FI for Colorado Teachers Part 3: The “What Ifs” and the “Yeah, Buts”

TL; DR: This is the third in a series of posts for Colorado teachers that discusses some of the possible objections people have as to why they can’t achieve Financial Independence. Hint: if it aligns with your values, the objections are easily overcome.

Part 1 in this series describes the “what” and the “why” of Financial Independence. Part 2 discusses the process of “how.” This post will focus on some of the objections people typically make when discussing whether achieving financial independence is possible, the “what its” and the “yeah, buts”.

First, a reminder that this series of posts is not saying that everyone should do this, it’s simply trying to show you a path on how you can do this if it aligns with your values and what you want for your life. So some of the following, especially the “yeah, buts”, might be valid for what you want. But this post will address those under the assumption that achieving financial independence and a “work optional” stage of life earlier than is traditionally expected is aligned with your values and is something you want to pursue.

The What Ifs?
Any time you try to make a long-term financial plan, you have to make a lot of assumptions. When we get to the case studies (starting with part 5 in this series), you’ll see assumptions that are made about inflation, investment returns, cost of living increases to the salary schedule, advancement on the salary schedule, increases in insurance costs, increases in the various limits in the tax codes, and many more. While we try to make reasonable assumptions for all of these, they are still assumptions, and actual experience will not match those assumptions exactly. Sometimes reality will be “worse” than the assumptions expect, and other times it will be “better”, but it will never be perfectly correct.

There are three ways to deal with this. First, many of the assumptions are interconnected, so when the actual experience is different than one of the assumptions, other of the assumptions are often affected in a similar direction and that helps balance it out. Second, you can try to make the assumptions on the more “conservative” or “less beneficial to you” side of things. For example, lowering the assumed investment return or increasing certain tax limits by smaller amounts each year. The spreadsheets in part 5 and the other case studies will allow you to make those changes, but they already have some “conservative” assumptions built in (like tax brackets and contribution limits increasing at a rate slightly below the assumed inflation rate). Third, and perhaps most importantly, is the idea of flexibility. As you live your life and actually experience whatever happens, you can (and will) make adjustments that can keep you on the financial path you’ve chosen.

So, what is the most common “What If?” that people are concerned about? The rate of return on investment is usually the biggest one. We have historical data that can give us a decent estimate on what that rate of return will likely be over a long time period, but – as all the advertisements say – past performance is no guarantee of future results. Plus our plan can be impacted a lot by something called “sequence of return risk”, in which when you get high or low investment returns can have a significant impact on your planning. (See this and this and this for more on sequence of return risk.)

How best to deal with this? You can adjust the assumption yourself in the spreadsheet, you can be flexible and make adjustments along the way (like increasing your savings rate to help make up for lower returns), or – and this is a big one – you can change your timeline a little bit. If investment returns are lower than your assumptions, that doesn’t mean your plan is kaput, but it might mean that your path to financial independence takes two or three years longer than originally projected. While that may not be ideal, keep in mind that what many folks should be comparing that to is a lifetime of “work not optional” and not achieving financial independence until their late 60s or so. Keeping in mind that context helps keep things in perspective.

There are many other “What Ifs?” that can come into play, like losing a job or illness. The way I think about those are two-fold. First, those are “What Ifs?” that will affect you whether you are trying to achieve early FI or not, and if you are doing the work to achieve early FI you will be in better shape if those “What Ifs?” happen than if you hadn’t been on this path. Second, this is another case where being flexible comes in. You can (and will) make adjustments along the way. Again, this is true whether you are trying to achieve early FI or not, but will actually be easier if you are.

The “Yeah, Buts”
The “What If?” objections can be addressed by changing the assumptions in the spreadsheet or being flexible and adaptable along the way, but the “Yeah, Buts” are a bit different. These typically fall into the category of, “I just can’t” or “It’s not realistic to….” . It’s important to keep in mind two things here. First, it is possible and realistic. But second, it may not be something you choose to do. This goes back to the idea that this path is not for everyone but, if it does align with your values and want you want out of life, than you can make the choices that make it possible and realistic.

So what are some of the “Yeah, Buts”? First is often, “Yeah, but I can’t live on that amount of money.” As was discussed in part 2, if you make good decisions around the “big three” of spending, then it is indeed possible.

Second is often, “Yeah, but I need a new car to get to work and therefore I’m going to have a car payment.” As also discussed in part 2, ideally you would live close enough to work that you (or at least one of you if you’re married) don’t have to drive to work, you can walk, bike or take public transportation. But, if you do need to drive, there are many, many, many reliable and affordable used cars that will save you a tremendous amount of money and don’t require a car payment (or, at worst, require a temporary car payment that you can then pay off within a year or two).

Third is often, “Yeah, but you assume that I’m starting out without any debt but I do have debt.” This might very well be true, although my hope is that we do a better job in the future of helping young folks not start out in debt. But, if you do have debt, your first steps will be to eliminate that debt. Does that mean you can’t achieve financial independence? No, it just means it might take you a few more years to get there, and it might mean that you have to work a bit harder making some additional money in the early years through additional responsibilities or side hustles in order to help you pay off that debt.

Fourth is often along the lines of, “Yeah, but as I make more money, I deserve to be able to spend more of it.” There’s nothing wrong with that, if that’s what you want. But if you sit down and figure out what actually makes you happy and fulfilled, and you determine that additional spending on top of meeting your needs and some of your basic wants doesn’t provide any more happiness or fulfillment, then you can increase your spending very modestly as your income grows and still have a very comfortable, but not extravagant, lifestyle.

Think back to how you lived in college, or perhaps your first few years out of college when you didn’t make much money. Most people were able to live just fine and were reasonably happy. If you can control “lifestyle inflation” as you start to make more money, then you can modestly increase your spending, life a happy and fulfilled life, and be on the path to Financial Independence. Again, it’s about choices and what you value, and then aligning your lifestyle with those values.

There are many additional “Yeah, buts” that we could discuss, but the response to those objections is generally along the same lines: align your lifestyle with your values, make adjustments as necessary, and then live your life. If the freedom and flexibility of achieving financial independence decades sooner matches up with your values and your desires, then you can overcome the “Yeah, buts”. If the “Yeah, buts” seem like too much of a sacrifice, then you can choose a different path.

  • Part 1: The Concept
  • Part 2: The Process
  • Part 4: Tax optimizing/401k/403b/457/Section 125
  • Part 5: Case Study: Teacher Married to Another Teacher
  • Part 6: Case Study: Teacher Married to a Non-Teacher
  • Part 7: Single Teacher

 

FI for Colorado Teachers Part 2: The Process

TL; DR: This second post in a series for Colorado teachers describes in general terms the process of “how” you would design a path toward Financial Independence. Hint: it’s pretty straightforward.

part2

Part 1 in this series describes the “what” and the “why” of Financial Independence. This post will focus more on the process, the “how” do you achieve it. While future posts will go into more (perhaps excruciating) detail, this is just a high-level discussion to give an overview of the most important factors you’ll need to look at and the most important decisions you’ll want to make. To be clear, there is not “one right way” to do this, but most folks’ approaches include many common themes, so we’ll explore them here.

In some ways, achieving Financial Independence is remarkably straightforward – spend less than you make, and then save and invest the rest. There are several important decisions you have to get right (the “big rocks”), and then a bunch of smaller decisions you can make (the “little rocks”) that will certainly help, but aren’t as critical, and then the even smaller decisions that will probably have very little effect (the “sand”). The main categories of personal finance are earning, saving, investing, and spending (lifestyle). Within each of these categories (and they are very much interconnected) there are just a few, relatively simple, “big rocks” you have to get right (or mostly right) in order to achieve Financial Independence.

Earnings
Your earnings – how much you make from your job – is obviously an important piece in your financial picture and your ability to achieve Financial Independence. But many folks think you have to earn a very large salary (say, six figures) in order to do this, and that’s just not the case. It is certainly much easier to do this the larger your salary is, and there is definitely a lower limit in terms of practicality (if you’re making minimum wage, then there’s not much room for saving and investing). So, there is definitely some privilege involved here, but perhaps not as much as many folks think.

Since this series is aimed at Colorado teachers, we can throw out both the six figures and the minimum wage and talk about salaries that typically begin somewhere between $35,000 and $45,000 a year and then increase over time. In future posts I will use the salary schedule for Littleton Public Schools (which starts at just over $40,000 with a BA degree) as that is the district I’m most familiar with and is reasonably representative of the salaries along the Colorado Front Range. (Salaries outside the front range are often lower, but often so is the cost of living.)

Because almost all school districts in Colorado have a well-defined salary schedule, it makes it reasonably easy to predict what your future salary will be and what, if anything, you can do to increase it. (While there is some inherent uncertainty regarding future salary schedules based on future economic events, we can make some reasonable assumptions about annual cost-of-living increases to the salary schedule that should be close enough to allow us to plan.)

There are four main ways to increase your salary as a teacher in most districts: have more years of experience, increase your level of education, take on extra roles, and move into administration. Accumulating more years of experience happens automatically and, for the purposes of this series, we will assume you don’t move into administration. (If you do move into administration, obviously your salary will increase and make achieving FI even easier.) So, to maximize your earnings as teacher, you should focus on increasing your level of education and perhaps taking on extra roles.

