The following is a guest post from a 25-year-old Financial Samurai reader who lives in Washington, DC, makes $55,000 a year and maxes out his 401(k). He believes maxing out your 401(k) is a choice on an average income. For those of you who feel like you can’t max out your 401(k), maybe this post will inspire you.
After Sam published his article, Achieving Financial Freedom On A Modest Income In Manhattan, I was fascinated to observe some of the no-can-do responses he received from his readers.
Instead of focusing on Sam’s message of cutting down housing costs, distracting yourself from spending temptation by working more than the average American, and building extra side income while you are young, the naysayers could not accept that he saved 30% of his $40,000 salary even when he did.
They said people making a similar income in today’s dollars would have no chance. Well I make a similar income in today’s dollars and I save an even higher percentage.
Maxing Out Your 401(k) Is A Choice
There’s a great saying: whether you think you can or you can’t, you’re right. It seems like no matter how much you demonstrate what’s possible, people don’t believe in themselves.
I used to be very salty against those who earned more than I did too. My parents didn’t pay for college, so I had to work ~15 hours a week during school and 30 hours a week each summer to afford my public school tuition. I also lived at home for the first two years of college as well to save money.
But when I graduated from George Mason University in December 2016, I didn’t have any debt. Tuition averaged only about $10,000 a year for my four years there so I handled it like a boss.
I studied accounting, the most boring major in the world. But I knew the chance of getting a decent paying job out of school was high.
I did not have the luxury of studying History or English like my rich private school friends who went to American, George Washington, or Georgetown.
Got A Decent Job Offer
I got two job offers after college, one for $45,000 and the other for $50,000. I took the higher one. It’s not like crunching numbers suddenly gets more exciting if you work for a major entertainment company versus an international hotel chain.
Over time, I will make more money as I gain more experience. My ultimate goal is to make $100,000 within 10 years after graduating from college if not sooner. Not unreasonable by any stretch of the imagination.
At the age of 25, I now earn $55,000 a year – 10% higher from when I first started two years ago. $55,000 feels like a healthy amount to me, but I’m a simple guy with simple pleasures.
In 2017 I contributed $18,000 to my 401(k) and in 2018 I contributed $18,500 to my 401(k). For 2021, I plan to max out my 401(k) again with $19,500. $19,000 is equivalent to 38% of my gross income and I don’t find the amount a burden.
Instead, I find the idea of working for the next 40 years as an accountant to be the biggest soul-crushing burden of them all! Hence, I save and save some more.
Maxing Out My 401(k) While Earning $55,000 In Washington, DC
Here’s my budget for those curious to see how I’m able to have about $40,000 in my 401(k) in only two years.
It’s nice that my employer matches up to $3,500 a year. Seeing the money pile up in my 401(k) is addicting and I don’t plan to stop.
With a $55,000 salary, I earn $2,115 gross every two weeks. Therefore, in order to max out my 401(k), I instructed my firm to take 35% ($740) out of each paycheck for my 401(k) contribution.
My asset allocation split is 90% stocks, 10% bonds. I plan to stay with this asset allocation until my 30s.
With $740 taken out, I’m left with $1,375 in gross income. I’ve got to pay $70 pre-tax in healthcare premiums, FICA tax of 7.65% (6.2% Social Security + 1.45% Medicare, 12% Federal income tax, and 5% Virginia income tax.
Note: For 2022, the maximum 401(k) contribution limit for an employee is $20,500. It tends to go up by $500-$1,000 every couple of years.
Enough Cash Flow Left Over
When it’s all said and done, I’m left with about $1,000 every two weeks to spend how I wish. $1,000 in spending money isn’t a lot, but it’s enough for me to live a comfortable life. It feels great knowing that even if I spend the entire $1,000, I’m still aggressively saving for retirement.
Also, I’m guessing I’ll be getting a ~$3,000 tax refund back given the standard deduction is $12,000 and my taxable income is only $36,000. We shall see. The standard deduction amount is $12,950 per person in 2022.
My job is not exciting, but it’s fine. I like the people I work with and I only average 40-45 hours a week. Things will get busier during Feb – April, but overall, the work hours are reasonable.
I get in about 8:30am and leave by 5:30pm for nine months of the year.
