Kristi & Big Ern
Episode 259
Episode Guide
Episode Summary:
Episode Timestamps
ChooseFI Podcast Show Notes: Episode Summary
Episode Title: Following Christie's Financial Independence Journey
Hosts: Jonathan Mendonsa & Brad Barrett
Guest: Christie
Episode Summary:
In this episode, the hosts follow up on Christie's journey toward financial independence, discussing the actionable strategies she has implemented since her last appearance. The focus is on her updated 401k contributions, the importance of expense ratios, Employer Stock Purchase Plans (ESPP), tax optimization, and the advantages of Health Savings Accounts (HSAs). This episode highlights ongoing financial education and practical steps for achieving early retirement.
Key Topics Discussed
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Introduction and Recap
- Introduction of the episode focusing on Christie's financial plan.
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Christie's 401k Transition
- Christie transitioned to a traditional 401k and maxed out her contributions.
- Shifted her fund allocation from a target date fund to the S&P 500.
- Consideration of expense ratios when selecting investments.
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Employee Stock Purchase Plans
- Discussion on the benefits and risks of participating in ESPPs, including a 15% discount on shares.
- Importance of diversification and not having too much invested in company stock.
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Maximizing HSAs
- HSAs provide a triple tax advantage (tax-free contributions, growth, and withdrawals).
- Discussion on keeping health expenses in mind when utilizing HSAs.
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Key Takeaways
- Review of actionable insights on 401k contributions, investment strategies, and tax optimization.
Actionable Takeaways
- Transition 401k contributions to a traditional setup and max it out, inspired by Christie's experience.
- Utilize Health Savings Accounts for their triple tax advantage while keeping health expenses in mind.
- Focus on expense ratios over fund types when selecting investments to maximize long-term returns.
Key Quotes
- "Realize money is a tool, not the goal."
- "Don't let the tax tail wag the dog."
- "HSAs provide tax-free growth, contributions, and withdrawals."
Chapter Markers
- Introduction and Recap
- Christie's 401k Transition
- Employee Stock Purchase Plans
- Maximizing HSAs
- Key Takeaways
FAQs
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What changes did Christie make to her 401k contributions?
Christie moved her contributions to a traditional 401k and started maxing it out. -
What is the significance of the Employee Stock Purchase Plan?
The ESPP offers a 15% discount on shares but carries risks of lack of diversification. -
What is a Health Savings Account?
HSAs provide tax-free contributions, growth, and withdrawals for qualified medical expenses.
Related Resources
Discussion Questions
- How can shifting 401k contributions impact your retirement trajectory?
- What are the risks and rewards associated with Employee Stock Purchase Plans?
- Discuss the implications of tax-loss harvesting in your investment strategy.
Podcast Description
Join Jonathan Mendonsa and Brad Barrett as they dive into actionable financial strategies and insights for achieving financial independence. This episode follows Christie's journey in optimizing her financial plan, exploring topics like retirement accounts, investing, and effective tax strategies.
Listen to the ChooseFI Podcast for more insights and actionable financial advice!
Unlocking Financial Independence: Strategies for Early Retirement
Achieving financial independence (FI) is a journey that requires strategic planning and mindful decision-making. In this article, we will explore actionable strategies to guide you toward early retirement by leveraging insights from a recent discussion on the ChooseFI podcast. Whether you're just starting or you're already on your path to FI, the following recommendations are designed to optimize your financial decisions.
Understanding Your 401(k) Options
Transitioning your 401(k) contributions to a traditional setup is a foundational step toward financial independence. Here’s how to effectively manage this important retirement account:
Max Out 401(k) Contributions
Aim to max out your traditional 401(k) contributions each year. For 2023, the contribution limit is $22,500 for those under 50, with an additional catch-up contribution limit of $7,500 for those 50 and older. This not only boosts your retirement savings but also reduces your taxable income.
Optimize Fund Choices
Instead of sticking to a target date fund, consider reallocating your 401(k) investments into lower-cost index funds such as the S&P 500. Focus on the expense ratios of your investment options. A lower expense ratio can significantly enhance your long-term returns. For example, if you have a fund with a 0.2% expense ratio, but can switch to one with a 0.03% ratio, the savings over time can be substantial.
The Power of Employer Stock Purchase Plans (ESPP)
Participating in an Employer Stock Purchase Plan can provide a unique investment opportunity. Here’s how to make the most of it:
Understand the Risks and Rewards
ESPPs often allow employees to purchase company stock at a discount (commonly around 15%). While this can provide immediate value, consider the risks associated with a lack of diversification. Holding a large portion of your wealth in your employer’s stock can be precarious, especially if the company faces challenges.
