Why My Net Pay for the First 6 Months of the Year is $0
Part of planning for an early retirement means that I'm constantly finding ways to maximize my contributions to all of the various retirement vehicles available to me: 401k, Mega Backdoor Roth, HSA, etc. As far as employers go, I've been very fortunate in that mine also allows for ESPP (employee stock purchase plan) deductions with a 15% discount. While it's not a retirement account, that's a very appealing offer, and one that I take full advantage of, right up to the IRS limit of $25,000/year.
There are two ways that I could plan out these contributions (as well as some middle ground between the two):
Carefully calculate each paycheck, the order of deductions, and the exact percentage required for each so that I end the year with evenly spaced sets of contributions.
Maximize every possible contribution as soon as possible in the year.
Each of these methods has their pros and cons. Option 1 allows me to spread my contributions evenly across the year, a sort of dollar cost averaging, while still providing me a living wage on which to spend on my daily living expenses. However, as a firm believer in "time in the market beats timing the market," I see a potential loss in gains.
Option 2 certainly helps remediate this by dumping a lump sum into each account as early as possible. In addition, because I have no idea where life may take me (I could be unemployed by the end of the year, experience a medical emergency, or any other life event that would remove my ability to contribute), I feel it's better to go with what I have now than to wait for what I expect to have later.
Philosophy aside, option 2 comes with one major drawback: sacrificing net pay in favor of earlier contributions. This takes a decent amount of planning; sacrificing a paycheck for nearly half a year means that I need to have my monthly living expenses planned out and available ahead of time. Fortunately, I have restricted stock from previous years' bonuses which vests in February each year. By saving just enough to make it through January (without cutting into my emergency fund), my stock award is enough to carry me through July, selling off just enough of my company stock to afford my monthly expenses. I see this as a trade that also helps diversify my holdings; selling a single stock to pay for living expenses allows me to save more into my diversified portfolio in my 401k and HSA.
So what does this look like in practice?
In December of 2017, I prepaid my property taxes for the first half of 2018. While I may change this strategy next year due to changes in tax law, it made sense at the time because it allowed me to deduct the tax from my 2017 taxes.
Cost: $6500 (yes, I live in a HCOL area - NYC - where this is 6 months of property tax)
To prepare for January's expenses, I kept enough money to pay for my mortgage plus my standard living expenses while investing the rest.
With some money in the bank, it was time to configure my deduction elections for the coming year:
HSA: $2600 one time deduction on my first 2018 paycheck. My company contributes $800
ESPP: 25% of paycheck (after tax; this is the maximum allowed by the IRS)
401k: 65% of paycheck (before tax; the is the maximum allowed by my plan)
After my before-tax 401k contribution is maximized at $18,500, I converted the same percentage to after-tax as part of a mega backdoor Roth strategy (more on that in another post).
With taxes, these contribution limits net me exactly $0 per paycheck.
Starting Gross Pay:
401k After Tax* :
Employer HSA** :
* I made a mistake on the first paycheck and forgot to change my 2017 after-tax 401k contribution to a pre-tax one. I fixed this for my second paycheck.
** My employer shows their HSA contribution as additional gross pay
Because of my lump-sum HSA contribution, I didn't have enough to purchase any ESPP stock. However, on my second paycheck, I purchased $1500 worth of stock. At $3000/month, it takes a full 7 months to reach the IRS max. However, with a 15% discount on stock purchase, as well as the fact that my company's stock is on an absolute tear this year, this contribution is a no-brainer.
On my second paycheck, I had fixed my pre-tax/after-tax 401k mistake and didn't have an HSA contribution. This allowed me to funnel even more pre-tax money directly into my 401k:
Starting Gross Pay:
401k After Tax* :
The resulting net pay was still $0.
For me, keeping a bare minimum amount of cash in my bank account, while receiving a big fat deposit of $0 each paycheck is an extra motivation to keep my non-essential costs low. In an emergency I could easily tap into my emergency fund, but knowing that I'm funneling as much money as possible into my retirement accounts and ESPP is enough to help me avoid over spending.
After about 6 months, I've contributed the maximum to most of my accounts, and am "forced" to receive net pay. But with my 401k, ESPP, HSA, and after-tax backdoor Roth IRA completely maxed for the year, I'm much happier investing in taxable accounts.