401ks Are Your Friend: Demystifying Personal Finance Part 3

Shockingly, I'm not a financial professional either

Shockingly, I’m not a financial professional either

Welcome to Part 3 of our Demystifying Personal Finance Series! This series is all about how to assemble a sound financial life as a young professional, though many of the topics covered are useful to folks of all ages. The series also serves as a reflection of the steps Mrs. Frugalwoods and I have taken to stay debt-free (other than our mortgage), save 71% of our incomes, max out our 401ks, avoid the lifestyle inflation trap, and map a plan for reaching financial independence in 2.5 years at age 33. A quick disclaimer: I am not a financial professional in any sense and am just some guy on the internet. Contrary to popular belief, Frugal Hound is also not a financial professional.

Saving for Retirement (And Why You Should Start ASAP)

Once you have your high interest debt under control, as we discussed in Part 2 of the series, it’s time to start thinking about the future. When you’re 24 (or even 34), retirement seems like a ridiculously long time away. And, unless you’re retiring early thanks to some extreme frugal weirdo actions, it is! But even if you’re not planning to retire until a more traditional age than Mrs. FW and I, you’ll still want to get started as soon as possible in order to retire comfortably.

There’s a famous parable (well, it’s famous in my mind) that addresses the importance of starting to save early. I call it the tale of Anna and Mauricio.

Anna and Mauricio are both 23 years old when they land their first “real” jobs. Anna starts saving into her 401k immediately at the rate of $300/month. Conversely, Mauricio waits 8 years (until he’s 31) to start saving into his 401k and then contributes the same monthly amount as Anna.

Anna stops contributing to her 401k at age 33 (which represents 10 years of saving) and Mauricio continues to contribute until he’s 65 (which equals 34 years of saving).

Assuming an 8% annual growth rate (which is considered a conservative and standard rate of return), who has more in their retirement account when they hit 65? Anna.

Did I blow your mind? Put another way, Mauricio NEVER catches up. How crazy is that? Anna’s 10 years of saving beats Mauricio’s 34 years of saving. Now THIS is why compound interest is a magical unicorn of awesomeness.

For more awe-inducing math, take a look at this sweet graph of their earnings:

Graph showing how saving for retirement early pays off huge.

Mauricio never catches up!

This graph is both inspiring and terrifying!

It’s one thing to intellectually internalize the power of compounding interest, but it’s quite another to look at a graph like that and meditate on your own preparations thus far.

As Frugal Hound is fond of saying… the best time to start saving for retirement was 10 years ago. The second best time is today! No matter where you are in the journey of saving for old age, it’s always a good idea to re-asses and determine if you should be putting more towards your future.

How Much Should I Save For Retirement?

Does this beard help my retirement strategy?

Does this beard help my retirement strategy?

If you google that phrase, you’ll find myriad benchmarks and theories. And in reality, the question you want to ask is “how much money will I need in order to safely retire?” Once you know that dollar amount, you can work backwards to ascertain how much you should be saving at present.

So how much do you need to retire comfortably? There are several different ways to address this, but the standard answers fall into just two categories

1) 8 times your final salary:

  • This is traditional retirement advice, which assumes that in retirement you’ll spend about 80% of what you spent while you were working.
  • However, I don’t find this particularly useful. Why? Our salaries have no bearing whatsoever on how much money Mrs. Frugalwoods and I spend every month. Since we live well below our means (to the tune of saving 71% of our incomes), this metric is essentially meaningless for us and anyone else on a similarly frugal path.
  • Obviously, how much you’re going to spend in retirement has a huge effect on how much you need to save.

2) Enough to live on 4% per year of your savings:

  • This is much more modern advice, which is modeled off of academic work demonstrating that a well-diversified portfolio will last throughout retirement if you begin by taking just 4% out per year and adjust for inflation.
  • The magic of this retirement savings approach is that the amount you need is directly controlled by how much you spend. If you’re currently behind on saving for retirement, my advice is to start living more frugally AND start saving more. That way, you’re working at the problem from both ends. And by permanently reducing the amount of money you need every year (as Mrs. FW and I have done), you’ll permanently reduce the amount of money you need to save for retirement.

OK, Mr. Frugalwoods, we get it, clearly we need to save for retirement. But how much per paycheck should we save?

Do I have enough saved for retirement?

Do I have enough saved for retirement?

This is highly dependent on your personal situation. That answer’s not a cop out, I swear! Here are the two elements that should determine this dollar amount for you:

1) The amount you’ve already saved.

2) How much money you plan to spend in retirement.