As most teachers have figured out, it pays to increase your level of education so that you can move horizontally as well as vertically on the typical salary schedule. So from the beginning of your career you should be focused (financially) on moving horizontally through the different education levels as quickly as you can until you hit the “maximum” educational level on the schedule. For most folks, that means getting your Master’s degree and then accumulating additional hours beyond that to the max on the schedule. (Some districts have a PhD category, but most folks probably don’t want to go that far.) For example, on LPS’s salary schedule they recently added an MA+90 category, so to maximize your income you want to get your Master’s as soon as possible and then start accumulating additional hours until you reach MA+90.

The second way to increase your income is to take on additional roles. This is often coaching, sponsoring an activity, or working athletic events. Again, looking at the LPS schedules, you can make anywhere between about $1,200 and $4,000 coaching or sponsoring an activity the first year, and then get small raises each year you continue after that. You can also work athletic events (supervising, taking tickets, working the chain gang, etc.) to earn additional money (not sure what the current amounts are, they are low but not insignificant). Obviously, if you have the time and interest, you can combine several of these options, perhaps coaching in two or even all three seasons, or coaching in one season and working athletic events in the other two seasons. How much you take advantage of this will depend on your interests and preferences as well as your goals that we discussed in part 1.

Finally, you can increase your income outside of your school employment. This can be working a second job (often during the summer) or doing side hustles (with tutoring being a natural one for teachers). Again, how much you take advantage of this depends on your personal preferences and your goals, but you can increase your income by a not insignificant amount with a reasonable time commitment.

Saving and Spending (Lifestyle)
These two “rocks” go together because they are pretty much inseparable. It’s surprising to some people that your savings rate is the most important factor in achieving Financial Independence, not how much you earn on your investments (although that is important as well). Your savings rate is really determined by your spending rate, and your spending rate is really determined by your lifestyle. So, ultimately, the most important factor in your financial well-being and your possible attainment of Financial Independent is your lifestyle.

To be perfectly clear right up front, you don’t have to live like a monk in order to achieve Financial Independence (not that there’s anything wrong with that). But it is really important that you live within your means and, actually, live below your means (which is how you increase your savings). Like most everything else in life, this is a choice, but it’s one that we often make on autopilot. This is where being intentional in how you want to live your life can make such a huge difference.

There has been a ton of research in the last few years that indicates that, once you achieve a certain level of income, happiness and personal fulfillment do not increase simply be earning more money. It is necessary to achieve that initial level of income that covers your basic needs (and at least some of your wants), but after that making more money doesn’t correlate with increased happiness and fulfillment. In general, the research also indicates that “possessions” don’t increase happiness, but “experiences” do. As a teacher in Colorado, you make enough (particularly if you increase your earnings as mentioned above) that it is very possible to achieve this level of income to meet your needs and some of your wants and still have enough left over to save (and eventually invest) in order to be on the path to Financial Independence.

There are three “big rocks” that you need to focus on in terms of your spending: housing, transportation and food. While there are certainly many additional “little rocks” that can help make a difference, housing, transportation and food are the majority of most people’s spending and the areas that you want to focus on.

Housing
Americans have a love affair with the idea of a house. It’s a certified part of the “American Dream” and, when combined with expectations from those around us, often ends up being an area we overspend on. There are many blog posts you can read on this topic, so I’ll try to keep this reasonably short.

Whether to rent (an apartment or a house) or buy is a very personal decision, but don’t assume that buying is always the right answer. I grew up in a time when the conventional wisdom was that renting was “throwing your money away” and that you should try to buy a house as soon as possible because it was an “investment.” Turns out that when you look at the numbers, a house does not have a particularly good return on investment when compared with other investing opportunities. The main reason that many people believe that it does is because it’s really a “forced savings”, so it does end up being many people’s best investment because it’s really one of the few investments they consistently put money into.

This is not to say that buying a house is a bad idea, but you should buy a house because you value living in a house and not because you think it’s the right thing to do financially. For many folks, renting is actually the better option financially (but, again, that’s moot if you want to live in a house that you own). If you do decide to buy a house, it’s very helpful if you’re extremely thoughtful about doing it.

Again, conventional wisdom when I was growing up was to “buy the biggest house you could afford” and then “trade up to the biggest house you can afford when you’re able.” From a Financial Independence perspective, those are both wrong. You should buy “the smallest house that meets your needs” and try to “never trade up” by making your first home purchase your “forever” home. (The transactions costs around buying and selling a home, moving, and making improvements to the house are a huge drag on your saving and investing, especially if you do it multiple times.) The key is to identify your values and act accordingly. Since buying bigger and more expensive houses doesn’t automatically lead to more happiness and fulfillment, buy a house that meets your needs (and no more), so that you can focus your financial resources elsewhere in ways that do increase your happiness and fulfillment.

Renting (either an apartment or a house) is often the better alternative financially, allowing you to save (and invest) more as well as allowing you to be more flexible in where you live. As we’ll discuss in the transportation section, minimizing your commute (and the expenses associated with that commute) is a huge driver (no pun intended) of both financial success and happiness. Renting often gives you more flexibility on where you live, which often allows you to optimize your commute (walking, biking or public transportation). You can (and should) also do this when considering buying a house, but there is often less flexibility on location when buying instead of renting. Just like with buying, when making the decision to rent you also want to rent the smallest and least expensive place that meets your needs.

Transportation
After housing, transportation is often the biggest budget item for most people, and it’s also one of the easiest ones to spend less on. Many folks I know just assume that a car payment (and often two of them) is a given, but it really isn’t. When I was growing up, buying a used car was a bit of a gamble because used cars weren’t very reliable. But cars made much better today and, if you choose from the particularly reliable ones, buying a used car is not much of a gamble and will save you a ton of money. While some folks will even need a loan for a used purchase, it should be much smaller and you should be able to pay it off quickly.

Even better than buying a reliable used car is not buying a car at all. If you can eliminate one (or more) cars from your life, you will save a tremendous amount of money. Most people really don’t have any idea of how much their cars are costing them. This is where the location of where you live (either renting or owning) is one of the most important “rocks” to get right. If you live close to where you work (ideally where both of you work if you’re married, but at least one of you), then you walk, bike, scoot, or take public transportation to work (and also increase your health).

And if you do own a car, get a reasonably-sized one. SUVs are incredibly popular in Colorado, daily I see a single driver commuting to their job on paved and well-maintained roads. Most people would be better served by a sedan or hatchback and, on the few occasions you really need an SUV, rent one, you’ll come our way ahead financially (and, by the way, might help avert climate catastrophe). If you want to optimize even further, consider a nice used plug-in electric vehicle or fully electric vehicle (not a lot of good used fully electric yet, but there will be in the next few years). You’ll also save a ton on fuel and maintenance.

Food
There has been a lot of discussion about Avocado Toast and the Latte Effect lately. While I think this has taken up way too much bandwidth, there are some ideas here worth considering. The key again is to be intentional about how you spend money on food and drink and to align it with your values. As a simple rule of thumb, the more you eat at home, the better off financially (and typically in terms of your health) you’ll be. As a teacher, you typically don’t have the opportunity to go out for lunch when you’re working, so you have an advantage over other working professionals that bringing your lunch is pretty typical (although some folks purchase a lunch in the cafeteria – you want to make that be a rare thing).

Going out for dinner is a wonderful thing, but should be done occasionally and not three to four times a week (that includes picking up fast food). Most folks, if they align their food habits with their values, will discover that eating a nice meal at home together is not only financially wise, but provides them greater happiness and fulfillment. If you want to get together with friends, consider hosting (or attending) a pot-luck. You’ll have more quality time with your friends, spend less money, and likely eat healthier.

The amount spent on food is the third “big rock” of spending, next to housing and transportation. If you can optimize all three of them, then you’re savings rate will increase and then you’ll have money to invest and be on the path to Financial Independence.

Investing
Many people are intimidated by investing and think they can’t possibly do it right, so therefore Financial Independence is out of their reach. It turns out that investing is really the easiest of the “big rocks” to do well. Your savings rate is more important than your investment returns, and your spending rate determines your saving rate, so you have a lot of control over two of the most important factors that affect your investing.

Because you are investing for the long-term, investing is really pretty easy. The specifics can vary significantly based on your situation and your risk tolerance, and you can perhaps achieve a slightly higher return by tweaking your investments and making them more complicated. But, in general, you should invest in a broadly diversified equity index fund and forget it. (See this and this for more, or get his book.)

Your biggest decisions revolve around which type of accounts to invest in (401k/403b/457/Roth IRA, regular taxable brokerage account, etc.). In part 4 of this series we’ll go into this more in-depth but, in general, you want to maximize the amount you can put into 401k/403b/457 type tax-advantaged accounts and, if you do want to retire early, also invest in some regular taxable brokerage accounts (so that you can draw on these funds when you retire earlier than is typical). As a Colorado teacher covered by PERA, you definitely have access to the PERA 401k program (which is a good one), but you likely also have access to a 403b or a 457 plan. If you do have access to a 457 plan, especially if it’s PERA’s, that’s the one you’ll want to invest in first because you can access that money more easily before age 59.5. (More on this in part 4.)

A key area related to investing (and, it turns out, related to how much you have to spend to live on) is to think more intentionally about your taxes. While we certainly utilized tax-advantaged accounts along the way, this is one of the areas where we could’ve improved the most. By learning the rules around taxes you can optimize the use of your income and tax-advantaged accounts available to you. Much more on this in part 4.

