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Savings Rate Logistics and Personal Finance Advice

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  • Avatar CFEonline 
    Participant
    Status: Physician
    Posts: 136
    Joined: 09/05/2018

    I’m curious how others approach a few things. Apologies for the lengthy writing.

     

    1.) Savings Rate Pre or Post Tax, or Adjusted

    • Background / My Thoughts
      • For an example with round numbers, say someone is making $200k pretax, a 50% savings rate goes to $100k. So are you trying to put $100k away, given that a large chunk of what you are investing is actually post-tax dollars?
      • Are others adjusting the money between pre/post tax based on the effective tax rate to figure out savings rate?
        • So if in this example the person was single and lived in Texas, after contributing $19k of the $200k to employer 401k, their taxable income would be $181k, yielding an effective tax rate of 19.76%. So if the goal was a 50% $100k savings rate, you saved $19k in 401k, you would still need $81k. But that is pre-tax dollars, and now you just have post-tax dollars to invest (for simplicity sake say no HSA, etc). In post tax dollars you would need X = $81k * (1-0.1976) = $64,994.40 post tax savings dollars. $6,000 of that goes into Roth IRA, so you’re left with $58,944.40 to put into a taxable savings account to achieve a 50% savings rate. So while the actual dollar amount you saved was $19,000 (pretax) + $58,944.40 + $6,000 = $83,9940, for an “effective” savings rate of 50%.
      • The other option would be still shoot for a precise 50% of your total income, so $100k.
        • With $19,000 pretax, you’d then put $81,000 roth/taxable savings away. However, this would eat up a larger chunk of your salary. $81,000 post-tax dollars at 19.76% income tax adjusts to X = $81,000 / (1 – 0.1976) = $100,947.16 pretax dollars. So you add the $19k to that and to put away a flat $100k into savings, you used up $119,947.16 of your total pretax income, for an effective savings rate of 60%.
    • Question
      • When calculating your goal savings based on savings rate, do you use your pre-tax or post-tax income, and how do you reconcile that inevitably portions of your savings will fall into each category?

     

    2.) What all counts as savings?

      • I recall from the original WCI book some talk around this issue, and essentially landing on things that increase your net worth. So obviously retirement / long term investment accounts. Not vehicles, some debate over house, so on. What makes sense to me is considering the purpose for the savings. In my case this would be to provide a means for living at the quality of life my spouse and I have become accustomed to once we stop meeting our living expenses with earned income. That brings up some questions.
        • Student Loans
          • Background / My thoughts
            • technically these don’t contribute to future means of living. I would still think about including these in our goal savings rate, with the caveat that once they are paid off that same monthly payment keeps getting scheduled to automatically draft out of the checking to a taxable long term investment account.
          • Question
            • do/did you count student loan payments in your savings rate?
        • House Down Payment
          • Background / My Thoughts
            • I’m of the opinion this is a living expense and therefore not a savings / investment. That is a bit difficult because if it does not count towards our overall savings rate, then the goal 50% savings rate and the speed we want to save for a down payment are not really compatible. While I made up the other salary numbers above, we do really want to shoot for a savings rate of 50% overall. However, we want to also save up the 20% down payment required for a hypothetical house at the upper end of our affordable range over the next 18 months. Based on the WCI book, that value would be a mortgage = to 2x our combined annual income. If the mortgage equals 2X our annual salary which is 80% of the house value with 20% down, the 20% down is quite substantial and calculates out to 50% of our annual salary. Saving that over 18 months adjusts to an annual rate of 33% of our salary. Added to a savings rate of 50%, taxes and other expenses, it does not compute. Options are a cheaper house, saving up over a longer period of time, not saving 20% down and using a physician loan, a lower overall savings rate, or including some or all of the down payment in our savings rate. I’m not too worried about it because I think we won’t actually buy a house that expensive. We like several options around 60% of the upper limit of what we can “afford”, and some at 50% or even 40% of that, though I could see going as high as 80% of that figure for the perfect setup.
              • One idea is to essentially define a minimum monthly savings towards house, and include savings above that in our overall savings rate, with the plan that once the down payment is saved these monthly payments in excess of the minimum rate continue to get scheduled to automatically draft into a taxable investment account. I would set this minimum rate to be whatever a monthly payment on a 15 year fixed mortgage for our estimated home value would be. Thoughts on that as a good / bad idea? Its not truly helping build retirement funds, but does build good habits of saving over spending the money and dovetails into the real desired savings.
          • Questions
            • When talking about mortgage = 2x annual salary, is that your post-tax earnings, or pre-tax pre-retirement savings earnings?
            • Do you include your mortgage payment, or any savings towards a down payment or paying off your house, in your savings rate?

     

    #232466 Reply
    ENT Doc ENT Doc 
    Participant
    Status: Physician
    Posts: 3523
    Joined: 01/14/2017

    Your post highlights why savings rate should never be used as a true financial planning tool. A savings rate is a derivative of a set savings goal (for retirement, in dollar terms). So stop thinking about your mortgage, student loans and anything else. Set your long term goals, and set your monthly saving towards each of those goals so you can achieve them.