Since I realize #2 might seem nearly impossible to determine at this stage of life, here’s the Frugalwoods rule of thumb: Aim to save 10% of your salary for retirement your first year out of college. Each subsequent year, add another 1%, with the goal of reaching the maximum tax deferred amount per year ($18,000 in 2015) by the time you hit 30. This is precisely what Mrs. FW and I did and we hit the $18k per person per year level at age 29.

Is this an aggressive savings rate? Heck yes. But did you expect anything different coming from us notorious frugal weirdos? Further, it’s been my experience that as people stroll into their mid-thirties and have kids, a mortgage, and a stay-at-home spouse… retirement savings suddenly become much harder to come by and a much lower priority. So, you might as well get a solid foundation nice and early.

But How Do I Actually Save For Retirement?

Now that I’ve hopefully scared you into motivated you to save for retirement and given a guideline for how much to save, where should you actually put your money?

This is the part that seems to intimidate my friends and coworkers the most. They know they should be saving, but the actual mechanics baffle them. Well friends, be baffled no more! It’s actually pretty straightforward once we break it down. So don’t be deterred!

If your employer offers a 401k (or a 403b* if you work at a nonprofit), you should use your employer’s program. Hopefully they match a certain amount of your contributions. But even if they don’t, the ease of automated savings is worth using your 401k first.

*The rules governing 401ks and 403bs are identical, so I’ll just use the term 401k from here on out, but if you have a 403b, all of these guidelines apply to you as well.

So what’s a 401k anyway?

  • It’s a tax-deferred savings account. This means you don’t pay income taxes on the money you put into your 401k, but you will pay income taxes when you withdraw your money in retirement.
  • You’re allowed to put a maximum of $18,000 per year into your 401k (in 2015).
  • Employers can choose to match your contributions with money of their own:
    • These matching funds do not count against that $18k limit.
    • My employer is very generous and matches up to 8% of an employee’s salary in 401k contributions. That means I put in my $18k every year and my employer kicks in an additional 8% of my salary.
    • Matching funds are free money. I can’t stress this enough, people. If your employer offers matching funds and you’re not taking advantage of it, you are literally leaving free money on the table. For this reason, matching funds are a major consideration for Mrs. FW and I when we evaluate potential employers.
  • You can begin to withdraw money from your 401k when you’re 59.5 years old. Prior to that age, you’ll pay a penalty to withdraw the money. For this reason, you shouldn’t ever liquidate a 401k prematurely except in the case of a life-shattering emergency. A 401k is not your emergency fund and it’s certainly not your “I’d like to buy a boat” fund.

How does money get into my 401k?

  • Money is automatically taken out of your paycheck and direct deposited into your 401k at the rate you specify. You don’t have to move money into a 401k manually, it’s a “set it and forget it” automatic deduction every month.
  • You can take your money with you when you change jobs:
    • You have a choice of either transferring the funds into your new employer’s 401k program or “rolling over” your 401k funds into an IRA. Usually, rolling into an IRA makes the most sense.
  • What is vesting?:
    • When greyhounds wear trendy vests.
    • Some employers have a “vesting schedule” for their employer matched 401k contributions. This means that you need to stay with that employer for a certain number of years in order to take the employer match portion of your 401k with you. Your contributions are always yours regardless of a vesting schedule.
    • My employer has a three-year vesting schedule. So if an employee at my company left after two years, they’d take all of their 401k contributions and 66% of the employer match with them when they left. Obviously, it’s best if you can remain at a job until you’re fully vested so that you can take 100% of your employer’s matched funds.
    • Not all employers have a vesting schedule, however. Mrs. FW’s doesn’t and so she’s eligible to take her contributions and her employer’s matching funds at any time.
All of Frugal Hound's money in the world!

All of Frugal Hound’s money in the world!

If your employer doesn’t offer a 401k program, you can use an IRA. The limits are lower, and the contributions aren’t quite as automatic, but any brokerage (such as Vanguard or Fidelity) can help you set one up.

To start saving into your 401k, just talk to your friendly HR department. Most companies have a form for you to fill out specifying how much you’d like to save per paycheck (remember, start with at least 10%!). Then, you can set up an online log-in (very similar to online banking) so that you can observe your 401k funds.

Once you’ve set up your 401k, there are two more important decisions to make: Roth or Regular, and what to actually invest in. Not to leave you in suspense, but, this post is already super long so I’ll tackle those considerations in Part 4 of the series.

As with all aspects of personal finance, the first step in saving for retirement is to take a proactive role and educate yourself. The very fact that you’re reading this means you’re well ahead of the majority of Americans. Don’t stress over past financial transgressions and don’t beat yourself up if you haven’t started saving for retirement yet. Start now and commit yourself to an aggressive savings rate that your future self will thank you for!

