to college funding (we of course will keep funding 401k, etc) makes sense, but we are assuming that college tuition will not quadruple by then and become even further out of reach?

I just don't like the idea of the lack of flexibility of a 529 (there is a lot of support out there for college funding -- scholarships, GI bill, aid, employer tuition assistance, etc). My wife and her siblings all got scholarships to a major university for cross country athletics.

doss,

If the college tuition quadruple, you will not be able to pay. It won't matter whether the money in any type of account.

KlangFool

[KlangFool]

I agree with KF's rules for the most part. However, I do think that being conservative is wise but has a cost as well.

The idea of cash flowing college expenses has clear advantages over 529 in one main respect: flexibility.
This allows money to be available for other purposes for whatever reason (job loss, child does not attend college, child earns scholarship, etc) and avoids the potential for a 10% penalty on gains.

The clear disadvantage/cost for not utilizing the 529 is the loss of tax exempt space. The cost of this flexibility varies depending on returns, duration, tax bracket, etc. One can look at the returns for any investment and compare it to the returns after taxes/capital gains to have a rough idea (not taking into account tax loss harvesting and other methods). For our children, holding an aggressive stock heavy 529 over the past 10-13 years has resulted in an extra $40,000 over holding the same investments in a taxable account. We do not have enough losses to offset these kinds of capital gains.

ks289,

<<The clear disadvantage/cost for not utilizing the 529 is the loss of tax exempt space. >>

Yes, that is true. But, there is a cost in term of investment efficiency by using 529 too. Instead of one portfolio for all purposes, you have to invest the 529 differently due to the specific time frame. You are investing for 10 to 15 years with 529. Meanwhile, you are investing 20 to 40 years with your one portfolio.

KlangFool

[KlangFool]

It might be to your benefit to give some thought to some of the recommendations that people have given you. Spend a little time analyzing their recommendations for your particular situation. You might decide that making a few changes or thinking about a few things differently may make your financial position stronger.

hale2,

1) My son is graduating May 2019. My daughter is graduating May 2020. As far as college education funding, it is end game for me.

2) As far as FI/Retirement, I will work as long as I can over the next few years. Meanwhile, my wife had found a part-time county job with full benefits. So, my health insurance is covered. I started a topic and we had an extensive discussion on that. You can read the following thread if you are interested.

viewtopic.php?t=220234&start=150

3) Worst case, our family takes care of each other.

KlangFool

[dknightd]

Life is a crap shoot. Past performance does not always match future performance.

[jharkin]

I did read through the thread, but I am going to go back and quote the first post to ask some follow up questions.....


KF, can I ask you a general question - what specific kind of engineer are you?
I've seen you mention being an engineer and also mention IT. But you also talk about HCOL area and facing lots of long layoffs. (if you want to decline to answer for privacy reasons I understand)

The odd thing is I am an engineer (Mechanical by degree) but happened to work all of my career in software. Maybe its a stroke of luck but I've managed to never yet get the layoff axe (20 years in) and everyone I know who did get laid off along the way (lots of folks) always managed to find a new job in a few months at most. A couple of cases For most it actually paid off financially between the generous severance and UI.

About the only people I know who took more than a year to find a new job are VP level folks. Some senior manager/director types end up at lower titles in a new company but often still had a bump in pay.

This has held true in my experience (Boston) even though the great recession... as technology hiring slowed but never as severely as the overall economy. I knew people in other fields that where suffering, but talented tech folks usually made out OK. Even college friends I know that stayed in physical engineering made it though relatively unscathed.

Rule #1
Save 1 year of your current annual expense every year. Then, you could be FI in about 25 years even with 0% real growth.

Rule #2
Do not overspend on house, car, and college education. At engineer's income level, as long as he/she do not overspend on those large expenses, he/she can save 1 year of annual expense every year.

I have only just now been able to start doing this in our 40s, now that my wife has gone back to work and our kids are in grade school. In my 20s I did not earn enough (HCOL area, student loans, not every tech person makes a google salary). In our 30s we where on one income with 2 young kids and all the expenses of being new parents and new homeowners.

I think these are great stretch goals but are very difficult for the majority of people in this country based on average incomes and cost of living...

KF Rule for buying a house.

1) 20% down payment plus 30 years fixed rate mortgage. The PITI monthly payment has to be 20% to 30% lower than monthly rent.

2) The net worth excluding house has to be at least 2.5 times the price of the house.

Some of the parameters to be adjusted for the individual circumstances.