    #232467 Reply
    Lordosis Lordosis 
    Participant
    Status: Physician
    Posts: 1863
    Joined: 02/11/2019

    I do not tax adjust my savings.
    People set arbitrary goals for saving and then come up with unique ways to make things count in order to meet these goals.
    I do not count my mortgage payments.
    My loans are done but they don’t count either.
    My retirement accounts and the money I put into equity in my taxable account are all I count. I am around 30%.
    My mortgage and 529 do not count but both should be done by the time I plan to retire. Lowering my retirement income needs.

    “Never let your sense of morals prevent you from doing what is right.”

    #232469 Reply
    Avatar CFEonline 
    Participant
    Status: Physician
    Posts: 136
    Joined: 09/05/2018

    I see what you’re saying about the savings rate goal being an arbitrary thing.

    I do think it has a couple benefits

    1. In the setting of a sudden large rise in income, picking an arbitrary, high savings rate defines some boundaries, and is kind of a fun game to figure out how to make it work. In doing so I think we’ll save more than we otherwise would. Pay down loans faster than the 5 year refinanced terms, save more than just the tax advantaged retirement account space or the 20% standard recommendation, etc. It also is a good way to keep expenses from creeping up. Rather than a vague keep expenses low and save the rest, which depending on your personality might result in lifestyle creep figuring the nebulous “rest” that you are saving is substantial without really knowing how a slight increase here or there will impact it, calculating out everything ahead of time shows how things will fit and what the margins are. Taking 50% off the table and then looking at predictable expenses with insurance, rent, groceries, vehicles, etc, then adding in saving for new car, annual vacation budget, other priority goals, helps put the importance of keeping non-priority elective spending minimized.
    2. Perhaps more importantly to me, it predicts a time frame for FI that takes into account your lifestyle and spending you are accustomed to. So I can tweak the rate and see how it impacts my lifestyle, and balance that against the change in years to FI it effects, to find the sweet spot. https://www.mrmoneymustache.com/2012/01/13/the-shockingly-simple-math-behind-early-retirement/

    That’s my 2 cents from going through this exercise anyways.

    #232474 Reply
    Rogue Dad, M.D. Rogue Dad, M.D. 
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    Joined: 03/07/2016

    My goal is minimum of 20% gross to accounts intended for retirement (what accounts available differ depending on your employment situation), though my real goal is 30%.

    I “count” all principal payments towards my mortgage or 529 as increasing my net worth, because they in fact do increase my net worth.  I do not count them towards my 20%.

    I have not picked a retirement date or $ amount required yet for retirement — I have a range with some uncertainty as I frankly don’t know what I’ll want to do 15-20 years from now — so working backwards to figure out a % doesn’t help.

    Rather I know if I keep to at LEAST 20%, barring major stock market disaster, I have a high probability of that range working out and having lots of options.

    I know if I want to retire before that range I’ll have to earn or save more or develop other income streams.

    It’s easy to make this complicated — sometimes it’s hard to keep it simple.

    http://www.RogueDadMD.com

    An alt-brown look at medicine, money, faith, and family

    #232478 Reply
    ACN ACN 
    Moderator
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    Joined: 01/08/2016

    Min 20% of gross income to retirement accounts. Easy peazy.

    Any mortgage, loans, ect don’t count to savings.

    If you're ever having a bad day, just remember in 1976 Ronald Wayne sold his 10% stake in Apple for $2,300.

    #232479 Reply
    Avatar Peds 
    Moderator
    Status: Physician
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    Joined: 01/08/2016
    1.) Savings Rate Pre or Post Tax, or Adjusted

    Click to expand…

    its based off gross.

    2.) What all counts as savings?

    Click to expand…

    anything not spent.

     

    #232480 Reply
    Liked by SLC OB, ZZZ
    Avatar Tim 
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    Status: Accountant
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    Joined: 09/18/2018

    “anything not spent“
    This in my “mental gymnastics is subdivided:
    • planned to be invested
    • planned to be spent
    The latter is consumption for the purpose of avoiding debt.

    Gross
    Taxes
    Retirement (pre and post tax)
    Net is spending
    Student Loans come out of spending (cost of the gross income). When loans are paid, one gets a second bump.
    Choose to build NW (taxable or invest or lifestyle).

    If you pay more tax then still need more post tax retirement to pay yourself first. The tax-tail shouldn’t wag the retirement savings %, reduces spending.

    #232484 Reply
    Avatar docnews 
    Participant
    Status: Physician
    Posts: 410
    Joined: 01/09/2016

    As you point out, net worth and nest egg goals can differ.

    Looking at net worth makes one ok with paying off low interest debt in the short term. But in the end you need a nest egg of a certain size and be debt free.

    Usually these nondescript savings mandates are post-tax because they assume you spend the rest on consumption (and not debt payments) so that with “average returns” and “average career lengths” you will have “enough” to retire. Hence with all these ASSumptions they are not really useful.