Want to make sure you’re among the first to receive Part 4 delivered hot and fresh to your email machine? Sign-up in the Frugal Hound email box below and she’ll send you a message.

Are you saving for retirement? What advice, or questions, do you have about the process?

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85 Responses

  1. I only get 401k access when I’m working through Actors Equity and that’s very unpredictable- so I save independently of my actor employment situation using an IRA. Limits are SIGNIFICANTLY lower though (not that I could set aside more than 5500/year at this point)

    • Mr. Frugalwoods says:

      Isn’t it weird how the limits are so restricted for people without a traditional full time employer? Makes no sense to me!

  2. Laura says:

    Is a 401k in addition to a pension? Or is a 401k what employers offer instead of a pension? Just curious, as I’m in Canada. We have RRSPs for tax deferred savings… I wish I had learned all of this stuff when I was 23 and just started working. *sigh*

    • Tasha says:

      A 401k is separate from and in addition to a pension. My job has both and requires employees to contribute a certain amount into the pension (1.3%) but participation in the 401k plan is entirely optional. Of course, I do participate in the 401k program for all the reasons mentioned above (employer matching, tax savings, etc.).

      • Mr. Frugalwoods says:

        Great that your employer offers both! Depending on your career goals, pensions can often be a really good deal. Depends on the plan and your tenure though.

    • Mr. Frugalwoods says:

      Yep, in addition to a pension. Pensions are often also called “Defined Benefit Plans” which is a good description of what they are. You pay in a certain amount, and you get a defined, known payout every year in retirement.

      Some employers offer both a pension and 401k, though in the US pensions are getting to be very rare and 401ks are vastly more common.

  3. Amy@DebtGal says:

    I haven’t worked full-time in several years, so I haven’t received an employer contribution for a while. I had one employer (when I worked full-time), who required that employees contribute at least 2%, and they contributed 13%!! Fortunately, my husband has been contributing to his 401K every year, and I have a Roth IRA. It’s been kind of neglected lately, though, as debt repayment has taken center stage in our financial life. Oh, and you’re so right about expenses increasing in the thirties!!

    • Mr. Frugalwoods says:

      Wow, that’s a wild match! Debt repayment vs. Retirement is tricky, but sounds like you are walking that line carefully.

  4. bev says:

    Thank you, thank you, thank you, Mr. FW. If anyone out there is reading these comments, please let me reiterate what Mr. FW is saying and emphasize how correct he is. None of this was taught to us when we were young, and finances were a taboo topic for many in my generation….let’s just say much older than Mr. and Mrs. FW. It wasn’t polite to talk about money, and there was no such thing as an internet. And also, my previous employer years ago, never “advertised” their retirement program. It was there to take advantage of, but you had to ask for it. I never did. Please start contributing now, I promise you won’t miss it after a few short months, and you’ll be far ahead of the game. We didn’t, and we’re paying for it now. We’ll be ok when we retire, just ok, but we could have had a far nicer retirement and peace of mind in old age if we had been smarter when we were young.

    • Mr. Frugalwoods says:

      Oh thanks Bev! I always tell new employees at the company I work for to signup from the first paycheck. It’s so true that it’s hard to miss what you never experienced in the first place.

      I’m actually of the opinion that companies should auto-enroll their employees from the start in a 401k program, and then allow them to opt out of they choose. Let people’s indecision and lack of info work in their favor!

  5. Kalie says:

    This is a very helpful post! Just curious–at what age did you start saving for retirement?
    The idea that you don’t need as much to retire if you live on less all along was kind of an epiphany to us a couple years ago. We see no reason to increase our lifestyle, as our family of four lives quite well on less than half our one income. It’s all about being content with what you have, rather than feeling like you’re deprived. That helps us stay motivated.

    • Mr. Frugalwoods says:

      We both started tax advantage retirement savings when we got our first jobs out of college, so at ~22. We’ve steadily increased since then, both in overall salary and in the percentage of salary saved.

      Being content sure is the key. Makes everything easier, finances included!

  6. 8% match from your employer is HUGE! I’d love to know the percentage of employees at your company that actually max out that match.

    • Mr. Frugalwoods says:

      I don’t know the percentage of employees that make the full 8% contribution, but overall participation in the program at any level is at 90%. I also do regular sessions on saving for retirement, which always results in a bump in participation afterwards. Funny part is, I’m not in HR. Just enjoy this stuff!

  7. Going to graduate school and entering the workforce at the old age of 27 has made me self conscious about my savings. I understood the parable of compound interest when I was 16, but didn’t really have an opportunity to do anything about it until recently, which is why I feel so behind with my saving. I wonder if there is a savings number that will make me feel caught up or if I’ll always feel behind. I have savings comparisonitis.