Housing Costs ($1,150/month)
I rent a nice three bedroom, two bathroom apartment in Arlington, Virginia with two other roommates for a total of $3,600 a month. The location is great. We have a nice balcony, fancy kitchen appliances we never use, and a small gym with a sauna in our building. Given my room is a little smaller, my share of the rent is $1,100 a month.
My share for cable, internet, and utilities comes to $50 a month, which isn’t bad given it’s being split three ways. We love to have friends over to watch football and basketball during the weekends. Obviously, we use a friend’s Netflix account for free to watch Ozarks (money laundering accountant) and other shows.
When you can share costs with other people, it feels like you’re getting great value. One day, I will follow Sam’s 30/30/3 home buying rule and buy a house. Then I will rent out a room or two to help get my mortgage paid!
Everything Else ($835/month)
Given I only make about $1,000 each paycheck, you can see how I’m spending almost 100% of each month’s salary. But again, that’s fine with me because I know that my 401(k) is getting maxed out.
Paying yourself first truly is the best thing ever. As a result, I hardly ever feel guilty about spending any money.
I’ve got my Metro monthly pass that gets me everywhere I want to go around the city.
I’ve also budgeted about $1,000 a year to go on a couple weeks of vacation. Nothing fancy, but enough to have a good time.
I don’t have a gym membership because I hate being cooped up in a room exercising. Running and biking outside feels so much better. I try and do 150 sit-ups and 60 push-ups every other day as well.
Side Hustling (+$500/month)
Given I only work 40-45 hours a week, I spend another five hours a week on average doing copyediting for a tax and financial website. I can easily bang out a couple hours of work in one evening or do a little bit of work in the morning before heading off to my day job.
They pay me $25 / hour, which comes out to $52,000 a year based on a 40 hour work week.
I use the $500 a month in extra income to build my after-tax Personal Capital account, which I opened two years ago. I’ll be able to contribute at least $6,000 each year in this account while also saving $19,000 in my 401(k) each year.
In 20 years, my after-tax investment account should grow to about $300,000 using a moderate 6.5% annual growth rate and a $6,000 annual contribution rate, giving me the opportunity to do new things if I want.
Given my side hustle income isn’t very high, I don’t have to pay estimated taxes. My goal is to ultimately generate $10,000 a year in extra income mostly by raising my rate, to save for my future. I strongly feel $300,000 in my after-tax account in 20 years is a conservative estimate.
There are so many ways to make extra income online now, you just have to look. I have the capacity to regularly work 60 hours a week without feeling burned out. I might as well take advantage while I’ve still got the energy.
Everybody is able to earn some side hustle income if they want to. But not everybody wants money bad enough to do something extra about it.
Financial Freedom On An Average Income
A $55,000 a year salary might not sound like that much to you, especially in the expensive Washington, DC area, but it’s plenty enough for me.
Within five years, I’m confident my salary will increase to $70,000+. By then, I will have enough for a down payment on my own place so that I can rent out rooms to other people to help pay my mortgage.
In another five years, I expect my salary to surpass $100,000. If I’m lucky enough to find the love of my life, we’ll have an even higher combined salary so we can live alone. I’ve got to imagine life will be even more affordable as a unit.
Who knows, but with enough dedication, maybe I can grow my side hustle income to $20,000 a year for a combined gross income of $120,000 a year by age 35.
No Excuses For Not Contributing To A 401(k)
I know I’m lucky not to have crushing student loan debt. But I also made a decision to go to my hometown state school while also working on the side. The vast majority of my friends didn’t work regularly while in school. Instead, they took vacations during the summers and winters and partied every week.
Be honest with yourself regarding how much you’re spending, how much you’re saving, and how much you’re hustling. If you’re coming home each night binging on Netflix or going out to the bars with your friends on a regular basis, you’re not maximizing your earnings potential.
Financial freedom is all about making choices. My choice is to have a lot more choices by the time I turn 40. – A Young Samurai In D.C.
After you link all your accounts, use Personal Capital’s Retirement Planning calculator that pulls your real data to give you as pure an estimation of your financial future as possible using Monte Carlo simulation algorithms.
There’s no rewind button in life. Make sure you have a proper handle of your finances.
Utilize free wealth management to grow your wealth faster.
For more nuanced personal finance content, join 50,000+ others and sign up for the free Financial Samurai newsletter. Financial Samurai is one of the largest independently-owned personal finance sites that started in 2009. Check out my Top Financial Products page for more great products to help you make and save money.