So, those are the big rocks. Be more intentional about the lifestyle that makes you happy and fulfilled. Make spending decisions that align with your values and your goals in order to increase your savings rate, including making better decisions around housing, transportation and food. Know the tax rules and utilize tax-advantaged accounts in a way that optimizes your savings, spending and investing, and invest in broadly diversified equity index fund(s).

Is it really that simple? Yes, and no. As we’ll see when we get to the case studies, long-term planning like this relies on many, many assumptions, and those assumptions will not always be spot on. In addition, some people will argue that some of the lifestyle decisions that are needed to live beneath your means are unrealistic. So, in part 3 of this series I’ll spend a bit of time discussing the “What ifs?” and the “Yeah, buts.”

  • Part 1: The Concept
  • Part 3: The “What ifs?” and the “Yeah, buts”
  • Part 4: Tax optimizing/401k/403b/457/Section 125
  • Part 5: Case Study: Teacher Married to Another Teacher
  • Part 6: Case Study: Teacher Married to a Non-Teacher
  • Part 7: Single Teacher

Financial Independence for Colorado Teachers Part 1: The Concept

TL; DR: This is the first in a series of posts that will lay out a possible path for Colorado teachers to achieve Financial Independence and retire* early. This post looks at the concept of Financial Independence and discusses a little bit of the “what” and the “why”.

*Retire only if you want to, but certainly achieve a “work optional” stage of life much earlier.

This is the first in what will be a series of posts discussing how Colorado teachers can achieve financial independence. (Actually applies to any Colorado public school employee, not just teachers, but will focus on teachers.) This post will focus on the concept of financial independence: what it is, why you might want to achieve it, and the basic outline of what it takes to get there.

There are many, many, many excellent resources online (some of which I’ll link to at the bottom of this post) that are better written, broader in scope, and more in-depth. But I decided to write this series because, as far as I know, there is not any that are devoted specifically to Financial Independence for Colorado teachers. The path to Financial Independence is different for everyone, but there are certain aspects of being a teacher in Colorado that make this an easier path and are worth exploring in detail (notably Colorado PERA and the specifics of the Colorado state tax code). My hope is that this can be a resource for Colorado educators to adapt some of the terrific information that is available elsewhere online in light of the added options that PERA and the state tax code give you.

If you’ve ever explored anything financially related online, you have probably come across the acronym FIRE, which stands for Financially Independent Retire Early. (I will include some links to resources at the bottom of this post you might want to investigate.) While the FIRE concept may seem to be pretty well defined, there are many different approaches, definitions, and opinions about exactly what it means, so let me give you my take as a frame of reference for this series of posts. (Not that you have to agree with my take, but just as a common understanding for these posts.)

It seems to me that there is often a misconception of financial independence that it’s all about money. In my view, it’s not. Money is the means but not the end. Financial independence is, at its essence, exactly that – meaning that you don’t have to be employed and earning income in order to meet your financial needs. When you “achieve FI”, that means you have enough savings and investments to live off of even if you never earn another dollar at a job. That doesn’t mean you have to retire, the ‘RE’ part of FIRE, but it means you can if you want to (or circumstances dictate that you have to). Some people refer to this as a “work optional” stage.

So if FI is not about money, what is it about? I think it’s about living your best life and the life you want to live. It’s about making the most of your limited years (time is not a renewable resource) and about maximizing the time you have to do what you want. It’s about being intentional about life and not just letting life happen to you, but taking a little bit of time to plan the life you want to lead, one that aligns with your values, and then take the steps to allow that to happen. Perhaps that doesn’t seem all that different than what most people do, plan for the future. But this is taking it one (or two) steps further than most people do and being much more granular about the financial aspects of your future in order to achieve the life you want to live.

One of the unfortunate things about American society (I’m focusing on the United States in these posts) is the lack of knowledge and open discussion about money and finances. In many families, money is a taboo subject, and most schools do little or no real financial education. As a lifelong educator, it saddens me that we don’t make an effort to really educate our students about money and finances. Not because money or wealth is important in and of itself, but because of the tremendous impact finances and financial decisions have on everyone’s life. (If I was pressed to name the two most important subjects we should teach in K-12 education, it would be Physical Education and Financial Education, as those are so important throughout everyone’s life, yet we devote very little resources to teaching them.)

That doesn’t mean society doesn’t talk about “Money” with a capital ‘M’. We are inundated with stories about making money and wealthy people, bombarded with marketing encouraging us to buy things, and often social pressures to look and dress and own the correct things to fit in. But that’s as far as it goes for most folks, we get the pitch for all these things that are “desirable”, but not the knowledge and resources to manage our financial lives in a way that matches up with our goals and our values. FI is about achieving your goals and living your values. That may include retiring early or it may not – it’s about making decisions that optimize meaning and happiness. Once you achieve FI you may still continue to work, but you’ll continue because you want to do the work, not because you need the paycheck. And if at that point in your life you are ready to do something else, you won’t be restricted from making a change because of the need for that paycheck.

I think most folks would think that my family has done really well financially along the way, and we have, but if I knew what I know now back when we were first starting our careers, we would have achieved financial independence much earlier. So this series is intended to help some of you, if you decide this is the path for you, to do it better than we did. So what does it take to get there? Future posts will go into more detail, but it generally boils down to spending less than you make, and then saving and investing the rest. It’s also about making smart lifestyle choices (living within and actually below your means), and understanding the math of things like compound interest and how your taxes work.

Below you will find links to subsequent posts in this series (as the posts are written, the links will become active), as well as links to some excellent FI(RE) bloggers and other resources that you may want to investigate if you want to go down the rabbit hole and learn much, much more about this idea.

  • Part 2: The Process
  • Part 3: The “What ifs?” and the “Yeah, buts”
  • Part 4: Tax optimizing/401k/403b/457/Section 125
  • Part 5: Case Study: Teacher Married to Another Teacher
  • Part 6: Case Study: Teacher Married to a Non-Teacher
  • Part 7: Single Teacher

Some excellent resources to learn more about FI(RE)

Focus On: DCSD Retirement Plans (401k/403b/457 Plans)

Summary: Choose the PERA 401k plan and invest as much as you can.

 

dcsdretirement

The first part of this post repeats the information in the LPS Retirement Plans post, then the rest of it is specific to the choices you have in DCSD.

The idea of retirement is a fairly new one. It wasn’t until early in the 20th century that the concept of retiring from work and “living a life of leisure” was even a concept. Many employers started offering pension plans and then Social Security came along in 1937. Then in 1978, the idea of a tax-deferred savings plan (401k) was created, although it’s original intent was not the way we’ve ended up using it.

Social Security was really designed to be part of a “3-legged stool” concept of retirement, that retirees would draw from their company pension, from social security and from their personal savings. As pension plans have gone out of favor and 401ks have taken their place (particularly in the private sector), it has really become a two-legged stool (which is somewhat problematic). For public school employees in Colorado, PERA is a social security replacement plan, so basically covers those two legs, leaving the personal savings leg for you to figure out on your own. That’s where employer-offered tax-deferred savings plans come in.

All PERA employers offer the PERA 401k plan to their employees, and some employers also offer access to the PERA 457 and the newly created PERA Roth 401k/457 plans. Many school districts also offer additional, non-PERA options for tax-deferred accounts. This post will focus on what’s offered in Douglas County School District, but you should check with your employer to see what options they offer.

DCSD allows you to choose between PERA and MetLife for retirement savings vehicles, offering the PERA 401k and the MetLife 403b, 457, and Roth 403b plans. There are subtle differences between 401k, 403b and 457 plans that can be important but, for the purposes of this discussion, we’ll treat them as roughly the same, with the important exception that you have separate contribution limits for 401k/403b and 457 plans which gives you the ability to save more if you have the cash flow to do that.

This post is not intended to be an in-depth explanation of 401k/403b/457 plans (or their Roth versions), but let me try to briefly describe them (if you decide to work with me we can dive deeper if need be). The idea behind 401k/403b/457 plans is to save money in a tax-deferred account, which means that you are not taxed on your income that you place into those accounts now, nor are you taxed on the earnings in those accounts as they accumulate, but you are only taxed when you make withdrawals which will hopefully be when you are retired. The traditional thinking is that most folks will be in a lower tax bracket when they are retired, so not only do you reap the benefits of saving “extra” all those years by not paying taxes up front, but when you do pay taxes upon withdrawal you will pay a smaller amount.

More recently Roth 401k/403b/457 plans have been created (along with Roth IRAs, which don’t flow through your employer) that take a different approach. For these plans you do pay taxes on any income you invest, but the earnings grow tax free and all withdrawals in retirement are tax free as well. In other words, pay the tax up front, never have to worry about taxes on this money again. For folks who think their tax bracket might actually be higher in retirement, this is a better option.

The obvious conundrum is how do you know for sure whether your tax bracket will be higher or lower in retirement? You don’t, which is why many folks choose to put money into both types of accounts to hedge their bets and give themselves more flexibility in retirement by giving them the option to withdraw from whichever account makes the most sense based on their current tax situation. (There are also some really nice benefits of a Roth if you are trying to leave an inheritance.)