    • Tasha says:

      I’m right there with you Kate. I finished grad school at the ripe old age of 29 and had zero savings to my name. I started off saving the minimum I needed to to max my employer match (because who leaves free money on the table?) and have slowly increased it over the past four years. We’ve managed to save 90k, which is not too shabby for baby steps.This year will be my first year hitting the magical $18,000 number. My SO will also hit $18k this year.

      If we just saved that and nothing else, we’ll have $1 million in 11 years and $2 million in 18 (assuming an 8% rate of return). That’s pretty darned sweet. So yeah, try not to worry too much about the late start. You can still get to a great place if you start saving now. 🙂

      • Mr. Frugalwoods says:

        Hey, that’s a great savings rate! Maxing out after only 4 years the workforce is pretty darn awesome!

    • Mr. Frugalwoods says:

      Well, you have a good reason for delaying… a law degree can be a solid career investment!

      The classic “You Should” advice about retirement savings benchmarks is that you should have 1x your current salary saved by the time you are 30. While that’s not quite FI territory, I think it’s a worthy goal… especially for someone who started earning later (but hopefully with higher earning potential).

  8. My wife works for the state and has a much smaller salary than me. We weren’t maxing out my contributions yet so we figured why look into hers as an option until I’m maxing out mine first? Well holy crap were we wrong!

    They offer some nice vanguard funds with low fees, and on top of that, they offer both a 401k and a 457b! Both have identical fees/fund selection. The 401k has no match.

    The only difference between the two is that 457b contributions don’t have any early withdrawal penalty (as long as you aren’t working for them)! So there is literally no reason to choose a 401k instead. I’m still baffled as to why both exist when the 457 is far superior. This will be a bridge to retirement for us, and we’re going to work on maxing this out before I max my 401k out!

    On top of that, we can max out the 457 and the 401k together! So theoretically, we could be saving 54k pre-tax (I wish).

    And Mr. FW, sucks about the vesting. We have a similar schedule for ours at my work.

    • Kent says:

      Being a state employee, I’m going to have to go take a closer look at my 457 plan now too, thanks for the comment. I didn’t start contributing right away (~4 years in) and the match was just $50 per month. But still, it was $2K left on the table so I’m kicking myself occasionally.

      As far as the state pension goes, I don’t vest until 7 YEARS in and it’s an all or nothing game if I change employment before that. But I guess that’s the sacrifice made for a defined benefit plan.

      • Mr. Frugalwoods says:

        Yeah, definitely look at the particulars of your plan. But generally 457s are the gold standard of tax deferred retirement savings. So much more flexibility than a 401k. Wish they were more common!

    • Mr. Frugalwoods says:

      Yep, I didn’t mention 457s since they are relatively rare… but they are an amazing vehicle for (early) retirement savings. And the ability to save 2x the amount of a single 401k is wild!

  9. Absolutely this: “And in reality, the question you want to ask is ‘how much money will I need in order to safely retire?’ Once you know that dollar amount, you can work backwards to ascertain how much you should be saving at present.”

    I would just tweak a little that priceless question in Mr. FW’s article. I would ask myself “WHEN do I want to retire and how much money will I need in order to safely do so?” THEN back calculate.

    The first time I ran those numbers, I did not like the answers I got. To allow for my then current spend rate, I would have to stay at my job much longer than I wanted to. So I took a frugality scalpel to my annual basic expenses and cut them by 42%. Then I ran the calculation again and came up with an answer I could live with and make work.

    Anyway, doing a back calculation my way or Mr. FW’s way is an eye-opening and highly recommended process.

    • Mr. Frugalwoods says:

      Frugality is so magic when it comes to planning for retirement. It’s works on the problem from both ends! I can’t tell you how many people fundamentally don’t understand that coupling of input and output. Thankfully we have the internet!

  10. Pablo says:

    You can actually withdraw money from your 401k at age 55 without penalty, provided that you are quitting, retiring, or even having been fired from your job. Mind, this does not work if you leave your job and rollover your 401k to an IRA. This is seldom discussed in the retirement blogosphere, and I am at a loss as to why.

    • Mr. Frugalwoods says:

      Yeah, that is certainly true. Only for the 401k of the employer you are retiring from though. Usually that isn’t a problem as long as your employer allows you to “roll in” previous 401k accounts.

  11. Norm says:

    I’d love to add one caveat, which was the focus of my recent post “For The Love Of God, Don’t Max Out Your 401k!,” that 401k providers can absolutely destroy your savings with their fees. If your employer offers a god-awful 401k plan, there are other savings vehicles which will outperform the 401k.