Develop a Selling Strategy
Once you’re eligible to sell your shares, don’t wait too long. Strategically sell shares to maintain a balanced investment portfolio. Aim to liquidate older shares to maximize your long-term capital gains tax benefits while being mindful of any potential loss aversion that can hinder timely decisions.
Leveraging Health Savings Accounts (HSAs)
HSAs offer a triple tax advantage that can be an incredible asset on your financial journey. Here’s what you need to know:
Utilize HSAs for Tax-Free Growth
Contributions to HSAs are tax-deductible, funds grow tax-free, and withdrawals for qualified medical expenses are also tax-free. This makes HSAs an excellent vehicle for both healthcare spending and long-term investment growth.
Keep Track of Medical Expenses
To maximize the benefits of your HSA, consider paying out-of-pocket for medical expenses and letting your HSA funds grow. Save your receipts for reimbursement later, benefiting from tax-free withdrawals.
Tax Optimization Strategies
Effective tax planning is crucial to enhance your wealth-building potential. Here are some strategies to consider:
Focus on the Bigger Picture
When making financial decisions, it’s important to not let tax implications dictate your choices. Avoid the “tax tail wagging the dog” mindset; instead, prioritize decisions that align with your overall financial goals, even if they entail paying taxes now.
Employ Tax-Loss Harvesting
If you have stocks with unrealized losses, consider selling them before the end of the year to offset any capital gains taxes. This strategy can effectively reduce your tax burden while allowing you to reinvest those funds into more favorable investments.
Key Takeaways for Your Financial Journey
- Transition to a Traditional 401(k): Move your contributions to a traditional 401(k) and aim to max it out.
- Focus on Expense Ratios: Prioritize low expense ratios in your investment selections for long-term gains.
- Participate Wisely in ESPPs: Take advantage of ESPPs but maintain diversification in your portfolio.
- Maximize Your HSA: Utilize HSAs effectively for tax-free growth while keeping track of qualified medical expenses.
- Make Informed Tax Decisions: Avoid short-sighted decisions based on immediate tax implications; focus on your wealth-building strategies.
Final Thoughts
Embarking on the journey to financial independence requires a proactive approach and a solid understanding of your financial tools. By incorporating these strategies into your financial plan, you can position yourself for an earlier retirement while maintaining financial security. Remember, the path to FI is unique for everyone; continuously educate yourself, adapt your strategies, and make informed investment decisions to unlock your financial potential.
For further resources and insights into building your financial future, visit the ChooseFI website and tap into the knowledge of a community dedicated to financial independence.
Households of FI - Kristi
What You'll Get Out Of Today's Show
- In our eighth Households of FI touchpoint episodes, Kristi was successfully following the standard path with a six-figure job and keeping up with the Joneses but waiting to take a breath and enjoy life. After finding FI, she realized the money was no longer the goal but simply a tool.
- Kristi has been connected with Big ERN, from Early Retirement Now, and over several conversations, they discuss Employee Stock Purchase Plans, 401K contribution strategies, the phase of retirement, and more.
- While wealth accumulation is simple math, decumulation is more complicated so Big ERN created the ultimate safe withdrawal rate series.
- Some recent changes Kristi has made to her investments since starting her path to FI are moving from a Roth 401K to a traditional 401K and maxing her contributions out. She also moved her current balance and future contributions out of target retirement date fund and into an S&P 500 fund.
- While Kristi has the option to self-manage her 401K in a Schwab account which would give her access to a total stock market fund, Big ERN doesn't believe that the difference between it and an S&P 500 fund is minor. Expense ratios are a more important consideration. Moving from a 0.2% expense ratio to a 0.02% might be worthwhile, but leaving the money where it is fine when the difference is 0.01% unless it is an in-kind transfer or a quick process. Human Resources may know how long the process is likely to take.
- Kristi approached her HR department about making after-tax contributions so that she could do a mega-backdoor Roth conversion, but the HR department was not clear on how much she would be allowed to contribute. She found the ChooseFI community to be quite helpful for bouncing ideas off of.
- She's also interested in her company's Employee Stock Purchase Plan (ESPP). The advantage of it is that she can purchase stock at a 15% discount, but she will pay taxes on the discount and be required to hold the stock for two years.
- Such a purchase gives her investment a 5% per year boost, however, there's no diversification in purchasing company stock. Kristi's income, bonuses, and employment are all already tied to her company. That being said, Being ERN says he would probably still do the ESPP, although he would only keep two year's worth of money in the plan and then pull it out. After taking it out, it will be subject to long-term capital gains.