Rule #2 I think is impossible for 90% of people. I know when we bought a house our total non-house NW was maybe 1/3-1/2 of the house value... but it worked out OK and 10 years later we are closing in on your rule.

The rule we DID follow was:
* Purchase price < 3x income
* Able to carry the loan on a single income


Otherwise I think we are in a similar situation but about 10 years behind you in age and progress. the other thing Ive done that's maybe a bit different is to try and diversify potential retirement income streams for risk mitigation. By that I mean, I work in tech and have all my assets in vehicles like 401k, IRA. My wife works in healthcare and while she makes a lot less she has always had jobs with pension eligibility. So in retirement we hope to spread the load across SS, traditional pensions, 401k/403b/457/TIRA/etc and Roth vehicles.

My goal is to take the next 10~15 years to save aggressively, so after college we can either RE if things go well, or worst case take a low paying service job just for the benefits and let the savings float until SS/medicare eligibility.

[KlangFool]

I did read through the thread, but I am going to go back and quote the first post to ask some follow up questions.....


KF, can I ask you a general question - what specific kind of engineer are you?
I've seen you mention being an engineer and also mention IT. But you also talk about HCOL area and facing lots of long layoffs. (if you want to decline to answer for privacy reasons I understand)

jharkin,

I worked in the Telecom industry.

KlangFool

[corn18]

I did read through the thread, but I am going to go back and quote the first post to ask some follow up questions.....


KF, can I ask you a general question - what specific kind of engineer are you?
I've seen you mention being an engineer and also mention IT. But you also talk about HCOL area and facing lots of long layoffs. (if you want to decline to answer for privacy reasons I understand)

jharkin,

I worked in the Telecom industry.

KlangFool

What industry do you work in now?

[Hyperborea]

I did read through the thread, but I am going to go back and quote the first post to ask some follow up questions.....


KF, can I ask you a general question - what specific kind of engineer are you?
I've seen you mention being an engineer and also mention IT. But you also talk about HCOL area and facing lots of long layoffs. (if you want to decline to answer for privacy reasons I understand)

jharkin,

I worked in the Telecom industry.

KlangFool

I knew a lot of people who worked in telecom either here in the Bay Area or in Ottawa*. All of them picked themselves back up and got other jobs. The software and hardware skills they had were easily transferable. It was easier to do so in the VHCOL Bay Area because of the density of jobs. One of the many plusses to working here rather than moving to smaller one major employer towns.


* I had friends at Nortel send me the joke about the value of investing in Nortel stock versus buying beer, drinking the beer, and returning the empty bottles for more return value than the value of the Nortel stock.

[willthrill81]

Rule #2 I think is impossible for 90% of people. I know when we bought a house our total non-house NW was maybe 1/3-1/2 of the house value... but it worked out OK and 10 years later we are closing in on your rule.

It's not impossible for most, but it's certainly impractical. Most following this would be at least in their 40s before they could own a home, and many would be in their 50s. There are many non-financial reasons to buy a home much younger than that, and in many areas of the country, it makes financial sense to buy rather than rent for 10-20 years while building one's net worth. I'd rather be 10-20 years into a 30 year mortgage in my 40s or 50s than just starting down that path. Around the time I turn 39, we should be completely debt-free, including our mortgage. Having that monkey off our backs will move us significantly closer to financial independence since our mortgage comprises about 1/3 of our monthly expenditure.

I do think that part of the 'saving' by renting versus buying is that many will go with a smaller living space if renting. Most homes are significantly larger than most apartments, for instance. But in our area, renting a home equivalent to ours would cost the same as a 15 year mortgage including escrow, making renting very pricey indeed.

The rule we DID follow was:
* Purchase price < 3x income
* Able to carry the loan on a single income

Those are good rules-of-thumb. We never exceeded about 2.1X our annual income on home purchases, and we always used 15 year mortgages. It certainly worked out very well for us.

I like Thomas Stanley's rule-of-thumb: if you could not make your mortgage payment if your current income were cut in half, then you cannot easily afford your home.

[Hyperborea]

The rule we DID follow was:
* Purchase price < 3x income
* Able to carry the loan on a single income

Those are good rules-of-thumb. We never exceeded about 2.1X our annual income on home purchases, and we always used 15 year mortgages. It certainly worked out very well for us.

I like Thomas Stanley's rule-of-thumb: if you could not make your mortgage payment if your current income were cut in half, then you cannot easily afford your home.