    I have another post going up, some day, ranking a variety of retirements accounts and variables based on their 20 year return. A high fee (~2%) 401k comes in dead last if you are in the 15% tax bracket, even worse than using a normal taxable account! But I agree on the matching. A high fee account WITH matching is actually very good. But you have to be careful! The fees will literally eat you alive.

    I started maxing out my 457 plan because, like Chris said above, I figured out that the penalty-free withdrawls would be very advantageous for early retirement. Conversely, Marge only contributes up to the match of her retirement account because it is one of those aforementioned high-fee 401ks.

    • Mr. Frugalwoods says:

      457s are amazing and I am jealous 🙂

      Fees can be killer. Thankfully *most* 401ks have at least one (many times only one) relatively low cost index fund. Hopefully that trend will continue.

      Getting employees to pick that single low fee index out of a list of 60 craptastic funds is a challenge though. Even at my progressive employer with a “good” plan… there are only 3 out of 40 funds with an ER of less than 0.10

  12. I’m close to maxing out my 457 plan and trying to do the same for my wife’s 457. We both have a roth IRA but need to increase contributions to that as well. I’m not sure whether the Roth 457 or the traditional 457 is better for us since we’ll also have a pension. I guess it depends on if we retire early (in our 40s). The pension is a bit of a golden handcuff for me. Age 55 is still early for most people but reading PF blogs…I’m looking at earlier.

    • Mr. Frugalwoods says:

      Hooray 457s and the full max!

      Yeah, the roth vs. regular can get really complicated. Combined with a pension… _very_ complicated!

  13. MEL810 says:

    OMG! Frugal Hound is NOT a financial professional? Another one of my illusions shattered:>
    My employer (State of VA) offers both a standard pension plan and a deferred comp. I am vested on the standard plan after five years.
    The deferred comp is matched up to $40.00.
    I do both plans. I have two regular savings accounts and am going to open a ROTH IRA this month.
    One of the biggest favors parents and/or our schools could do for kids is to give them a contemporary financial education.
    I, unfortunately, did not receive either. My parents were a financial mess and fought about money continually. School didn’t offer one damn thing until I took a business math course in college and that only taught a few basics. A lot of my boomer generation is bliss ignorant about finance. Many of us expected the old pensions and social security and savings accounts/savings bonds of our parents’ generation to suffice and didn’t know what to do when this changed. That is one reason I think so many people in that generation do things like fall for Ponzi schemes like Enron, Madoff, etc..
    I am learning the hard way later in life but am starting to catch up. Thankfully, I never fall for get-rich quick stupidity and I am resourceful and am finding extra ways to earn and prosper.

    • MEL810 says:

      I might add some of my Boomer generation was a bit lost in space about many of life’s practicalities (Me until I hit 45!). And some of were a tad on the lazy and/or entitled side. (Not me.)

    • Mr. Frugalwoods says:

      Sorry to burst your frugal hound bubble, Mel 🙂

      A pension that vests after only 5 years is pretty good. And diversifying your savings vehicles by also doing the deferred compensation is a great idea.

      It does seem like there was a generational disconnect when companies stopped “parenting” their employees by providing lifetime pensions and switched to the 401k model.

      While the old pension model wouldn’t have been great for us in our frugal weirdo situation… it would be better for the vast majority of people.

  14. Bre Christian says:

    I can’t wait for Part 4! My husband and I are regular readers and we always appreciate how you put financial lingo in an understandable format. We both have 401ks right now and regularly contribute, but following your rumblings about retiring early have kicked us into high gear. Keep up the good work Frugalwoods and don’t stop those greydorable pictures (greyhounds are so adorable they need their own adjective)!

    • Mr. Frugalwoods says:

      Hey thanks Bre! Frugal Hound does usually steal the show on the blog… a she does in real life 🙂

  15. If you work and company has 401K, you should be contributing for the match and for the tax savings. For many people it will be their only retirement account, because many people don’t do Roth IRAS. Which is unfortunate.

    • Mr. Frugalwoods says:

      Definitely. We’ll talk about Roth’s in the next installment… but I tend to think most people will be served better by a traditional. I’m sure there will be a great debate 🙂

  16. I max out my pre-tax 401k. Luckily I think we’re charged a measly $40 a year in admin fees, and it is ran through Vanguard, which I’m thrilled about. Unfortunately I cannot contribute to a traditional IRA, so I’m stuck with a Roth.