Many employees, especially younger ones, kind of throw up their hands at all this. Retirement seems like a long way off, the choices can be complicated, and of course choosing not to spend money right now can be difficult for some folks. But the beauty and power of investing is compound interest, and it’s most effective the more time you give your money to grow, so the sooner you start, the better (and easier) it is to generate the retirement savings you want.

Many folks thinking about 401k/403b/457 plans also don’t take into account the effect on the tax-deferral on their current income. They think about putting say $100 a month into a 401k, but then worry they can’t do without that $100 a month. But they’re missing that their actual paycheck won’t go down by $100, but more like $70 (if you are in the 25% federal bracket, plus 4.65% for Colorado taxes). The government is basically saying, “invest $70 and we’ll give you $30” (always remembering that eventually they are going to tax you on that when you withdraw it). If you choose the Roth options, you don’t get that tax break up front, so your paycheck will decrease by $100 (but the potential for tax-free growth over time is tremendous).

So, with that overview, if you are a DCSD employee, should you choose PERA or MetLife? Well, again, that depends on your individual circumstances and I’d be happy to discuss those with you, but for most people PERA is the better choice because of lower fees.

PERA offers a choice of several funds or a self-directed brokerage account if you want more control. For most folks, the funds are the better choice. In 2011 PERA chose to go with a “white-label” approach to investments. Research has shown that many folks make poor investment choices when given too many choices so, instead, a “white-label” approach has you choose among asset allocation choices instead of picking individual funds.

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I’ll write more in future posts, but there are basically three things you can control when saving for retirement:

  1. How much you save.
  2. What asset allocation you choose.
  3. How much in fees you pay.

By going with a white-label approach and trying to keep fees low, PERA has tried to simplify the second and third choices for you. For each of their asset classes, PERA has typically gone with a combination of a passive (index) approach and an active (managed) approach. This combination gives you lower fees than a fully active approach, but higher fees than a strictly indexed approach. PERA thinks that they can achieve higher returns than the index this way. I’m a big fan of index funds, so I’m not totally convinced of this approach but, so far in their short lifespan (since 2011), they have mostly achieved this to a small extent.

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PERA does also give you a self-directed brokerage option (for an additional fee), which allows you almost unlimited choices in investments. For most folks, the additional complication of choices and fees make this sub-optimal, but it’s there if you want it.

selfdirected

For some reason, DCSD and/or MetLife have made it extremely difficult to get information about the plan. It took me three weeks of emails and calls to finally get the information we needed. (The way they currently have it set up, you can only find out information about investment choices and fees after signing up and giving them money, which is less than ideal. They are working on fixing that.)

MetLife gives you access to a small set of individual mutual funds, which is one of the reasons the fees tend to be a bit higher (0.34% administrative fee plus the underlying fund fees, some of which are pretty high). Here’s a comparison of fees for a large-cap investment in the PERA white-label fund, the PERA self-directed brokerage option invested in a large-cap index fund (they require you to keep $500 in PERAdvantage funds), and the MetLife option invested in the same index fund. (You can view comparisons for other asset classes here.)

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If you look carefully, you’ll notice that the cheapest option is the PERA self-directed brokerage option (as soon as you pass about $20,000 in your account), with the PERAdvantage funds coming in second, and MetLife coming in last. Since the middle and third columns are essentially the same choice in terms of what you’re investing in, there’s no reason to choose the higher fee MetLife option over the PERA option. If you are investing a lot, you can save in fees by going the self-directed brokerage option, but this is where PERA would argue that they think they will outperform the index and make up those fee differences. The differences are small enough between the first two columns that, for most folks, it’s probably best to stick with the PERAdvantage options.

Importantly, this fee difference gets much more extreme if you choose anything other than the three Vanguard choices in MetLife. The MetLife Target funds have a total fee of 1% (compared to 0.18% for PERA), and the International Fund is 1.48% (compared to 0.52% for PERA). This is really, really bad, and you should avoid these at all cost (pun intended). The only reason to choose MetLife is if you’ve maxed out your 401k and want to contribute additional money to a 457 (since their contribution limits are separate, and DCSD has chosen not to allow contributions to the PERA 457 plan). I hope that DCSD considers adding the PERA 457 option in the future as an alternative to the high-priced MetLife.

In future posts I’ll write more regarding possible asset allocations (which fund(s) should you choose), contribution limits (and the fact that you get separate limits for 401k/403b vs. 457, allowing you to save much more if you can), and the power of compounding. But, for now, this gives you an idea of where to start. The key thing is to start now and put as much as you can into one or more of these vehicles so that your “stool” will be sturdy enough to support you in retirement.

Saving for College: 529 Plans

Summary: If you want to save for college, there’s probably no better choice for Coloradans than the College Invest 529 plan.

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We live in an interesting time. There’s no question that, right now, having a college degree is really helpful both in getting and staying employed and in earning more while employed. But that doesn’t mean that college is the right choice for everyone, and some folks are beginning to wonder if the traditional college degree will retain it’s place of prominence for much longer.

Of course the purpose of an education is more than just preparation for employment, but certainly that’s a big part of why many folks choose to go to college, so this poses a dilemma. We don’t know if college will continue to be the “path” to career success, yet it is so expensive that most folks with children will need to save up some money ahead of time to help pay for it. My crystal ball is way too cloudy to definitively answer this but, should you choose to at least hedge your bets and try to save up some money in advance, I can give you some good advice on how best to do that.

The short answer is, especially in Colorado: a 529 plan. Like 401k and Section 125 plans, it’s named after a section in the tax code. It allows you to invest money for your child(ren) and the investment grows tax free, and then any qualified withdrawals (used for higher education expenses) are also tax free. It’s similar to a Roth IRA in the sense that you put after-tax dollars into it and then earnings and withdrawals are tax free, except the purpose for the money is different and the timeline is shorter.

While you can choose any 529 plan, in many states (including Colorado) it makes sense to choose your state’s plan because they offer additional incentives. In Colorado’s case, your contributions are tax deductible which, in effect, means you earn an automatic 4.63% return on your money when you deposit it. (You don’t actually get that money until you file taxes for that year, at that point it reduces the taxes you owe Colorado so that you either pay less or get a larger refund.)

They are way too many nuances to 529 plans to cover in one blog post (this site has lots of information), but here are the basics of what Coloradans needs to know:

  1. College Invest is the Colorado state plan
  2. Choose the Direct Portfolio
  3. Decide what your total goal is by the time your child(ren) graduate from high school and contribute accordingly
  4. Get started now

There’s much more to it, of course, including choosing how to invest the money, but those are the basics. We started ours for our daughter as soon as she had a social security number, because that’s required to open a 529 plan. (Because she was adopted at 9 months, and then had to go through the citizenship process, this was a little later for us than for many of you.) But you can even begin to save before they are born, either by putting away money that you will eventually transfer into a 529 plan after they are born, or by opening up a 529 plan and then changing the beneficiary once your child is born.

Once the account is opened, you can invest lump sums whenever you want, or set up automatic investments from a checking or savings account that occur every month. We did both, plus for a while we had a rewards credit card where the rewards went directly into the 529 account. You then choose your investment options, choosing between an age-based option (similar to target-date funds) that automatically shift to more conservative investments as your child approaches age 18, or by choosing a particular portfolio. The portfolios changed a bit in 2004, but since that change we’ve been in the “Growth Portfolio“, which is 75% stock/25% bond.

That might be too aggressive for some folks (especially as our daughter is about to begin her senior year in high school which means we’re close to the withdrawing phase), but because of our overall financial security, and because of the bond-like nature of our PERA pension, it was a good fit for us. For reference, here are the actual returns our account has earned (your account will always be somewhat different than the generic portfolio return because of the timing of your contributions).

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Note that the 10-year return currently includes 2008, which is pretty remarkable that it’s still so high. Going back to October of 2004 (when the portfolio changes occurred), our total annualized return has been 6.7%. At this point we are debating whether to shift the portfolio to a bit more conservative choice but, because the conservative portion of these portfolios are in bonds and that segment of the market has its own issues right now, we’re not sure. Given we still have 5 years left (senior year plus at least four years of college), equities are still likely to outperform bonds over that period.

Either way, this account has been incredibly successful for us (more on that below). Which brings up a big concern that some folks have – what if you don’t need the money? The reasons to not need the money can vary from your child ends up not going to college, to your child earns scholarships, to you actually saving and earning more than you need. Thankfully, there are options for dealing with each one of these.

    1. Your child doesn’t go to college: First, there are a variety of post-secondary options other than college that sill qualify. If none of those apply, you can always change the beneficiary to another child or even to yourself or eventually a grandchild, or you can withdraw the money for non-qualified expenses. If you do the latter you pay federal and state taxes plus a 10% penalty on any of the earnings that you withdraw (not on the contribution portion). For any of the contribution portion you withdraw that you took a Colorado tax deduction at the time of contribution, you would have to make Colorado “whole” on those taxes. While this may sound bad, it’s really not. In the end it’s “extra” money that you wouldn’t have had otherwise (because it would have gone to the college).
       
    2. Your child earns scholarships: For whatever dollar amount in scholarships they get, you can withdraw that amount of money for other purposes. Similar to #1 above, you would have to pay federal and state taxes on any of that that was from the earnings portion (not contributions, as you already paid tax on those), but you would not have to pay the 10% penalty. You can of course still pay for expenses not covered by the scholarship, and you can leave the money in for future use (or for a future beneficiary).
       