Whenever I’m told I should “max out my 401k” I always wonder if this person knows me, personally. If you have particular goals that that particular strategy supports, great. But what if you have different goals? What if you are putting your money on some other investment approach, that is working really nicely with your 401k/403b/rental income/regular paycheck/additional investments/plus your other ideas/goals?
Maxing out your 401k pretty much is a choice (even with student debt), but you need an idea of what matters to you and where you want to go, before you immediately go that route.
Nice post.
As someone has reached FIRE, you’re doing all the right things, including sharing with others how to get there.
I live in the SF Bay Area on a similar income and, until recently, I saved a similar percentage of income. I’m 48 now, and after 22 years of consistent savings (about 15 of them saving 25% or more), I can throttle back a little.
I wish I had been more focused when I was young like our young Samurai here. I didn’t get serious until I was 26, and I had a few years’ worth of student loans and credit card debt to pay before I could contribute more than a trivial amount to retirement savings.
I know the point of this blog is to encourage good behavior in saving and planning for the future. I also know that if you take care of the little things, the big things take care of themselves. Save a little (or a lot) when you are young and the dividends when you are old can be great. But, at least in my personal experience, I have always been amazed at how little saving in my 20s would have had any real influence on my future in my 30s. I am able to save now in a year what I could save (including with compound interest) in my entire 20s. Personally, I’m glad I spent my 20s attending private school, networking, and blowing all of my money socializing and having fun. The people I met in my 20s are my clients now in many cases (and very good friends). I suppose it is the classic debate between earning income and saving what you make. If I had extra money in my 20s I would invest it in my education and career prospects way before my 401k. Then (if single) going out and having fun next. I would have an emergency fund of course, but maxing my 401k in my 20s, no way. I wouldn’t trade more fun in my 20s for an extra $200k or whatever in my 30s. Ask a 60 year old with $10,000,000 in his 401k what he would pay for one year of his 20s back. One month. One day. One night.
Look, congrats on being disciplined. That is a skill that will serve you very well in the future. But, it is easy to lose prospective. With the right social skills, and that same dedication you’ve shown, you can make your yearly salary in a month. But, you need exposure to people–lots and lots of people. People that inspire you to do much more than what you currently think you are capable of. People that will help you just because they like you–or because you remind them of themselves when they were your age. For example, my accountant makes around $800k a year. He works hard, but he is hardly the “best” or the “brightest” accountant I’ve ever met. But, I like him (he is a good friend). He is a nice guy and always has my back. Over the last 10 years I’ve probably sent him 100 wealthy clients. None of that would have happened if I never met him because he was watching reruns on TV while maxing his 401k in his 20s. In my experience, going out and meeting people (particularly in your 20s) requires money. Do all the free stuff you can do of course to meet people, but I think it is unrealistic to meet lots of people with $100 a week budget for going out. Real life costs money.
Also, not to get too sappy and break the internet, but I met my wife in my 20s. She wasn’t the first girl, but she will be the last. It took quite a few bad experiences to even recognize the good ones. Dating costs money. Money that was extremely well spent in my 20s in my view. Way better spent than investing in index funds.
I know FS talks a lot about his NY experience and living off of $40k a year and maxing his savings. But, if we are all being honest, he is not where he is today because of that. His wealth and his success is a combination of dedication, real life experience, education, and most importantly courage. Having a savings (or safety net of some sort) helped give him the courage to quit his job and start this blog. So it was a factor. But one of many–and not nearly the most important one in my view. Get “obsessed” or “addicted” with squirreling every dime and you will surely fall short of your potential. First and foremost, you must invest in yourself before you can reach for the stars. That’s what FS did. That’s what I did. I would encourage you to do the same. Think much much bigger than you are currently. I get the sense you have much untapped potential. Then, when you are old and boring like us in our 30s and 40s with families, max the hell out of your 401k!
I think it’s more about developing good financial habits early, because much more is at stake once you’re wealthier and have dependents.
It’s like when I was forced to study 3 hours a night in high school. It carried over into college, and it carried over when I was working. Spending an extra 20-30 hours a week after working 60 hours a week on FS came from childhood discipline.
Discipline early = discipline later in life.
Agreed. I read in Arnold’s Sc hwarzenegger’s bio that his father’s answer to everything was discipline.
In college, I was studying 8 hours a day. That work ethic spilled over into grad school, work, investing, and life.