That can depend on where one lives. I paid about 3.5x my salary at the time I bought my home. Even if I had sold it for exactly what I had paid for it in 2002 I would be far ahead based only on the amount of rent I would have saved during the 16 years over the total purchase cost. It actually sold for nearly 4x what I paid for it. I'm going to guess that I probably did all right.

[wrongfunds]

Rule #2 I think is impossible for 90% of people. I know when we bought a house our total non-house NW was maybe 1/3-1/2 of the house value... but it worked out OK and 10 years later we are closing in on your rule.

It's not impossible for most, but it's certainly impractical. Most following this would be at least in their 40s before they could own a home, and many would be in their 50s. There are many non-financial reasons to buy a home much younger than that, and in many areas of the country, it makes financial sense to buy rather than rent for 10-20 years while building one's net worth. I'd rather be 10-20 years into a 30 year mortgage in my 40s or 50s than just starting down that path. Around the time I turn 39, we should be completely debt-free, including our mortgage. Having that monkey off our backs will move us significantly closer to financial independence since our mortgage comprises about 1/3 of our monthly expenditure.

I do think that part of the 'saving' by renting versus buying is that many will go with a smaller living space if renting. Most homes are significantly larger than most apartments, for instance. But in our area, renting a home equivalent to ours would cost the same as a 15 year mortgage including escrow, making renting very pricey indeed.

The rule we DID follow was:
* Purchase price < 3x income
* Able to carry the loan on a single income

Those are good rules-of-thumb. We never exceeded about 2.1X our annual income on home purchases, and we always used 15 year mortgages. It certainly worked out very well for us.

I like Thomas Stanley's rule-of-thumb: if you could not make your mortgage payment if your current income were cut in half, then you cannot easily afford your home.

Have we actually established that KF did follow his own Rule #2? I don't think he ever answered that question even after being asked about three times so far. His answer has been "I have 2.5X net worth" or something like that rather than saying "I *had* 2.5X at the time of purchase".

[KlangFool]

I did read through the thread, but I am going to go back and quote the first post to ask some follow up questions.....


KF, can I ask you a general question - what specific kind of engineer are you?
I've seen you mention being an engineer and also mention IT. But you also talk about HCOL area and facing lots of long layoffs. (if you want to decline to answer for privacy reasons I understand)

jharkin,

I worked in the Telecom industry.

KlangFool

What industry do you work in now?

corn18,

I design wireless network on a project basis for any customer in any industry. So, I have no idea what industry I am in anymore.

KlangFool

[KlangFool]

Rule #2 I think is impossible for 90% of people. I know when we bought a house our total non-house NW was maybe 1/3-1/2 of the house value... but it worked out OK and 10 years later we are closing in on your rule.

It's not impossible for most, but it's certainly impractical. Most following this would be at least in their 40s before they could own a home, and many would be in their 50s. There are many non-financial reasons to buy a home much younger than that, and in many areas of the country, it makes financial sense to buy rather than rent for 10-20 years while building one's net worth. I'd rather be 10-20 years into a 30 year mortgage in my 40s or 50s than just starting down that path. Around the time I turn 39, we should be completely debt-free, including our mortgage. Having that monkey off our backs will move us significantly closer to financial independence since our mortgage comprises about 1/3 of our monthly expenditure.

I do think that part of the 'saving' by renting versus buying is that many will go with a smaller living space if renting. Most homes are significantly larger than most apartments, for instance. But in our area, renting a home equivalent to ours would cost the same as a 15 year mortgage including escrow, making renting very pricey indeed.

The rule we DID follow was:
* Purchase price < 3x income
* Able to carry the loan on a single income

Those are good rules-of-thumb. We never exceeded about 2.1X our annual income on home purchases, and we always used 15 year mortgages. It certainly worked out very well for us.

I like Thomas Stanley's rule-of-thumb: if you could not make your mortgage payment if your current income were cut in half, then you cannot easily afford your home.

Have we actually established that KF did follow his own Rule #2? I don't think he ever answered that question even after being asked about three times so far. His answer has been "I have 2.5X net worth" or something like that rather than saying "I *had* 2.5X at the time of purchase".

wrongfunds,

I made a mistake with my tenses. And, I corrected my post.

<<delamer,

It was around 400K and I have had about 1 million.

KlangFool>>

KlangFool

[wrongfunds]

Having that settled, I am solidly back in your camp But I still do not agree with your Rule #2. Even with engineer salary, it would have been very difficult to wait until that rule was met. During that time, the prices would have gone up faster than rate of portfolio increase.