    3. You end up with more money than you need: Your options are the same as #1 above.

For us, we may actually end up being in the position of having more than we need. Because we did a good job of contributing (especially a fair amount in the early years so it could compound), and because the returns have also been pretty good (recently the earnings portion of our portfolio exceeded how much we’ve contributed), it’s likely Abby’s total expenses will be less than what we currently have in the 529 plan (barring a severe market downturn in the next couple of years, or she decides to go to med school). (Make no mistake, this is a good position to be in.)

We can’t really tell yet, because we don’t know for sure which college Abby is going to, how much it will cost, what if any scholarships she might receive, how many years it might take her to finish, or whether she chooses to pursue anything beyond a bachelor’s degree. Plus there are other factors, including the American Opportunity Tax Credit, which means that at a minimum we’re going to want to spend $2000 a year from outside of the 529 plan (and perhaps as much as $4000) in order to claim that credit. But at this point my best prediction is that when she finishes her college work, we’ll have to decide whether to withdraw what’s left or leave it for possible future use by us or Abby’s possible children. Again, a good problem to have, and definitely not a potential reason to shy away from using a 529 plan.

If you live in Colorado and want to save some money for your child(ren)’s higher education, you should definitely be looking at a 529 plan as part of your larger financial plan. If you choose to work with me, this would certainly be part of our discussions. And keep in mind that while it’s better to start right after they are born to maximize the compound investment earnings potential, it’s never too late. Even if your child is in college now it makes sense to funnel your payments through the 529 plan. Even though they might not be in there long enough to really benefit from the tax-free investment growth, you will still get the 4.63% Colorado state tax rebate. When most folks are paying $20,000 and up (sometimes way up) a year, 4.63% isn’t nothing ($926 if it was $20,000).

Credit Cards: Evil or Good?

Summary: When used wisely, credit cards are an excellent financial tool and can actually pay you to use them.

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Credit cards have a bad reputation in financial circles, and for good reason. Lots of folks have used them to spend more than they can afford, and then end up paying exorbitant amounts of interest because they carry a balance. The problem, of course, is not with the credit cards themselves, but with the behavior of the person. If – and this is a big if – you have self-discipline and only buy what you truly need and can afford, then using credit cards is actually a very smart financial move. The rest of this post assumes that you can use them responsibly – if that’s not true, then stop reading now. If it is, then it turns out that the credit card companies will even pay you to use them.

There are many posts you can read that will dive into this much deeper than I will, particularly if you want to use credit cards to “travel hack.” I will just briefly describe the somewhat haphazard way I’ve gone about this to demonstrate that you don’t have to be an expert to take advantage of this (while acknowledging that it can be done better if you take the time to become an expert).

Until fairly recently we were a one credit card family. We’ve always been disciplined about our spending and we started using a credit card early on and pretty much charged everything we could simply for convenience reasons. Then credit card companies slowly started introducing “rewards” credit cards in different flavors, and we went ahead and changed our one credit card to a credit card that earned us 1% cash back that went directly into the 529 college savings plan we had started for our daughter (more on 529 plans in a future post). We still just stuck with one credit card and didn’t really see the need for more than one. Flash forward a few years and suddenly reward credit cards are everywhere, and we also happen to be financially secure, including owing no debt, so didn’t have to worry about possible impact on our credit score (if you do it right, opening multiple credit cards isn’t that much of a concern anyway).

Since some of the new reward credit cards offered more enticing deals than simply 1% back into the 529 plan, I started researching them a bit. I discovered that not only did many of them offer more than 1% cash back (at least on certain items), but they also frequently offered bonuses for signing up. At first that seemed too good to be true (I mean, really, they are going to pay me to get their credit card?), but after investigating it turns out that it was legitimate. Credit card companies make their money from merchants (who pay a fee for each transaction), and from credit card users who don’t pay off their balances each month. (Part of me feels ethically conflicted about this, so that might be a reason not to do this if you feel that same conflict strongly enough.)

For a while we were pretty content with just that one, but then in 2012 we added in a Chase Freedom Card (*referral link). This card also offers 1% back on everything, but then 5% off on categories that Chase chooses each quarter. Those categories can change from year to year, but for 2017 look like this (fourth quarter has often included Amazon):

chase

This then became our primary card and we eventually cancelled our earlier card. While it was a bit annoying that the categories changed each quarter, it was still better because we still got the 1% on everything and then got the 5% on some things each quarter. I don’t have an easy way to tell how much we earned with this card then, but it would’ve definitely been more than with the earlier card. Especially because this was also the first time we got a “sign-up bonus” and I’m pretty sure it was $200 (it’s currently $150 after a minimum spend).

We stuck with this card for quite a while, but then in 2014 we added in a second card, the U.S. Bank Cash Plus Card. At the time we still had our checking account at US Bank (more about our switch to Ally Bank in a future post) so it was nice and convenient, plus in addition to offering 1% cash back on everything, it offered 5% cash back in two categories and 2% in one other category that you can choose each quarter. While it’s a bit of a hassle to choose those categories each quarter, it only takes a minute or two and can definitely add up. Here are the current 2% and 5% categories you can choose from:

usbankcashplus

Because we also had (pre-defined) categories for our Chase Card, each quarter I check for what those categories are and then choose complementary categories for the US Bank card. For example, I usually choose the 2% for the US Bank card to be for groceries, except for the quarter that Chase offers 5%, then I’d switch it to restaurants. For the two 5% categories, we really only take full advantage of one of them – cell phones. We have a family plan that includes myself, my wife and my daughter, but also my sister, my mother-in-law and my father-in-law. We pay the bill and then they reimburse us, so the bill is somewhat significant each month. By charging it to this credit card, we get 5% back each month on that. Because we really don’t buy that much, the other 5% category isn’t that important, but we usually choose department stores for when we occasionally buy some clothes. Over the life of this card (since July 2014), we’ve earned more than $1800 cash back. I think the sign-up bonus for this one was only $25 once we redeemed $100 in cash back, but I think that for a while it was a $25 bonus every time we redeemed at least $100 (that’s ended now). The sign-up bonus right now ups the 5% categories to 5.5%, 2% to 2.5%, and 1% to 1.5%, all for the first year, then it drops back down to the normal levels.

It was nice having two cards in case there was a problem with one, and it was nice being able to juice our cash back a bit, and of course we always paid off the balance each month. We were content for quite a while with just those two, but then I kept reading more and decided to add in a third card – the American Express Blue Cash Preferred Card (*referral link) in December of 2016. This is a card that I honestly thought we would never get because it has a $95 annual fee. With all the no-annual fee cards, why would you choose to pay a fee? Well, it turns out the cash back on this card is more than enough to cover the annual fee and still earn us more than some other cards.

amex

First, the sign-up bonus included $150 cash back after a minimum spend, so that more than took care of the $95 annual fee the first year. If we decide it isn’t worth it, we can always cancel the card before the year is up and avoid the $95 fee for the next year. An additional sign-up bonus was 10% back on Amazon purchases for the first 6 months. We got this card right before Christmas, and we also have quite a few family birthdays in the first 5 months of the year, so we took good advantage of this. The on-going rewards include 6% back on groceries (this is where we come out ahead even with the $95 annual fee, which is why at the moment we don’t intend to cancel it), 3% back on gas and department stores, and then 1% on everything else. There is a $6,000 annual limit on the groceries, but conveniently one quarter we can use the Chase Card and get 5% back on groceries and then use the Am Ex for the other three quarters of groceries and stay within that limit. We now put restaurants for the 2% category for the US Bank card instead of groceries (although during the 3rd quarter we use Chase for restaurants because it’s 5%).

Now that we had three cards, I was feeling that was plenty. But then I needed to book an airplane flight to visit my parents this summer and ended up on a different airline than usual. When I was about to book the flights, up popped an offer for a branded credit card that would give me $100 cash back on that very flight. The rest of the benefits weren’t that great, but I went ahead and got the credit card simply to pay for that one flight. Now that the flight has been completed, I’ll cancel the credit card. (Haven’t yet just in case I need to book an emergency flight on this carrier in the next few months.)

Then, funny enough, because we got that credit card (which happened to be offered by Citi), Citi then tried to upsell us on another credit card, the Citi ThankYou Premier Card. It also has a $95 yearly annual fee, but it’s waived for the first year, and you can earn $500 in bonus points with a minimum spend, plus additional points for travel purchases.

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As it so happened, we need to book several flights for later this year and those, combined with paying our annual house insurance on this card, met the minimum spend. So we got this card, put the flights and the yearly house insurance on it, and got slightly over $575 in points between the bonus and the 3% bonus on travel expenditures. The only thing I didn’t really like with this one is that if you wanted to use those points for cash back, they were only worth 50% of the value. If you booked travel through their site, they were actually worth more than 100%, but I didn’t want to deal with that going forward, so instead we converted them into $475 in Target gift cards plus $100 at Red Robin. It will take us a while, but we do eat at Red Robin and shop at Target occasionally, so again it was basically free money. We’ll keep this card until our travel is completed, then cancel before we have to pay the annual fee.

After this one I was ready to take a break for while (although still planning in about 12 months to explore options again for additional reward and sign-up bonus opportunities), but then for our next Amazon order an offer popped up to get an Amazon Credit Card. This was something I had been planning on eventually doing because it gives you 5% back on Amazon purchases (had to wait until after the 10% cash back from the Am Ex card was done), so went ahead and did it now because they also offered a bonus of $70 cash back.