- The ESPP may have contribution limits, in which case she should make the additional contributions to her 401K and then do the backdoor Roth conversions.
- Big ERN likes to say don't let the tail wag the dog, meaning that asset allocation and expected returns should be the primary concern before tax considerations.
- Kristi has a difficult time determining exactly how much to contribute as her company does it by percentage and how bonuses are paid out. If she overshoots it, she could miss out on the company match in the last month of two of the year. Big ERN says some companies will do a true-up, or another HR term, where they will still contribute the match.
- Some who have access to a true-up prefer to contribute the maximum to their 401K at the beginning of the year so that their money is in the market longer.
- Those without a true-up need to be careful. Big ERN suggested Kristi could look at the minimum and maximum of her salary and bonuses to come up with a range. $19,500 divided by her maximum would give her a rough percentage to start the year with. Toward the end of the year, she will need to look at it again and make adjustments.
- Kristi also asked about Big ERN's thoughts on the stages of retirement, but she is most interested in the early retirement phase.
- Retirement is an uneven path. Health expenses may be higher before Medicare kicks in and there will be a boost of income once Social Security is received. How do you structure your withdrawals? What are the tax aspects? Which accounts do you tap into first? And what should the assist allocation be?
- Big ERN doesn't recommend 100% equities for people in retirement. 75% stocks and 25% bonds is a better allocation.
- Kristi will likely have to rely on more than just her taxable accounts during the early retirement phase. She could tap into her Roth IRA accounts as well which may get her to 59 1/2 when she could then begin withdrawals from her 401K tax and penalty-free.
- It's best to spread the tax liability as equally as you can due to our progressive tax system. Although trying to optimize taxes is important, safe withdrawal rate and asset allocation are significantly more so. Not all of the withdrawals in retirement are taxable. Some of the withdraw money is principal, which taxes were already paid on.
- Good tax planning versus alright tax planning in retirement probably doesn't make a significant difference.
- Kristi was also curious about when contributing to taxable accounts might be advantageous over continuing to fund retirement accounts for those who want to retire early. Big ERN thinks what there are cases when it might make sense, but for most people who can assume they will be in a lower tax bracket in retirement, it's better to fund retirement accounts.
- Previously, Big ERN had provided Kristi with a spreadsheet to use for determining cash flow issues before she turns 59 1/2 and model Roth 401K conversions.
- Kristi says that she has been participating in her company ESPP but hadn't sold any of the company stock until recently. She debated how much to sell and still has a lot remaining. Big ERN suggests that she could sell over a period of time to avoid any regret that might occur with a large price increase. However, there could be commissions associated with selling. As long as she's held it for more than two years, it's all subjective to long-term capital gains or will help with tax-loss harvesting. Low-cost shares with the highest capital gains should be deferred as long as possible.
- A little tax-arbitrage is the sell the investments with the highest cost-basis and lowest tax bill.
- Big ERN mentions that a lot of people have loss aversion but sometimes it's best to cut your losses, let it go, and take the tax benefit.
- Kristi has concerns about HSA rules changing after she's stashed all that money away and paying out-of-pocket for medical expenses. HSAs, however, have a triple tax benefit. there are no taxes paid on contributions, the money grows tax-free and comes out tax-free as long as it's used toward qualified medical expenses.
- HSA participants can save their receipts and allow the money to grow. Current or previous years' health expenses may be submitted for reimbursement.
- In the United States, rules tend to be backdated, so that if HSA rules do change in the future, the old rules will likely still apply to the contributions. Still, Big ERN suggests not letting the HSA grow to more than 15% of total net worth.
- It's important to note that not all target-date funds are the same. The closer the retirement date, the more conservative the fund is going to be. For most people, a total stock market or S&P 500 fund with a low expense ratio is good enough.
- Taxes shouldn't drive decision making. Make the best moves that impact you over the long-term. Buying a house for the mortgage interest deduction makes no sense for most people with the new higher standard deduction.
- When it comes to tax deductions, the point isn't o get a deduction just to get a deduction, it's to bring home more income
Resources Mentioned In Today's Conversation
- Take control and build your plan for financial independence today with NewRetirement and get 14 days for free
- ChooseFI Episode 221 Introducing Our Households of FI!! Part 1
- ChooseFI Episode 224 Introducing Our Households of FI!! Part 2
- Early Retirement Now
- Invest in low-cost broad based index funds with M1 Finance
- ChooseFI Episode 035 Sequence of Return Risk | Early Retirement Now
- ChooseFI Episode 019 JL Collins The Stock Series Part 1
- Is an Employee Stock Purchase Plan (ESPP) Better than a Retirement Account?
- Get on our email list and start on your own path to financial independence