Personal Finance Blog
How to become a millionaire by 40, easily!
When I was in college, trying to decide on my major, I had some pretty lofty goals for my life. These
goals included, among many others, becoming a millionaire. At the time I thought this was rather
farfetched; a million dollars was then, and is still now, a huge amount of money. Furthermore, I decided
to go into engineering, and engineers don’t become millionaires, just the doctors and lawyers do.
I didn’t let this stop me though, I was determined to figure out a formula for becoming a millionaire on
an engineer’s salary. I did extensive research on all the government tax advantaged savings programs,
and I think I have finally figured out how to do it! I will go over the high level details of my financial
model below. In later blog entries I will describe the different components of the plan in more detail.
Before I tell you how it is done, I need to go over some of the assumptions that go into this model. First,
this model assumes that you are married and have a two income household. This assumption is for two
reasons, to get a high enough income to allow for the desired savings rate, and because some of the tax
advantaged programs have limits for each person or a higher limit for a family. Another assumption is
that you have a high deductible health insurance plan which gives you access to an HSA.
Now for the plan!
First, max out your 401(k) plan at work! The current contribution limit for an individual in $18,000 for
2017. Combine this with the contribution of your partner and now you are stashing away $36,000 a
year. My model does not assume any employer match or profit sharing contributions; if you are lucky
enough to get any of these types of contributions then it is a bonus!
Next, max out your HSA contribution. The maximum contribution to an HSA is $3,400 for an individual,
and $6,750 for a family. Maxing out the HSA has a couple benefits, and is my preferred place to save.
HSA contributions are not subject to ANY tax, which means no federal, FICA, or state tax. Contributions
can be used for medical and dental expenses as needed, and are allowed to grow tax deferred.
Contributions can be invested in mutual funds and thus should see similar market returns to any other
retirement account. One of the great things about an HSA is that once you are 65 years old you can
withdraw funds for any purpose, penalty free! You would then just pay regular income tax on the
withdrawals.
Finally, max out your IRA. Individual contribution limits for an IRA are $5,500 for 2017. This means that
you can contribute $11,000 per year to you and your partner. IRA accounts, depending on where you
have opened it up, generally have the most options for investments, and should allow you to invest your
money in more than just mutual funds. I, personally, have most of my IRA invested in ETFs.
Okay, so where does this all leave us. If you follow my model, you will be saving $53,750 a year. This
may sound like a lot, but remember this assumes a two income household (making at least $150k per
year should be sufficient). After taxes, you should still be taking home around $50,000 per year, and if
you are intentional with your spending and stick to a budget this should be plenty to live off of. If you
take the $53,750 and put in all towards smart investments that average 10% gain per year, it should take
between 10 and 11 years to hit the million dollar threshold. This means that if you start this plan at age
30, and stick with it, you should be a millionaire before you turn 41! If you already have some money in
savings you will hit that mark even sooner.
I know sticking to the plan may not completely realistic. There are a lot of valid reasons to reduce
contributions, including saving for a down payment or putting money away for kids college, but I really
wanted to just show that it is possible to become a millionaire without having a huge income, and
hopefully give families some hope and motivation to kid up their savings rate even when they are young.
How to get 30% off Healthcare! (or why you should max out your HSA)
Open enrollment just ended, and I am super excited about the increased HSA contribution limits for
2018! The family contribution limit has gone up by $150 to $6,900 for the upcoming year. If you are on
an individual plan the increase is $50 up to $3,450 for the year. Those 55 years old or older in 2018 can
contribute an additional $1,000 bringing the totals up to $7900 ad $4450 for the family and individual
plans respectively. If you are on a high deductible health care plan, as I am, you should be maximizing
these contributions each year. If you are not contributing this level already, or think I am crazy for even
suggesting it, keep reading as I outline the many benefits of the HSA.
First of all, HSA contributions are COMPLETELY TAX FREE! That’s right, no federal, state, local, or FICA
taxes apply! Even traditional retirement savings contributions still have FICA taxes applied so that
makes HSA contributions the most tax advantaged way to save. When used to pay for qualifying
medical expenses for yourself of members of your household, withdrawals from the account are also tax
free. This means that by simply using the HSA to pay for medical expenses, you are effectively getting
30% off all your medical expenses (depending on tax bracket)! For example, if you have a $700 medical
bill, it would cost $1,000 in gross income to pay for it out of your after tax income, but it would only cost
$700 in gross income when paid out of the HSA.
Another benefit of the HSA is that you can invest the balance in mutual funds! Usually, if you have over
$1,000 in the account, you can invest the excess in mutual funds; if you put that money in an S&P 500
index fund you could be looking at 10% growth per year, which when compounded annually will result in
significant growth in principal (that $6,900 contribution grows to $136,923 over 30 years). It is now
estimated that retirees spend at least $250k on healthcare related expenses, and that is excluding any
long term care. If you use the HSA to cover these expenses they will all be tax free since the growth in
the account is also not taxable.
The final benefit of the HSA is that once you are 65 years old, funds may be withdrawn for non-medical
expenses without penalty, and are only subject to normal income taxes. This means that you can use
your HSA as another tax advantaged retirement savings account. The funds grow tax free, so over the
life of the account, if you are well invested and have good returns, this could amount to thousands of
dollars in savings.
Hopefully I have you convinced to max out your HSA contributions. If that is too much of an expense at
this time, make a plan to gradually increase the amount so that in a year or two you are able to max it
out. If you get a raise this year, consider putting that extra money into the HSA rather than taking it
home. It is much easier to save money that you never see, and you’ll be thankful you did later!