Now, at this point, this may sound a bit crazy to you, but it’s all pretty straightforward. As I mentioned previously, I’m not an expert on this, and there are many blog posts that explain how you can systematically go about this to optimize your rewards (especially if you want to use them for travel). But even just doing it haphazardly like we have can easily earn you more than $1000 in bonuses, plus probably several thousand a year in cash back. (There are enough cards out there, and you can even get the same card again after not having it for a while, that you can probably keep rotating through them and continue to get bonuses for quite some time.)

This only works if you’re fairly secure financially (helps you qualify for all these cards), and if you don’t succumb to temptation and use these cards to spend money you otherwise wouldn’t. It really does end up being pretty much free money at the cost of a very small amount of time, for items you would be buying anyway. Even if you don’t want to get multiple cards at the same time, make sure the one card you do have is the optimal one for your spending habits, then periodically see if it makes sense to switch to a new one that also works for your spending and allows you to earn the bonus.

Now, what should you do with all this free money? Well, it depends on your circumstances, but most of the good options involve investing it. I’d be happy to work with you to figure out the best way to do that.

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Working Teens and Roth IRAs

Summary: If you have a teenager with a job, opening a Roth IRA for them is really good idea from both a learning and a financial perspective.

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Our daughter is 17 and has had a part-time job for a little over a year. She makes minimum wage and probably works about 8 hours a week on average during the school year, and a bit more during breaks if we are in town. (Ironically, this summer she’s interning at a summer camp, which means she’s working full-time but making less.) While I think it’s safe to say that not many 17-year-olds are thinking much about retirement, ours is (well, at least she is when I make her :-).

As a result, as soon as she received her first paycheck, she opened a Roth IRA via Vanguard (since she’s not yet 18, it’s a custodial account, but will become completely hers once she turns 18). Why in the world would we do that? Simple, because it’s a fantastic opportunity for her to learn about finances and planning ahead, and also because it’s an incredibly smart move financially for her to do this now.

If you aren’t familiar with Roth IRAs, they allow you to put money (earned income up to $5500 per year for those under 50) in post-tax (so you don’t get an immediate tax deduction like regular IRAs or 401ks). That money then grows tax-free (like a regular IRA or 401k) but then, and this is key, upon withdrawal is also tax free. That means for my daughter, and most teens working part-time like her, this money is never, ever taxed because she doesn’t make enough in a year right now to owe state or federal taxes.

In 2016 she earned a total of $1651 and contributed the same amount to her Roth IRA. In 2017 so far she has earned $2133 and contributed that to her Roth IRA. With some investment gains, her current balance is about $4000. She’s invested in a low-cost Vanguard Index ETF because since she started with $0 she didn’t meet the $3000 minimum for the index mutual fund, and the ETF allows you to buy individual shares at whatever the current cost is. We’ll wait until she surpasses $10,000 so that she qualifies for the low-cost admiral fund and then probably move it over into the mutual fund version (same expense ratio as the ETF, but a little less hassle on our part to invest).

So why is this an “incredibly smart move financially”? In a word (okay, two words): compound interest. If she continues to work about the same amount between now and August 2018 (she graduates in May 2018 and will probably be going to college in the fall), she will have invested somewhere around $7,500 in her Roth IRA. Including the investment gains she’s had so far and assuming a bit of a gain in the next year, let’s call it $8,000 at the point she starts college.

Now she’s likely to work part-time in college, and eventually she will begin full-time work, at which point she will most likely add a 401k to her retirement savings plan and she may or may not continue to contribute to a Roth IRA depending on the circumstances. For the moment, let’s assume she never contributed another dollar to her Roth IRA for the rest of her life, let’s explore what happens.

Well, predictions are just that, predictions, but we can do some decent estimates based on historical results. The stock market has typically returned over 10% a year on average for a long time (and small-cap value, what our daughter is invested in, is even a bit higher), but most folks think that at least in the short term (the next 10 years or so), those returns will be muted a bit. So for demonstration purposes, we’ll use 8% returns (feel free to substitute in a lower or higher amount if you want). So if she has $8,000 invested in her Roth IRA at age 18, doesn’t invest another dollar for the the rest of her life, and “retires” (whatever that will mean at that point) at age 68, how much money will she have? Over $375,000.

That’s fantastic, considering it’s totally tax free and it came simply from the part-time jobs she worked while in high school. But it also overstates it a bit, as those are not today’s dollars, but 2068 dollars, which means you have to take into account inflation. We’ll assume inflation of 3%. Historically inflation has averaged 3.5%, but it’s been lower lately, and governments try harder now to manage that rate, so lots of folks think it will be lower going forward (that’s also part of the reason that the expectation is that stocks will earn lower than 10% going forward as well). So, in reality, what we’re calculating here is a 5% real return after inflation (8% nominal return minus 3% inflation). That amounts to over $91,000 in today’s dollars. That may not sound quite as impressive, but keep in mind that’s assuming no additional investments after she graduates from high school, and that money is completely tax free. (That’s also likely more than a lot of the adults reading this post currently have saved in their retirement account.)

This entire scenario assumes, of course, that the teen can afford to invest this money. Many teens have to work to help support their family day-to-day, so this unfortunately isn’t an option for them. Ours doesn’t have to help support the family, so this is another advantage of us being financially secure – we can not only help our daughter learn about saving, investing, financial planning and retirement planning, but we can give her a head-start on her savings and investing. If your family is in a similar position, I highly recommend you consider this option and, if you choose to work with me, this is something we will investigate.

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PERA Transition Year (aka, 93/93 or 110/110)

Summary: For many public school employees, a transition year is a fantastic benefit that can make a huge difference in your retirement finances. It’s definitely worth finding out if your school district offers it, under what conditions, and then investigating whether it might be right for you.

transition

The working after retirement rules for PERA specify that retires can work up to 110 days in a calendar year for a PERA-covered employer after they retire (there’s no limit on non-PERA covered employment). While any PERA-covered employee can possibly take advantage of this, it works especially well for public school employees because our contract year naturally occurs half in one calendar year and half in the next, meaning you won’t exceed the 110-day limit in either year. Some – but not all – school districts offer this transition year benefit (sometimes referred to as 93/93 or 110/110), but often with special conditions. For example, in Littleton Public Schools you must have been continuously employed by the district for the previous 10 years in order to qualify, and the district does not pay benefits during the transition year. Check with your district to see if it’s offered and what conditions there may be. (In Douglas County Public Schools it is also working in the district the previous 10 years plus the permission of your supervisor.)

Despite this being around for a while, lots of folks are a bit unclear on the details (or unaware of it altogether), so I thought I’d use my experience as an example. I officially retired on June 1, 2017 and am now working a transition year with LPS. I currently have 29 years of teaching experience under PERA, plus I purchased 6 years of service credit, giving me 35 years of service credit that my retirement benefit is based on. Thirty-five years translates to 87.5% of my Highest Average Salary (HAS) if I choose option 1 under PERA (full benefit comes to me, but when I die the benefit stops). Since I chose option 3 (I get a reduced benefit, but when I die my spouse gets the exact same benefit until she dies), I’m getting about 91.5% of that which comes out to about 80.1% of my HAS. It’s important to understand that the factor that determines that reduction percentage changes, both according to your age and your spouse’s age and due to PERA’s current actuarial assumptions, but the changes are relatively small from year to year.

What this means is that during this transition year, I’m effectively getting 180% of the pay I would normally get, minus the amount I have to pay for my own insurance coverage. I’m adding on to my wife’s insurance (as is our daughter) so that comes out to approximately 5% of my salary, so I’m making about 175% of what I normally would. (Also, in LPS your pay for the transition year is “frozen” at what you made the previous year, so I do not receive the small cost-of-living raise I would’ve normally received.)

The other thing to keep in mind is that in addition to losing benefits, I’m “giving up” the service credit I would earn with PERA by working this transition year. I (and LPS) still contribute to PERA during this year, but I do not earn any service credit, which is effectively giving up 2.5% of my HAS. Because I’m 75% “ahead” from getting the benefit during my transition year, that’s equivalent to roughly 30 years of retirement. (Not exactly because of the time-weighted value of money, it is actually much longer than that because I can earn money by investing that 75% over those thirty years, but good enough for our purposes). So, with that back-of-the-envelope calculation, the “break-even” point is 30 years. If I live longer than that (which I have decent chance of), then theoretically not taking the transition year would work out better. In reality, because of the compounded investment returns that I can make on that 75%, it’s likely to be 40 years to break-even or perhaps a lot more, so for me the (financial) decision was pretty easy. (The fewer years of service credit you have, however, the closer you need to look at that calculation.)

There are other things to consider in addition to the “break-even” point when looking at the transition year option.

