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Over the past few years I've been reading a lot of material on personal finance. A common theme is explaining where readers should put their money. Common advice is a retirement investment account, a savings account, paying down debt, etc. I want to summarize what I've read and applied to my situation to show where I spend a paycheck, or rather, where each percentage of my income goes. I'll also explain why I choose to put my money in those categories if they're of any interest. These expenses are for a year when I was single. Being married changes these categories a bit. I pay less tax now, and I can invest more in HSA.
Here is a view of my gross income broken into general categories
From this, we gather my sorted by largest to smallest funding decisions:
Here is the breakdown for that:
Keeping it to the most impactful top 5, I get:
The expense percentages are not too out of the norm. The three biggest expenses for most Americans are home, transportation, and food. The big difference is I choose to live in a more desirable location, while forgoing a car. My location lets me live without a car, so I don't have the transportation costs that are common for Americans. My food and dining is expensive due to eating out too much. I prioritize spending on travel.
The main takeaway from this section is that living close to work, groceries, and anything else that you need every week can almost entirely remove transportation costs. For the uncommon case of needing to go to a specific far place quickly, there's Uber/Lyft.
Taxable investing is broken down into 2 sections: Backdoor Roth IRA contribution and regular taxable investing. $6k every year will go into the Roth, while the rest is invested into an index fund in a taxable account. This can be used to fund the eventual purchase of a house. Taxable investing is important for funding any big purchases that need to happen before retirement funds are accessible.
The takeaway here is that taxable investing is important to reach shorter-term financial goals. It's suboptimal to reduce retirement contributions to increase taxable investing, so reducing expenses is necessary to optimally reach short and medium term finance goals.
Taxes are made up of federal income tax, and FICA. I reduce my tax obligation mostly by:
The takeaway is there are a limited amount of ways to reduce taxable obligation, so take advantage of what you can.
This is maxing out the traditional 401k. There are plenty of reasons to do this for high income earners. These can be read online somewhere else, since I don't have time to get into all of them. For any high-income earner who doesn't plan on working until their 60's, it's a no-brainer to max out the traditional 401k.
The takeaway is max traditional 401k. It's good, and you can't go back in later years and do it, so do it now.
The company I work for allows contributing to our 401k with after tax money that can be rolled-over in plan to a Roth 401k (Mega Backdoor Roth). I do the max the company allows here and I move the money out to a Roth IRA. Roth IRAs are really nice for saving for early retirement, since contributions can be withdrawn early without penalty. Also, Roth IRA conversions can be withdrawn 5 years after the conversion, so starting early will give extra tax-free investments if needed. It's best to avoid withdrawing when possible to allow compounding for as long as possible.
The takeaway is Mega Backdoor Roth allows for someone to have a generous amount of Roth space for annual savings. Roth space is very valuable due to having no tax obligation in the future.
A Health Savings Account is one of the few ways a high earner can reduce their tax burden. It also is the best way to save for potential medical expenses due to being tax free on qualified withdrawals. There's a limited amount of space for annual contributions, so it's important to begin maxing it out early.
The takeaway here is HSAs are a very nice investment account that is very limited in contributions ($3,550 per year for single, $7,100 for married filing jointly). Take advantage of funding it early when it's not needed, so medical expenses are funded as they become more common in the future.
For high income earners, there are many avenues to optimize the monthly paycheck. My 2020/08/18 - Investing in All Tax-Advantaged Accounts blog post explains how some of this optimization plays out in the long term. By optimizing the paycheck like above, you will invest more money, pay fewer taxes, receive more gains, and end up with more money in the end. By reducing expenses by spending intelligently, you can also save for shorter-term goals effectively. I will write a post about how I plan to save for my first house in an efficient manner.