    Nonetheless I do calculate my savings rates each year for my own encouragement.

    #232508 Reply
    Avatar wideopenspaces 
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    Status: Physician
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    Joined: 01/12/2016

    Since I am relatively young and have no immediate plans for a really early retirement, my rule is that we save 20% gross income to retirement funds each year. Anything beyond that (paying extra on the mortgage, adding more to retirement or putting money into the 529) is icing on the cake. Which we often do, but for me I feel fine about our spending as long as we meet retirement savings goals each year. If you have a specific number or time frame you are working towards, you might just figure out what you need to put away monthly to meet the goal and go from there.

    #232552 Reply
    Liked by Antares, Tim, SLC OB
    Avatar SLC OB 
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    Joined: 06/23/2018

    The important number is 20% towards retirement (as much as you can in pre-tax, then backdoor Roth, taxable, etc.).

    I do not “count” my mortgage payment but I do “count” any EXTRA principle payments towards our mortgage or rental properties.

    I would just figure out what works well for you and stick with it…. until it doesn’t work well, then talk to the partner and change it.

    Enjoy the ride, life is short, you will be fine.

    #232558 Reply
    Avatar Budgetmaestra 
    Participant
    Status: Attorney
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    Joined: 04/30/2019

    We also focus on the 20% of gross to retirement. In counting savings rate I also go off gross, and I include retirement, hsa, etc $ extra payments to principal, 529 savings etc. if I want to feel better about ourselves then I also include our ordinary mortgage payments to principal. So then our numbers look better and I feel better. I use gross because it’s easier. That means our savings rate will never be 50% but I don’t see why I should even care about that.

    #232612 Reply
    Liked by Tim
    Avatar CFEonline 
    Participant
    Status: Physician
    Posts: 136
    Joined: 09/05/2018
    Splash Refinancing Bonus
    Rather I know if I keep to at LEAST 20%, barring major stock market disaster, I have a high probability of that range working out and having lots of options.

    Click to expand…
    Min 20% of gross income to retirement accounts. Easy peazy.

    Click to expand…
    my rule is that we save 20% gross income to retirement funds each year.

    Click to expand…
    The important number is 20% towards retirement (as much as you can in pre-tax, then backdoor Roth, taxable, etc.).

    Click to expand…
    We also focus on the 20% of gross to retirement.

    Click to expand…

     

    So when figuring your 20% of gross (or w/e %), do you value pre vs post tax savings any differently? Does that effect your choice to make your contributions as pre or post tax? (For instance, if your 401k supports Roth contribution vs regular)

     

    In the original example of a W2 employee making $200k gross, filing single at an effective income tax rate of 19.76%, access to a standard 401k employee deferral of $19k and no other pre tax options, going for the 20% of gross income savings rate, what dollar amount into what kind of accounts would your interpretation/application call for?

     

    A.) $19k pre tax 401k, $21k taxable account / Roth IRA (Roth / post tax given no value over pre tax)

     

    B.) $19k pre tax 401k, $16,850k in taxable / Roth IRA (equivalent to $21k pre-tax with effective tax rate of 19.76%)

     

    C.) Some other amount

    #232972 Reply
    Avatar Peds 
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    Nope just straight 20%.

    #232978 Reply
    Liked by Tim
    Avatar Jack_Sparrow 
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    Joined: 01/09/2019

    I would recommend looking at it from another perspective. I would look at your spending now versus anticipated spending in retirement especially if you are deviating from the traditional route and trying to go FI.  Figure out that you are going to spend say 100k in retirement (plus inflation), do some quick math on a 3 or 4% withdrawal rate and that number is how much you need in retirement savings. The back calculate what combination of years, and money invested in savings is required to hit that number.

    Student loans, mortgages, and taxes are all a liability requiring you to spend, but these liability should be reduced in retirement. I wouldn’t call them savings, since none of them are going to generate income to live off of. (assuming you never sell your house or downsize), just reduced liability which reduces the amount of savings you need in retirement.

    So your actual savings should be what will generate income for you in retirement.

    Its probably presumptuous of me, but it seems like from your post however, you just want to set a goal of 50% because it sounds great and are trying to use some mental gymnastics to back calculate what can be constituted in that 50% savings rate. If you are making 200k and set a goal of putting aside 50% “savings”, and want to include mortgage, student loan, even taxes reduction in there. That’s fine, that’s psychology more than anything. That’s the same thing as an actual savings rate of X% and paying down liability which sums to 50% of your income. But you wouldn’t say you were savings 20% of your income if you were just putting it into a mortgage, student loans and taxes.

    Don’t get me wrong, I am a resident and I put 22% of gross income towards student loans and retirement accounts. But its actually 13% in retirement account and 9% towards student loans. I know in 2 years when i have my loans paid off, I’ve ear marked all student loans payment for savings. So I feel pretty comfortable that my 78% of my income spend is sustainable, and feel i will be able to meet my long term goals since student loans is a short term issue. But putting away 13% isn’t going to get me to retirement as soon as 22%.

     

     

     

     

     

    #233124 Reply

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