Starting young increases your dividends in life due time. Once I hit $100k in investments, I was able to relax more because I worked hard enough in my youth to have that money do the heavy lifting for me today.
I made time for fun. Affordable fun. But I always kept my eye on the prize of FI.
It’s impressive to save that much. I do wonder if it would be possible to retire early (if that’s the goal) without saving much more per year. For example, 20k/year invested for 20 years at a 5% real return would grow to less than $700k. Very good, but not much for early retirement. If you can increase your income, then it could definitely be possible.
I think some type of investment with leverage, like real estate, is best for young people. Especially if you can find roommates to pay the mortgage.
Although it really depends on what you want.
I’m really impressed by this guy.
Young Samurai – I work in Financial Planning & Analysis (FP&A) and it’s been a great career because pretty much all corporations have an FP&A department. Think about this area in case you ever get too bored in Accounting. Look for job titles called Financial Analyst to start out. It still has the month after month, quarter and quarter, year after year cycles like Accounting does, but a bit more interesting. I work at a big company in DC so feel free to reach out if you want to hear more about this career path. I can let you know if anything ever comes up at your level for you to apply to, if it’s a career path that interests you. No offense, but I find accounting to be dreadful. Also, having a combined accounting and FP&A background will set you up nicely in the future for Finance executive positions like VP or CFO.
Great job setting your priorities. I think most people can max out their 401k if they make about that much. When you’re starting out, you have to live a more frugal lifestyle. Having roommates can help a ton. I maxed out my 401k when I was that age and it worked out really well in the long run. Keep at it!
Wow kudos to you! That is an amazing achievemen and takes discipline which you clearly have .ore than most.
If you were my client though I would urge you to consider not maxing out your 401k but put enough in to get 100% of the match from your Employer then put the balance (or more!) elsewhere.
Consider this, the larger you grow your 401k the larger your ultimate tax burden. If you hit 71 with a $3m balance what will be your RMD and at what tax rate?
I would urge you to look at tax-exempt options that would allow you to not have a tax burden when you need the money.
I would also look for plans with greater flexibility for things like home purchase, kids’ education, business opportunities, etc.
For most their largest deductions during working years are kids and mortgages both are usually done by retirement so your tax rate goes up.
The adage about being in a lower tax bracket because you are retired is nonsense and a terrible goal unless it’s because you are living on tax-free dollars.
The issue you ignore is the benefit of tax free compounding. His $3.0M in the 401K when he is 65 might only be $2.0M or probably even less if he paid taxes on it and then had to pay yearly taxes on the dividends and capital gains.
No. If you put say 10% into a ROTH 401k they put 10% in. If you put 10% into a 401k they put 10% in. The difference is your take home check is smaller for the ROTH 401k. What this means is you pay the taxes on the take home amount today but your 401k balance will be the same either way… BUT the ROTH you don’t have to pay taxes on when you retire. So 3M would still be 3M not 2M… vs having 3M that you pay taxes on where you’re probably in higher tax brackets due to inflation plus potentially making more.
100% agree with Jon.
Assuming the same growth/tax rates you will end up with the exact same balance whether you go roth and put less in initially or go traditional and put more in but have to pay some of it back to the IRS.
As indicated in my previous post, the question comes down to this…do you believe you will be in a lower tax bracket when you retire?
If you do, great! However, that is a huge risk you are taking that is completely out of your control and cannot be mitigated by investment strategies, etc.
Think of this, many people tell me that they want to be debt free when they retire. To that end they overpay a mortgage sacrificing along the way to pay off something that is fixed, low interest, potentially tax deductible and decreasing.
Compare that to the lien on your 401k. It is unknown, at a high rate, increasing as the value of your 401k does.
Okay, if the choice is between a 401k or a Roth and for this person I do agree they should do a Roth then I agree with your point. However, once he gets past that Roth limit and just has it in a regular after tax account then it would apply. Granted if he doesn’t make 6 figures the difference between tax free and taxable compounding won’t be as much as if he would be making 6 figures. In DC with his background I am pretty sure he’ll be at higher income levels pretty soon. He may even be over the Roth limit soon.
Matt
We seem to agree that a Roth is best. Why then does the Gov’t set such low limits on them? Could it be that the Gov’t has their best interest in mind when setting these limits?
I don’t advocate ANY Gov’t based plan (beyond any Employer match) for those reasons.