I will also take some exception to the no 529 rule as I believe if you are going to help your kid anyway, then it make sense to take advantage of it. In retrospect, I am glad that I did it for my younger son.

But your first principle is something which middle class and high middle class need to strive for. It is deceptively simple and if you follow it, you will be able to become FI at reasonable age under almost any condition. For couple earning comfortable living, "1/3 for all taxes, 1/3 for all savings and rest for spending as you wish" should be possible without much lifestyle crimping. If you have high income, your tax percentage goes up but you still have lot more absolute dollars to spend. If you are earning middle income range, you will be paying less than 1/3 in taxes but then you will have more percentage wise left for spending.

People can try to nitpick specific details of this method but the principle behind is very solid. Full credit has to be given to KF for it.

[KlangFool]

Folks,

<<For my housing rule.

1) I use PITI at 20% to 30% lower than rent in order to account for the additional financial risk and maintenance cost of house ownership.

2) I use net worth excluding the house at 2.5 times of the house purchase price. You could use a lower number if you believe you are at a lower risk.>>

Many folks disagreed with my housing rule #2.

1) I live in a recourse loan state. I cannot walk away from my mortgage.

2) I work in a specific area that there are limited job opportunities in my area. There are probably less than 6 metro areas in the USA that has jobs in my area. In any other locations, I will either be unemployed or under-employed. This means I probably have to move to somewhere else in order to find a job. Or, stay unemployed longer and hope for recovery.

3) In the case of an economic crisis, both housing and stock market will take a hit. In my case of AA around 70/30 to 60/40, it means takes a 35% to 30% loss.

4) My rule allows me to take a 35% and 30% loss and pay off the mortgage and sell the house at a loss and move.

If your job situation is not that extreme, you could take a lower ratio. But, in my opinion, it is useful to take your net worth as part of the consideration in buying a house.

KlangFool

[willthrill81]

The rule we DID follow was:
* Purchase price < 3x income
* Able to carry the loan on a single income

Those are good rules-of-thumb. We never exceeded about 2.1X our annual income on home purchases, and we always used 15 year mortgages. It certainly worked out very well for us.

I like Thomas Stanley's rule-of-thumb: if you could not make your mortgage payment if your current income were cut in half, then you cannot easily afford your home.

That can depend on where one lives. I paid about 3.5x my salary at the time I bought my home. Even if I had sold it for exactly what I had paid for it in 2002 I would be far ahead based only on the amount of rent I would have saved during the 16 years over the total purchase cost. It actually sold for nearly 4x what I paid for it. I'm going to guess that I probably did all right.

Yes, very true. In expensive housing markets, one must be prepared to spend a higher proportion of one's income on a mortgage. A typical advantage in that scenario is that your income is usually significantly higher than it would be in more affordable housing markets, meaning that your income less your mortgage may actually be higher even with the higher mortgage payment.

I think where people really get themselves into trouble with housing is by overextending themselves in terms of their payment. It seems that most of those who get into housing trouble did not have a large enough down payment and/or bought as much house as their loan officer said that they would loan them, maximizing their monthly payment and minimizing their equity in the home at the time of purchase.

[Chuck]

Regarding the 529:

An unqualified withdrawal from a 529 is pro-rata basis and investment gains. You will pay regular income tax on the gains, plus a 10% penalty. (The basis is post-tax anyway.) If you received any state tax benefit from the contribution, you'll likely have to pay it back as well.

If you were unemployed and spent all your taxable money already, presumably your marginal rate is very low. It might even be 0%, in which case you could draw funds from the 529 paying only 10% federal tax on gains, which is not so bad. (That 10% is mitigated somewhat by the tax deferral along the way.)

Held long enough, a crafty investor might decide that the tax deferral might completely overcome the tax penalty, and just use it as a vanilla tax-deferred account. (The pro-rata non-qualified withdrawal rule would make it useful in filling up low brackets over a extended period of withdrawals.)

Point being, if you foresaw an 80% chance of using the 529 for education expenses, and a 20% chance of using it in a dire unemployment scenario, then the pot odds still favor using the 529.

[KlangFool]

Regarding the 529:

An unqualified withdrawal from a 529 is pro-rata basis and investment gains. You will pay regular income tax on the gains, plus a 10% penalty. (The basis is post-tax anyway.) If you received any state tax benefit from the contribution, you'll likely have to pay it back as well.