  17. Great suggestions! I didn’t start out quite as aggressively as you suggest, but I did start out at 5% when I was 19 years old (still in college). I chose 5% so I could get the full employer match. Since then I’ve increased my contributions by 1% almost every year (except 1 year). I also get a larger employer match at my current job than my previous job which also helps my savings grow quicker.

    • Mr. Frugalwoods says:

      5% at age 19 is outstanding! It is wild to think how different some employers are from others when it comes to retirement benefits. I’m always astonished to realize that there are some people in my office who don’t contribute enough to get the match! Free money is a heck of the thing to turn down.

  18. Frugal Hound needs a piggy bank!
    Oh yeah I’m saving away with an AWESOME match. Good info, FW!

    • Mr. Frugalwoods says:

      Frugal Hound’s money is in a trust, or else she would spend it all on anchovies and squeaky toys. 🙂

  19. The hubby has a 403b. We started out many years ago with the percentage that his work matched and have slowly raised it to 10%. We would love to contribute more to our Roths as well. I’m thrilled that the hubby loves investing and stays on top of it all!

  20. Greypaws says:

    At what rate are you figuring inflation? I think that needs to be taken into account and added when planning for retirement.

    When we were young we sucked at saving, until we discovered auto-paycheck deductions. We started out with 12.00 a week, there after each raise DH received, 1/2 went to savings and 1/2 went to us. Doesn’t sound like much but hey, one needs to start somewhere. We’re old and also came from the generation that knew very little about investing. In all fairness, 50 years ago one could retire at 65 from the job they got right out of high school at 18 with no additional schooling, have a nice employer funded retirement, plus their SS. The savings bank offered 5% + rate and if you had stocks or bonds, they gave you a good return. Butter was also 8 cents a pound, which does us no good when we go to the store today.

    • Mr. Frugalwoods says:

      Inflation is mighty important. The 4% figure I referenced as a safe withdrawal rate is the result of research that did take into account inflation when running it’s simulations, so I feel pretty confident sticking to that rule of thumb is at least a good starting point.

      It’s funny though, thinking back, that interest rates have been so low for so long. My folks talk about buying their first house for crazy rates in the early 80’s… but I’ve never experienced an inflationary period anywhere close in my time as a financially cognizant adult. I’m sure it must be unnerving!

  21. Even Steven says:

    What a great company match, icing on the cake of course with all the savings you put towards your 401K.

    • Mr. Frugalwoods says:

      Yes it is! One of the reasons I’ve worked for the same place for 8 years running. Heck of a stimulus for the retirement accounts.

  22. I miss my 401k. That’s one huge downside of working for yourself. “If you’re currently behind on saving for retirement, my advice is to start living more frugally AND start saving more.” I would also add to try and earn extra money!

  23. We are trying to get more systematic about our retirement savings, which we’ve been inconsistent about. (We have never, however, left matching funds on the table.)

    I’m actually really frustrated by my state employer’s system. They take away 8% of my money, whether I want them to or not, and invest it in the state defined contribution plan. They put in money, too, but that only vests if I stay five years. Then that’s all locked away until I’m 60.

    If I leave before the five years, they give me back my 8% as a lump payment, plus a whopping 3% interest.

    Don’t get me wrong, I’m all for automatic enrollment plans and Social Security, but… I dunno, it feels like they’re stealing my money. At least if it was a 401(k) with matching funds, I would get to choose how the money is invested, but this way, they just… take it and do what they like with it. Sigh.

    • Mr. Frugalwoods says:

      Yeah, that’s a tough one.

      I should write a post about this, but one of the things that fascinates me about frugality and Financial Independence is how our success is at the same time the downfall of most normal folks.

      For the normal person, a pension is a great thing. They can’t spend it, can’t get a loan against it, and they don’t have a choice but to contribute to it. It starts automatically and they never even miss the money. And while the returns may not be spectacular, they usually are pretty safe and predictable.

      As opposed to 401ks which allow savvy folks like us to shoot ahead financially, while allowing the vast majority of folks to shoot themselves in the foot.

      I don’t exactly feel guilty, but I do puzzle over how what’s good for me (and for you!) is an overall terrible system for the vast majority of people.

      Anyway, like I said, probably a post in there somewhere 🙂

  24. Shannon says:

    I recall sitting in a first time homebuyer’s class in my 20s (required for the type of loan I got) and they showed this amazing table of Person A contributing just for the first 8 years of their working career, then Person B contributing for the last 30+ years. Person A put far less in but had way more money at the end! It stuck with me forever even though I was aware of compounding interest. Putting savings on hold can be detrimental! I think I could only start with $50/month in the beginning but that is better than nothing.