  • Because you have to retire from PERA and keep working for your employer, you have to know you are going to retire (and commit to it) about 16 months before you will actually stop working for your current employer. For some folks, that’s difficult to do.
  • As mentioned above, in many districts you’ll lose your benefits, which includes not only health, dental and vision, but things like life insurance and sick days (in LPS you get 5 sicks days for use during the transition year). So you have to figure out where you are going to get coverage (from a spouse, from LPS via COBRA where you pay the full premium, from PERACare, or on the individual market).
  • During the two calendar years that the transition year affects, your taxable income will increase (both your regular income and your PERA distribution are taxable), and there’s a decent chance it will move you into a higher tax bracket. (In LPS you get two “paychecks” – one from LPS, one from PERA – for a total of 14 months, 7 in each calendar year.) This is especially true in LPS if you have a lot of accrued sick days, as LPS gives you a payout on those as well, for me that’s over $9000 additional taxable dollars for 2017 (this is not PERA-includable salary). This is why many folks increase their contributions to 401k/403b/457 plans during these two years.
  • And it depends a lot, of course, on your personal financial circumstances and needs. There’s no one-size-fits-all when it comes to retirement planning.

So, should you take a transition year (assuming your district offers it and you’re eligible)? It depends, and if you choose to work with me we will look at this very carefully, but it’s definitely something to know about, investigate, and perhaps even make some financial decisions prior to retiring based on the knowledge that you will be receiving this benefit.

photo credit

Your Next Car Should Be Electric

Summary: While there are a plethora of environmental and climate change reasons to go electric, your next car should be electric because it will save you money and time, and will make your life better.

 

model3

As I indicated in the Why You Should Go Solar post, I believe climate change is a huge issue and so I’m not exactly unbiased in this discussion. Having said that, I would be writing this post even without the environmental impacts of choosing an electric car. You should choose an electric car because it’s just a better choice of car for most people. (By the way, if you really want to build wealth, health and fight climate change, consider replacing one of your cars with a bicycle.)

There are lots of reasons to go electric, this guy lists 30 (only a few of them are a bit tongue-in-cheek). Let me (briefly) give you my top three:

  1. The most important non-renewable resource you have is time. Getting an electric car will give you more of it. No more gas stations (you start every day with a full “tank”). No more oil changes. Practically no more maintenance, rotating and changing the tires is about it – by one estimate there are about 18 moving parts in an electric car, compared to over 20,000 in a typical ICE (internal combustion engine) car.
  2. You will enjoy driving more. Electric cars drive like sports cars, let you merge into traffic much easier, and are incredibly quiet. If you like to drive and think, it will be so much quieter. If you like to talk or listen to podcasts, it will be easier. If you like to listen to music, it will be higher quality.
  3. You will save money. Right now, with current incentives, you will save money up front. Over time you will save money on fuel costs (depending on current gas prices, the electricity you use costs only half as much as the equivalent amount of gas), maintenance, and a longer usable life of your car (if you so choose).

I can happily go on for a long time, going more in-depth on the above reasons or discussing many others, but since you have access to Google and can readily find that on your own, I’ll spare you (at least in this post, in person…be ready :-). For the rest of this post let me (again, reasonably briefly) go through a few of the vehicle choices you have right now and some of the pros and cons of each.

Tesla Model 3: Full disclosure (or confession), we’re first-day reservation holders on a Model 3, so I’m definitely biased (and excited to get ours later this year or perhaps early next year). Tesla is the reason I can write this post. Because of their incredible work over the last decade or so, electric cars are going mainstream. While you have several good choices today, every auto maker will be coming out with compelling electric cars in the next 2-5 years because Tesla has shown that you can make a compelling car that people will want to buy (at least 400,000 people have reserved a Model 3 and put a $1000 deposit down a year in advance, including yours truly).

Up until now Tesla has been the leader, but their offerings have only been in the luxury car segment (Model S and X cost $70,000 to $150,000-ish). That was part of Elon Musk’s master plan (here’s part deux), to generate revenue to fund the development of a mass-market car. With a base price of $35,000, I would still consider a Model 3 to be on the upper end of that mass market, but certainly within the range of what many middle-class Americans pay for their cars. (We’ve never paid more than $21,000 for a car, so this is definitely a change for us.)

The Model 3 is designed not only to be a great electric car, but to be a great car, directly competing with the BMW 3-series and the Mercedes Benz C-class. (This post does compare total cost of ownership to a Camry, but mainly from an evaluating Tesla as a company perspective.) The reveal event is scheduled for July 28th, so at that point we’ll know all the details about the car and hopefully the pricing on the available options. (Once we know the pricing on the options, I will write a follow-up post on the details of our Model 3 purchase.)

The main points to know about the Model 3 at this point for comparison purposes is a $35,000 base price, at least 215 miles of range on a charge, access to Tesla’s Supercharger Network, and all the hardware included to enable fully autonomous driving in the near future should you want that (and enhanced autopilot driving right now). The other thing, unfortunately for most of you reading this, is that if you aren’t currently on the wait list, if you sign up for one today it will likely be early 2019 before you can get one. It qualifies for the $7500 federal tax credit (although if you aren’t already on the list, you will likely be in the phase-out period by the time you can get one, so might only be $3750 or $1875) as well as the $5000 Colorado tax credit.

Tesla Model 3 Net Base Price after tax incentives: $22,500

2017 Chevy Bolt: The only non-Tesla long-range fully electric car currently on the market, the $37,500 base price Chevy Bolt is a good car. It was named North American Car of the Year for 2017 as well as Motor Trend’s Car of the Year for 2017. It gets 238 miles on a charge, is a reasonably roomy hatchback, and is a pleasure to drive. To be clear, the Model 3 is anticipated to be in a different class than the Bolt. The Model 3 is targeted at the low-end luxury market, the Chevy Bolt at the “regular” market.

There are probably three main drawbacks to the Bolt right now:

  1. Chevy is constraining production, so there is somewhat limited availability (although definitely more available than the Model 3 🙂
  2. Some people feel it is a little “small”. From what I know, I don’t think so, but if you’re used to an SUV, I imagine it will feel small.
  3. The Bolt does not have the advantage of the Supercharger network. This is only an issue for long road trips. On a long road trip, the fast-charging capabilities of the Supercharger network is a huge advantage for Teslas. There are plenty of charging stations available for the Bolt, they just won’t charge as quickly as the Superchargers will. (And, of course, you can plug into any electrical outlet.) As the charging infrastructure is built out, and faster chargers are deployed, this will become less of an issue (although it’s unclear whether today’s Bolt will be able to take advantage of those faster charging speeds).

The Bolt qualifies for the $7500 Federal Tax credit and the $5000 Colorado tax credit, so the base price in Colorado is effectively $25,000 (Chevy is still a long way away from selling enough electric cars for the Federal incentive to phase out for them.)

2017 Chevy Bolt Net Base Price after tax incentives: $25,000

2017 Nissan Leaf: Next to Tesla, Nissan has had the most impact on the EV market with the Leaf. With a base price of $30,680 and a range of just over 100 miles, it’s a great car for what it was designed for. As a “daily commuter” car, it’s great, and has all the electric advantages. The main downside is total range and the fact that Nissan did not build thermal management into the battery, so the battery degrades more over time than batteries from Tesla or Chevrolet.

Everyone is eagerly anticipating the release of the next generation Leaf (2018 model year) in early September. This is expected to be in the same range category as the Model 3 and the Bolt and hopefully will be thermally managed. Nissan has kept a tight lid on the features and pricing of this car, but I would anticipate it will be in the 230 mile range on a charge and around $33,000 base price before incentives, so $20,500 in Colorado after incentives, but I could be very wrong. (Nissan is closer than Chevy to phase out, but since they don’t have 400,000 reservations like the Model 3 does, it shouldn’t be an issue if you are buying now.)

Because the next generation Leaf is on the way, however, there is a window of opportunity to get a great deal on 2017 Leafs. If you are okay with the range limitation and the battery degradation, you can get 2017 Leafs for $25,000 or less before incentives, which means around $12,500 or less after incentives in Colorado (and currently you can even get 0% financing for 60 months). That’s a pretty good deal and worth considering. As we get closer to September, you can probably even deal and save a bit more (for any that are left in inventory).

2017 Nissan Leaf Net Base Price after tax incentives: $12,500
2018 Nissan Leaf Net Base Price after tax incentives: Guessing $20,500

2017 Chevy Volt: This is a plug-in hybrid, not a pure electric vehicle, but is a great choice for many folks, especially if you aren’t quite comfortable yet going pure electric. It gets about 50 miles on pure electric, and then switches over to the gas engine to extend the range to 420 miles. Since most people’s daily driving is less than 50 miles, it functions like a pure electric vehicle most of the time, but gives you the comfort level of knowing that the gas engine will kick in if you run out of charge (and you can fill up at gas stations instead of worrying about charging).

The base price is $34,095 but, after the Federal and Colorado tax credits, that drops to $21,595. That’s a really good price for a really great car that gets you almost all of the advantages of an electric car with the safety net of a range-extending gas engine.

2017 Chevy Volt (plug-in hybrid) Net Base Price after tax incentives: $21,595

There are other choices out there (and many more coming soon), but those give you a pretty good idea of some of the options available to you. For many of you, however, you might want to consider one more option, which is buying a used electric or plug-in electric car. Again, there are lots of options, but one of the best would be to look at used Chevy Volts, particularly 2013 models with average to low mileage.

I can speak directly to this because we ended up purchasing a used 2013 Chevy Volt at the end of December. We were not really looking at getting a new (new to us at least) car, since we had the Model 3 reservation. But we have a new driver in the household and, on occasion, having a third car would be nice (first world problem). Plus, our 1995 Honda Civic, which has been a great car, was starting to experience a few issues and we were worried it might not last until we got the Model 3 (our other car is a 2006 Toyota Prius).

