What account should your retirement savings go into?
As dilemmas go, this is a pretty interesting one: where should you park your retirement savings to maximize their potential? Let’s say you’ve paid off all your credit cards, your student loans, and even your car loan. Your net worth is finally positive, the world is your oyster, and you’re feeling great. (As you should!) Now comes the big question: what’s the best way to park your money, and where?
Whether you live in the US, or Canada, or Europe (hola/bonjour!), or someplace even more exotic, you have certain options with retirement accounts. It’s 401k and traditional IRA and Roth IRA in the US, RRSP and TFSA in Canada, etc. Your local options may vary, but the bottom line is the same: there are tax-advantaged accounts where you can stash your cash and grow it until you’re old enough to withdraw the gains. (In the US, that’s typically 59.5 years old – a rather odd and arbitrary number.)
You can play it safe and slow, the way your parents did and the way Suze Orman and all the other ancient experts would recommend: always max out all of your retirement accounts, wait until you’re 59.5 years old (or older), and then enjoy the last 10-20 years of your life to the extent of your aging body’s ability, wondering if maybe, just maybe, you could’ve done something differently.
Or you can go full-on YOLO by putting nothing in your retirement accounts, keeping everything in a taxable account, and going wild with stocks, stonks, options, and what have you. (If you want to trade modern-day Beanie Babies, there’s always crypto and NFTs, I suppose.) There are certain risks with that, of course: just a couple of bad YOLO/FOMO decisions could wipe out your entire account. Then you’d be left with no money and no retirement savings, wondering if maybe, just maybe, you could’ve done something differently.
(As always, an important side note: I’m not a financial advisor, and all of this is for entertainment purposes only. Average people shouldn’t invest in the stock market, especially with their retirement savings, and would be better off with index funds, as I wrote over here.)
And then, of course, there are multiple-redundancy hybrid approaches. Personally, I’m a big fan of backups: I have several emergency bags (so-called “bugout bags”), decent reserves of food and water, a fair amount of camping gear and medical supplies, etc. I use the same philosophy when it comes to my money. Ask yourself this: if your main investing account gets utterly destroyed, how will that affect your retirement savings?
My personal solution was a hybrid approach: when I lived in the US, I could maximize all of my retirement accounts (both Roth IRA and 401k) for decades, and then retire to a comfy nest egg of several million dollars. But as you already know, this blog is all about retiring early. I didn’t want to sacrifice even a single year of leisure in exchange for more comfort decades later. It’s important to set up a good and concrete plan. (See my earlier post on future-anchoring.) My plan was relatively straightforward: I wanted to get $100K in each of my retirement accounts, just under $200K in my main taxable account, and have my real estate as a safety cushion. Let’s break it down, shall we?
$200K in my main taxable account (well, technically ~$172K) would be enough to generate $1K a month, which is juuust enough for me to live on here in the beautiful Quebec City. Over time, as I get closer to the magic 59.5 age, I can start dipping into the principal: as long as there’s any money left at all by my 59.5th birthday, I’d be good to go.
Having $100K in each of my retirement accounts would ensure two separate time capsules: I can’t withdraw that cash without suffering severe tax penalties. (Though it’s possible to withdraw your original Roth IRA contributions tax-free, just like with TFSA in Canada.) I quit the rat race when I was almost 35, which means both of my retirement accounts would compound quite nicely for about 24 years. $100K is a nice, round, and impressive number, and if you apply the magic of compound interest for a quarter of a century… To quote Bill Murray, “So I got that goin’ for me, which is nice.”
My 401k is on autopilot: mostly in a target-date fund, partly in Amazon stock. My Roth IRA is entirely under my control: I love the tax-free aspect of it, and while I might never match Peter Thiel and his $5 billion Roth IRA balance, I like to think I could do a lot with my money.
There’s also real estate. In 2016, I spent a year bouncing between crappy rentals in Seattle. I refused to pay more than 30% of my take-home wages for a rental, which severely limited my options. One year, three rentals, and a lot of hilarious (if cringey) stories later, I made the biggest impulsive decision of my life and bought the cheapest condo in all the land with all my savings. Free pro tip: if the condo you’re considering is suspiciously cheap, ask the HOA about upcoming special assessments. Expensive lesson learned too late…
Ironically, paying HOA fees and 3.75% mortgage fees on an actual condo was cheaper than renting even a single room in Seattle. Somehow, the recent housing boom has mostly affected, well, houses – not condos. Even so, my property’s value has gone up 60% since I bought it 5.5 years ago, and it’ll go even higher when they finish building a subway station right next to it in 2024. That was something I’d anticipated back in 2016, even though there was some risk of the subway project getting cancelled. Yay long-term thinking.
Right now, my condo generates a pittance each month. (I try to be a nice and laid-back kind of landlord, and haven’t raised the rent in three years.) Its main value is as a tax write-off, but I expect to sell it and park the money in an index fund in a couple of years. Having a passive stream of rental income is nice, but it also comes with more complications, repairs, and ethical dilemmas than I care to deal with.
And last – and least – there’s Social Security. I may have escaped the US just before the unpleasantness (strategize, always strategize!) after living there for 16 years, but I’d put in enough time to qualify for a full set of Social Security benefits. I’ve got no plans to give up my US citizenship, so at some point in my 60s I’ll start getting retirement checks that will probably be insultingly low to survive on in the US, but should be sufficient to live on in some cheap tropical countries.
So, let’s review: even if I somehow blow up my main taxable investing account, I’d still be able to liquidate my real estate. (Which I’ll do anyway.) Even if that fails too, I’ll have not one but two retirement accounts to fall back on. And if I’m particularly unlucky, there’ll always be the fifth and final column – Social Security. (I doubt it’ll come to that, though.)
If you’re only now starting to make your own early retirement plans, then a) congratulations!!! and b) I hope this structure helps. Always have redundancy plans in place for your retirement savings, whether it’s early retirement or the more traditional kind. Think of it as a multi-stage rocket: the actual part going into space is pretty small (that’s you!), and it requires a huge foundation filled with rocket fuel to escape the gravitational pull and go all the way into space. (And yes, in this metaphor you’re an early retirement astronaut. How cool is that, eh?)
It’s not enough just to squirrel away a certain amount of cash: what’s your backup plan for retirement savings? Backup backup plan? How about a backup backup backup plan? At some point, the backup redundancy planning might get a bit ridiculous, but that’s a good problem to have.
And so, to summarize: make a plan, follow the plan, ace the plan. Figure out how much money you’d be comfortable with in your retirement accounts (especially since it’ll compound for many years), get that money in there, put the rest in your taxable account, and maybe get some real estate on the side just to be safe. (Entirely up to your risk tolerance level, of course.) Do all that, and you’ll be the ace financial strategist in no time at all. (Side effects include the sense of existential horror when listening to your friends and relatives talk about their money.)
Ready, steady, go! And, as always, don’t forget to leave a comment if you’ve got some of your own advice you’d like to add, eh?