    We do save for retirement and ER is a priority of ours. We don’t have the option of 401ks. However, our employer gives us a non-matching 401a at 14+% of our salaries. Many people only have this and can retire at 65. We chose to open several other accounts offered through our workplace and max them out such as HSA, Roths, 457bs, 403bs for each of us. The 14+% plus the 55% we are putting on ourselves, we’re almost at the equivalent of 69% of our incomes being saved. Most of them are pretax accounts so we can lower our current taxable income. We need to, however, look at the various companies we can use (Fidelity, TIAA-CREF, etc) and see where we can lower our fees. This will be kind of cumbersome but necessary!

    The 457bs will be our early retirement income to get us from ages 44-59.5, with the help of the HSAs for medical premiums/expenses. We max out the HSAs, but we do not touch them even if we have medical bills now. Then we also have backup plans, but calculations show we can make the 457b last for early retirement.

    • Mr. Frugalwoods says:

      Wow, that’s pretty amazing that you have all of that tax deferred space to fill up! Sounds like you are really on top of it and have a solid plan… well done!

  25. I started saving for retirement from my first job at 22 and while I am thankful that I did, I definitely wish that I saved more outside of my retirement account as well because a few years ago we sold some of our IRA money to fund the down payment on our home. It is a financial black eye of mine and it was painful to pay the taxes, but if I had that money outside of a retirement account, it wouldn’t have been quite so painful.

  26. Budget Beth says:

    I am vested in my employer’s pension and contribute to my employer’s 401K (but no match is offered.) I’m trying to systematically up my percentage to max out like you suggest. My husband works for a college and has one of the best matches ever…for every $1 he puts in they put in $3 up to 6% of his salary…so it’s more of a match plus plus… Love reading your posts!!

    • Gwen says:

      My employer matches 6%, but the first 2% is matched 300%. So, my 6% match turns into 10%! Mo free monies for me!

    • Mr. Frugalwoods says:

      Wow, match++! An old job that Mrs. FW had a few years back also did a $1 contribution gets $2 matching… those were some fine times!

  27. Gwen says:

    My first year of working, I put in 18% plus a 10% employer match in my 401k. I also managed to contribute a bit to my Roth IRA. This year, I bumped up my contribution to 25% to max it out (plus the 10% match), in addition to maxing my Roth. I feel broke but great! I’m 10% of the way to retirement!

    • Mr. Frugalwoods says:

      Wow! Superstar saver right here! I don’t know if I’ve ever heard of a first year saving rate of 18%!

  28. Heather says:

    I work in the public sector, so I have a 457b. As long as I contribute at least $50 a pay check, they’ll kick in another $10. I contribute a bit more than that, but hey, free money! We also have a mandatory pension and my time at my previous job carried over to my new job towards being vested. Yay!

    • Mr. Frugalwoods says:

      That sounds like a pretty good setup! 457’s are excellent vehicles for early retirement… I wish I could use one!

  29. I have 401(k) and IRA. I have increased my contribution to 401(k) by 20%. I think that would be enough to speed up the savings. Hoping that I could retire as early as 50 years old.

    • Mr. Frugalwoods says:

      It all depends on what you spend! Upping that contribution is great, but make sure to hone in your budget as well. Make those saved dollars go farther!

  30. Paul says:

    I’m reading this post with envy as an American living in Australia. Australia has a slightly different system called superannuation – instead of stashing pre-tax money, you pay a reduced tax rate (15%) on employer and employee contributions, and the earnings are also taxed each year. However withdrawals, once you reach a certain age, are then tax-free. Employer contributions are mandatory at 9.5% and going up to 12%. I think it’s not as good as the 401(k) system since taxation of the earnings in the middle slows the growth rate. Gotta let that wealth build first!

    However, unfortunately for me, the US government believes that all US citizens owe them taxes no matter where they live, and they don’t recognize the existence of foreign pension plans. So while the law is a bit murky, it looks like I may be charged massive punitive taxes by the IRS on any growth in my superannuation account, which will make it difficult to save anything. I also can’t buy mutual funds in Australia even with post-tax dollars without getting slammed with annual punitive taxes by the IRS as an American with an “offshore” investment account (apparently the fact that I’m also offshore is not relevant).

    US residents are so lucky to have tax-advantaged savings plans, and many other countries have similar systems. If only the US would allow its overseas citizens to participate in their employers’ retirement plans without tax penalties.

    • Mr. Frugalwoods says:

      Hey Paul! I assume you’ve talked with a CPA who is familiar with international tax treaties? I know there are tons of obscure rules that change all the time, but that usually living overseas ends up about break-even compared to living in the states as long as you have a good accountant and can shift money around appropriately.