In the case of the Roth low income/contribution limits.
In the case of non-Roth penalties, RMDs, taxes.
I would recommend a plan with NO income or contribution limits and tax-exempt growth and distribution.
This past week I set up a plan for a repeat client who asked if she could put $35,000/yr into a plan for the next 20 years (when she plans to retire). Her income is $500k/yr. No problem.
IF it performs as I illustrated (6.8% avg growth based on S&P) her $700k will get her $125k/yr tax-free for 15yrs of retirement (her goal) yielding $1,500,000 in return. She can of course take a larger or smaller income.
One final note…it isn’t the case in the example above but in had she started at a young age (with a much smaller amount) this ONE account could also help with downpayment on a house, kids’ college tuition, business opportunities, major purchases, etc.
Matt
I am not disagreeing with you about the importance of tax-free compounding my solution would provide the same.
The difference, and the risk is that in a a 401k type Qualified Plan there is a tax to be paid. The question is do you pay it today, when you know what it is or do you wait 40+ years and pray that it is less?
That leaves a huge risk in the form of a tax lien against your Retirement that you CANNOT escape! So the question is would you rather pay tax at your current rate (temporarily lowered by the new tax law) based on your deposit OR pay taxes on the withdrawal at whatever rate the IRS/Congress deems appropriate in 40 years?
I would advocate paying the tax now, eliminating the risk and enjoy the growth.
Yeah, $25 for utilities and $70 for healthcare is totally realistic. Wtf.
I agree! If other people don’t have my same expenses, even though they have different circumstances, it can’t be realistic!
Or, you can just read. Getting ahead is so easy bc so many people can’t read.
Oh of course I’m so dumb, I didnt realize that reading would reduce my cheapest healthcare option from $125 biweekly to just $70 a month. Thank you Andy for your wisdom
And splitting utilities 3 ways?
He’s a single young person. Health care costs are low.
Some companies subsidize 100%.
Just because $125 a month is YOUR employer’s cheapest plan doesn’t mean EVERYONE’s is. Sheesh!
And really, you’re just nitpicking. The REAL savings for our Young Smaurai are (in order of importance):
1. Sharing a place (including utilities and cable costs).
2. Not having a car.
All the other stuff is trivial by comparison.
And yet mine is closer to the $70/month. I guess your $125 biweekly is unrealistic.
Note the lack of student loans… maxing out a 401k makes no sense with student debt right? With so many people saddled with student debt, is it any wonder that people are “behind” with their 401k or retirement account?
Good Job !!
We had two of our three children when I was in grad school – it seemed like a good idea at the time. It was just me working for a decade and we put the maximum away. It was hard but worth it. When I look at what I have compared to what I contributed – well it is stunning.
You DO NOT want a life-style demotion when you retire.
I would recommend you consider Roth 401k instead of regular.
OK, is that something I just tell my employer to do? Or do I have to open up a new account somewhere? If I contribute $19,000 to a regular 401(k), how much can I contribute to a Roth 401(k)?
Can you expand on why a Roth 401(k)? Also, can you give me some background about you? Thanks
Your employer should offer a Roth 401k as an option. The contribution limit is the same as the 401k. You can contribute a total of 19k in a Roth 401k and regular 401k.
If your employer doesn’t offer a Roth 401k you can convert your 401k to an Roth IRA and pay tax when you convert.
The benefit is you have tax free earnings, so you will pay taxes on everything you put in, but not when you withdrawal. Look up a Roth calculator and you can quickly see the benefit.
I take it back, if it is possible to get your AGI down to a level that maximizes the Saver’s Credit, then regular 401k is better for that, nevermind, I forgot about your side hustle. You already probably make too much, but worth checking out.
https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-savings-contributions-savers-credit
Background: FIRE:light :) graduated in 2.5 from in-state public university entirely funded by academic and athletic scholarships, to start working as an actuary, once I passed all my exams and paid off my house I decided I didn’t like the job and didn’t need the income based on my simple tastes so took a part-time gig with the same company to keep health insurance and enough income to max out my 401k. Few years after that I got knocked up and now I’m a SAHM with two children, managing my husband’s retirement funds, we max out his 401k with ROTH contributions and also each have a ROTH IRA we max out. He doesn’t mind his job and the company offers a pension, so he will potentially just stay there until age 55, but who knows.