So we originally explored both new and used Nissan Leafs, but finally decided that with the battery degradation issue we didn’t want to go with a somewhat compromised used Leaf, and with the Model 3 coming a new Leaf wasn’t quite as compelling for us. We had decided to live with two cars and hope the Civic held out until we got the Model 3, but then we ran across some good deals on 2013 Chevy Volts that were coming off lease with relatively low mileage. As we got closer to the end of the calendar year, the deals kept getting better, so we started investigating a bit more.

Eventually we found a base model 2013 Chevy Volt with about 21,000 miles on it for only $13,500 and decided that was too good to pass up. Especially because this car came from out of state, and at that time Colorado still offered a state tax break on any EV that had not been previously licensed in Colorado. That saved us an additional $2145, bringing the net price down to $11,355. (Unfortunately, Colorado discontinued the tax break for used cars at the end of 2016). This was also a Certified Pre-Owned vehicle, meaning we got a one year warranty and two free maintenance visits over the next two years (oil change and tire rotation).

The 2013 Chevy Volts typically get between 30 and 40 electric miles on a charge, and then the gas engine extends the total range to about 380 miles. But, again, for most folks’ daily commutes, that’s plenty. To give you an idea, we’ve driven the car about 3800 miles so far and have yet to put gas in it. We’ve used a total of 3.2 gallons of gas, and about half of that is because the car will force the gas engine on periodically if you haven’t had to use it just to keep the gas engine in good shape. I anticipate not having to put gas into it for another 12 months or so (perhaps more if our Model 3 arrives sooner rather than later).

Used 2013-ish Chevy Volt Base Price (no tax incentives): Neighborhood of $14,000

Buying a used car is often a much better financial decision than buying new (current EV incentives change that equation a bit for electric vehicles right now), so this is an excellent choice to consider for those who don’t want to spend so much, or who aren’t quite comfortable buying a fully electric car yet. It will provide a nice bridge vehicle to the near future when the charging infrastructure is built out, the range of pure EVs will likely be greater, and economies of scale will likely make the prices even more competitive. (I’d predict the “tipping point” is 3 to 5 years before buying an electric car will be the obvious choice for almost everyone – sooner if a carbon tax somehow gets passed in Washington.)

If you choose to work with me, part of our discussions will be around making good financial decisions around your transportation needs, so discussing electric would certainly be part of that. But, even if you don’t want to work with me on financial stuff, I’d be happy to discuss (cajole, harangue, hassle you about) electric vehicles. They will save you time and money (especially right now with the Federal and Colorado tax incentives), help save the planet and, oh yeah, are really fun to drive.

Focus On: LPS Retirement Plans (401k/403b/457 Plans)

Summary: Choose the PERA 401k plan and invest as much as you can.

lpsretirement

The idea of retirement is a fairly new one. It wasn’t until early in the 20th century that the concept of retiring from work and “living a life of leisure” was even a concept. Many employers started offering pension plans and then Social Security came along in 1937. Then in 1978, the idea of a tax-deferred savings plan (401k) was created, although it’s original intent was not the way we’ve ended up using it.

Social Security was really designed to be part of a “3-legged stool” concept of retirement, that retirees would draw from their company pension, from social security and from their personal savings. As pension plans have gone out of favor and 401ks have taken their place (particularly in the private sector), it has really become a two-legged stool (which is somewhat problematic). For public school employees in Colorado, PERA is a social security replacement plan, so basically covers those two legs, leaving the personal savings leg for you to figure out on your own. That’s where employer-offered tax-deferred savings plans come in.

All PERA employers offer the PERA 401k plan to their employees, and some employers also offer access to the PERA 457 and the newly created PERA Roth 401k/457 plans. Many school districts also offer additional, non-PERA options for tax-deferred accounts. This post will focus on what’s offered in Littleton Public Schools, but you should check with your employer to see what options they offer.

LPS allows you to choose between PERA and TIAA for retirement savings vehicles, offering the PERA 401k, 457, Roth 401k and Roth 457 plans, and the TIAA 403b, 457, Roth 403b and Roth 457 plans. There are subtle differences between 401k, 403b and 457 plans that can be important but, for the purposes of this discussion, we’ll treat them as roughly the same, with the important exception that you have separate contribution limits for 401k/403b and 457 plans which gives you the ability to save more if you have the cash flow to do that.

This post is not intended to be an in-depth explanation of 401k/403b/457 plans (or their Roth versions), but let me try to briefly describe them (if you decide to work with me we can dive deeper if need be). The idea behind 401k/403b/457 plans is to save money in a tax-deferred account, which means that you are not taxed on your income that you place into those accounts now, nor are you taxed on the earnings in those accounts as they accumulate, but you are only taxed when you make withdrawals which will hopefully be when you are retired. The traditional thinking is that most folks will be in a lower tax bracket when they are retired, so not only do you reap the benefits of saving “extra” all those years by not paying taxes up front, but when you do pay taxes upon withdrawal you will pay a smaller amount.

More recently Roth 401k/403b/457 plans have been created (along with Roth IRAs, which don’t flow through your employer) that take a different approach. For these plans you do pay taxes on any income you invest, but the earnings grow tax free and all withdrawals in retirement are tax free as well. In other words, pay the tax up front, never have to worry about taxes on this money again. For folks who think their tax bracket might actually be higher in retirement, this is a better option.

The obvious conundrum is how do you know for sure whether your tax bracket will be higher or lower in retirement? You don’t, which is why many folks choose to put money into both types of accounts to hedge their bets and give themselves more flexibility in retirement by giving them the option to withdraw from whichever account makes the most sense based on their current tax situation. (There are also some really nice benefits of a Roth if you are trying to leave an inheritance.)

Many employees, especially younger ones, kind of throw up their hands at all this. Retirement seems like a long way off, the choices can be complicated, and of course choosing not to spend money right now can be difficult for some folks. But the beauty and power of investing is compound interest, and it’s most effective the more time you give your money to grow, so the sooner you start, the better (and easier) it is to generate the retirement savings you want.

Many folks thinking about 401k/403b/457 plans also don’t take into account the effect on the tax-deferral on their current income. They think about putting say $100 a month into a 401k, but then worry they can’t do without that $100 a month. But they’re missing that their actual paycheck won’t go down by $100, but more like $70 (if you are in the 25% federal bracket, plus 4.65% for Colorado taxes). The government is basically saying, “invest $70 and we’ll give you $30” (always remembering that eventually they are going to tax you on that when you withdraw it). If you choose the Roth options, you don’t get that tax break up front, so your paycheck will decrease by $100 (but the potential for tax-free growth over time is tremendous).

So, with that overview, if you are an LPS employee, should you choose PERA or TIAA? Well, again, that depends on your individual circumstances and I’d be happy to discuss those with you, but for most people PERA is the better choice because of lower fees.

PERA offers a choice of several funds or a self-directed brokerage account if you want more control. For most folks, the funds are the better choice. In 2011 PERA chose to go with a “white-label” approach to investments. Research has shown that many folks make poor investment choices when given too many choices so, instead, a “white-label” approach has you choose among asset allocation choices instead of picking individual funds.

whitelabel

I’ll write more in future posts, but there are basically three things you can control when saving for retirement:

  1. How much you save.
  2. What asset allocation you choose.
  3. How much in fees you pay.

By going with a white-label approach and trying to keep fees low, PERA has tried to simplify the second and third choices for you. For each of their asset classes, PERA has typically gone with a combination of a passive (index) approach and an active (managed) approach. This combination gives you lower fees than a fully active approach, but higher fees than a strictly indexed approach. PERA thinks that they can achieve higher returns than the index this way. I’m a big fan of index funds, so I’m not totally convinced of this approach but, so far in their short lifespan (since 2011), they have mostly achieved this to  a small extent.

perafees

PERA does also give you a self-directed brokerage option (for an additional fee), which allows you almost unlimited choices in investments. For most folks, the additional complication of choices and fees make this sub-optimal, but it’s there if you want it.

selfdirected

TIAA is more like the self-directed brokerage option, which is one of the reasons the fees tend to be a bit higher (although still not bad compared to many other companies, 0.42% plus the underlying fund fees). Here’s a comparison of fees for a large-cap investment in the PERA white-label fund, the PERA self-directed brokerage option invested in a large-cap index fund (they require you to keep $500 in PERAdvantage funds), and the TIAA option invested in the same index fund. (You can view comparisons for other asset classes here.)

401kfees

If you look carefully, you’ll notice that the cheapest option is the PERA self-directed brokerage option (as soon as you pass about $20,000 in your account), with the PERAdvantage funds coming in second, and TIAA coming in last. Since the middle and third columns are essentially the same choice in terms of what you’re investing in, there’s no reason to choose the higher fee TIAA option over the PERA option. If you are investing a lot, you can save in fees by going the self-directed brokerage option, but this is where PERA would argue that they think they will outperform the index and make up those fee differences. The differences are small enough between the first two columns that, for most folks, it’s probably best to stick with the PERAdvantage options.

In future posts I’ll write more regarding possible asset allocations (which fund(s) should you choose), contribution limits (and the fact that you get separate limits for 401k/403b vs. 457, allowing you to save much more if you can), and the power of compounding. But, for now, this gives you an idea of where to start. The key thing is to start now and put as much as you can into one or more of these vehicles so that your “stool” will be sturdy enough to support you in retirement.