      No idea what your employment situation is, but I do have some software engineering friends who do work for overseas companies and have actually setup their own US company for the foreign “employer” to pay. Whether this makes sense depends on your particular tax situation as well as Australian and US law… but it might be something to bring up with your CPA and Tax Attorney. Unfortunately I think living and working overseas pretty much requires professional legal help to make sure you don’t get screwed by taxes.

  31. Emmaline says:

    Excellent post! It’s always great to start early. My then boyfriend now husband started around 26. We’ve been maxing it out or close to the limit ever since. With the matching we have more than 600K(woot!) in it now. You should see the smile on his face everytime he checks it out!

  32. Some companies (my husband’s) also have a 401a – which is a mandatory contribution, and doesn’t count against your 18k limit (yay!). My “match” is pretty simple and a really great deal – the University puts 8% into the account for me vested after 3 years, no contribution on my part required (unfortunately, no partial vesting, it goes from 0% vested at 2yrs364days to 100% vested at 3 years). I still contribute the legal max at this point, but the 8% “match” is really nice. Even while paying off all our debt, we needed to have 10% of Dad’s salary being contributed to get the full match at his workplace, so that helped us jumpstart savings.

  33. 401ks for us and I’ve been talking to our 3 children as often as possible to start saving and investigating as young as possible. I want them to understand the rule of 72 very well!

    • Mr. Frugalwoods says:

      Good idea with the kids. As soon as they have earned income, they can open a Roth IRA. It’s pretty neat to think about starting saving at 16 rather than 26! While I did save money when I first got a job, I wasn’t savvy about the vehicle. Wish I would have started a roth back then.

  34. akosua says:

    I plan on contributing to my 401K (at the very least to get my employer’s contribution after one year)…however if I’m not thinking i’ll be able to retire early, should I still try and max out even though I’ll be hit with taxes later on in post-work life? Or contribute some and then invest the rest in things like index fund stocks? thanks!

    • Mr. Frugalwoods says:

      It really depends on two things:

      1) Your current taxable income
      2) Your expected expenses in retirement

      If 2 is much lower than 1, then it’s likely the number works out in favor of maxing your tax deferred savings (401k) now.

  35. JAX says:

    I have a question about the 4% safe withdrawal rate. I have about $500k in 401k retirement account & about $300k in real estate equity. Total net worth around $800k. Do I include the real estate equity in the 4% formula or keep it out? I’m not selling it but keeping as an income property. Is the 4% rule based off of net worth? Thanks for your time.

    • Mr. Frugalwoods says:

      Different folks will have different opinions on this, so take mine with a grain of salt 🙂

      For us, we count net cashflow on property towards our yearly “income” number. (This is after an allowance for expenses, maintenance, capital expenditures, vacancies, etc…)

      This then will reduce the amount we need to withdraw from investments, thus making our 4% number much smaller.

  36. Dani says:

    I know I’m really late to this party, but I have to admit, I knew my company’s retirement plan was excellent, but did not realize how much until reading everyone else’s. I get 15% of my yearly salary put in each year by the company. No match on my part, just straight up company contribution. No vesting (Though there was a two year waiting period before it began, but I was able to negotiate that period being waived. Never hurts to ask people!)

    Now the flip side of that is that my yearly salary is about 15% below the state/20% below the national average for similar positions. Win some, lose some. 🙂 But no complaints about what they are contributing.

    • Mr. Frugalwoods says:

      That’s a pretty amazing plan! I’ve heard of some of those that are negotiated replacements for a pension that a company has decided to stop offering. Invested wisely, a plan like that will set you up for a great retirement!

  37. Dena says:

    I have a question that is *kind of* related? I know you use Personal Capital, have you talked to any of the financial advisors there?

  38. The Collins says:

    Really informative post, exactly what my wife and I were wondering about our 401Ks which were automatically created for us. Just one question, you make a point of putting in 10% of your paycheck towards your 401K, do you suggest 10% of your net or gross income?

  39. i believe in Roth contribution whole-heartedly, especially during relatively lower income years. in my career going forward, my lowest tax bracket will be the next 4 years, even when compared to my tax bracket in retirement.
    that’s why i’m contributing 23.5k in to roth ira+roth 401k and putting SEP-IRA (pretax) and maxing out my kid’s 529 and Roth IRA this year.
    saving for retirement is quite easy as long as we prioritize it. last year, i made just about 60k and was able to save 23.5k in Roth space in addition to becoming completely debt free.
    i love how this website reminds us that our happiness comes from within and that we don’t really require much money to live a wonderfully fulfilled life.
    it’s quite amazing to me to see how much 400k can get you in the woods…. perhaps i’ll spend part time on a homestead life the frugalwoods!

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