If you were unemployed and spent all your taxable money already, presumably your marginal rate is very low. It might even be 0%, in which case you could draw funds from the 529 paying only 10% federal tax on gains, which is not so bad. (That 10% is mitigated somewhat by the tax deferral along the way.)

Chuck,

1) After the taxable account, the person could withdraw their Roth IRA contribution.

2) While spending the taxable account and Roth IRA contribution, the person could perform Roth conversion.

3) After the taxable account, Roth IRA contribution, the person could spend the Roth conversion.

4) Only after (1) to (3), then a person may pay a tax penalty on the Roth IRA earning.

All of the above does not have the limitation of the 529.

https://www.madfientist.com/how-to-acce ... nds-early/

You could read a better write up on this at the above URL.

KlangFool

[Chuck]

All of the above does not have the limitation of the 529.

This is non-sequitur to the discussion of whether or not to use a 529 account when paying for college expenses is an expected outcome.

There is a 2x2 matrix here, on one axis you have a 529, or a taxable account. On the other axis, you have withdrawals for education, or withdrawals for unexpected unemployment.

Code: Select all

            education expense    non-education expense
  529            GOOD                   BAD
taxable          BAD                    GOOD

Now the questions are, HOW good, and HOW bad in each scenario, and what is the probability of those scenarios occurring? The choice of accounts is totally under your control, so there is no probability there. So the only factor is whether you will be paying education expenses (presumably if you are liquid enough to do so) or of you are unemployed and destitute, and have to tap this money.

There is some value N, where if you have greater than a N% chance of being destitute, you should prefer the taxable account. If your chance of being destitute is less than N%, then you should choose the 529. Most people EXPECT to not be destitute, which is why most people are saying that if college expenses are in the future, then a 529 account is the right choice for saving.

So, looking at the scenarios where you choose wrong:

If you guess that you will be destitute, and choose the taxable account, the "penalty" for paying education expenses will be capital gains taxes, plus income taxes on dividends, and possibly state income tax on the amount not contributed to a 529 plan.

If you guess that you will be able to pay college expenses, and choose the 529, the "penalty" for using the money to survive unemployment will be the actual penalty of 10% of the gains on the account, plus the "would have been capital gains tax" that is converted to regular income tax.

So there is a cost to being wrong in both scenarios, so you have to try to guess right (and avoid the cost), and then eat the cost if you're wrong.

[Spirit Rider]

Held long enough, a crafty investor might decide that the tax deferral might completely overcome the tax penalty, and just use it as a vanilla tax-deferred account. (The pro-rata non-qualified withdrawal rule would make it useful in filling up low brackets over a extended period of withdrawals.)

Several Boglheads without children have used Colorado's Stabile Value Plus 529 plan as a location for a portion of their emergency funds. With the following rates; 2008 - 2012 averaged ~= 3.00% 2013 = 3.04%, 2014 = 2.64%, 2015 = 3.09%, 2016 2.54%, 2017 = 2.59% and 2018 = 2.29%.

Here are the corresponding CAGRs* for I-Bonds; 2008 - 2012 = 1.89%, 2013 = 1.56%, 2014 = 1.55, 2015 = 1.68%, 2016 = 2.18% and 2017 = 2.40%. *eyebonds.info/ibonds, with May/Nov purchases.

The latest 2018 Stabile Value Plus rate is a little disappointing, but until recently +- 3% was a lot better that the < 1% non-deferred options available with savings accounts and still quite a bit better than I-Bonds. Also, it has a $400K contribution limit rather than $10K/year.

For example, from 2008 - 2012, 3.00% (2.7% net after penalty) was a lot better than 1.89% not not even counting the < 5 year penalty. People have this emotional adverse reaction to paying the 10% penalty for early withdrawal from tax-deferred accounts, when it can simply be factored into the return/deferral value proposition.

[FoolMeOnce]

Rule #1
Save 1 year of your current annual expense every year. Then, you could be FI in about 25 years even with 0% real growth.

All well and good if you don't plan on living any longer than 25 years.

Or am I missing something?

Wouldn't be "all well and good if you don't plan on being retired for any longer than 25 years"? That sounds about right to me. Finish college, work for 25 years, be retired for 25 years, die.

LiterallyIronic,

1) The goal is Financial Independence. It is not retirement. Hence, a person may choose to work, not work, or spend more money, or do something in between.

2) At the worst case, aka the investment has 0% real return. It only keeps up with the inflation, the person will reach the number in 25 years. But, in the average case, the person will reach the number much earlier.

KlangFool

Why 25 years?