By Erin Lowry
Jan. 31, 2023
The last decade of my life has seen one annual constant: contributing to a retirement plan.
Given the glories of compound interest over time, I’ve been a borderline zealot in the way in which I proselytize for my fellow millennials and our Gen Z compatriots to contribute to their retirement funds. I’ve always said you should at least contribute enough to get your employee match while focusing on other financial goals (or shackles) like building an emergency fund or repaying student loans.
Then I was confronted with balancing my own dreams of New York City homeownership against my desire to save for retirement. Should I press pause on investing for retirement to funnel a lump sum of cash toward a down payment?
Turns out I was right all along.
Last month, I considered rerouting the amount I’d set aside for my 2022 retirement contribution to a savings fund for a down payment. Since I’m self-employed, I don’t have an employer who contributes to my retirement account, but I can use a SEP IRA, which allows for a maximum contribution that’s the lesser of 25% of an employee’s total compensation or $61,000 in 2022. (It’s been increased to $66,000 in 2023.)
Then I sent my accountant the information for my estimated taxes for the fourth quarter. Yet another reason self-employment isn't always glamorous — we have to save up for and pay estimated taxes quarterly, unlike our W2 counterparts who simply have their employers withhold taxes for them.
A few days later my accountant called with the results. If I didn’t contribute to my SEP IRA at all, I would owe almost $8,000 more in taxes than if I maxed out my SEP IRA contribution for the year. (The amount I’d set aside wouldn’t fully max out my annual contribution limit, but still would have resulted in me owing $6,000 more in taxes). That’s a down payment for some people!
Perhaps, to some, $6,000 seems a small amount to quibble over if you’re still putting a lump sum towards a down payment for a home in an expensive city. But to me, it feels like a situation where I’d be cutting off my nose to spite my face. The sum that would have remained after paying my big tax bill was too modest an amount to be an advantageous strategy compared with reducing my tax liability and setting up my future self for a stronger retirement.
Still, I fully accept that there are many people for whom it does make sense to take a knee, or better stated, reduce retirement contributions for a year or two to focus on shoring up cash reserves for a down payment on a home. Of course, I’d still plead that they at least take advantage of any available employer match. But, the question of whether or not to prioritize home-ownership savings over retirement contributions is a particularly excellent example of why “it depends” is the answer to every personal finance question.
As my colleague and editor, Alexis Leondis, has illustrated, owning a home, especially outright, pays significant dividends in retirement. It enables those on a fixed income to better control the cost of housing while those who are renting are subject to the whims of a landlord’s rates and the state of the rental market.
Two-bedroom apartments in Manhattan carry a median rental cost of $4,650 after a dramatic increase of $720 in the last year, according to Zillow’s market research. Things may be stabilizing, but New York is a city whose renters will always be at the mercy of a volatile and expensive housing market, excepting the fortunate minority who have rent-controlled or stabilized units.
Most Americans don’t live in major metropolitan areas. Those who live in areas with homes at more reasonable prices may be able to take a year or two off from contributing to a retirement fund in order to funnel the thousands of dollars needed for a down payment into savings. Perhaps they live in one of the nine states without income tax, so pausing contributions to a tax-advantaged account has even less impact than for their counterparts who pay state income tax.
For my situation, I realized there was another retirement account I could tap without such a tax hit: my Roth IRA. A byproduct of a Roth 401(k) from a former employer, my Roth IRA contains a few years of post-tax contributions. It's more than five years old, which means I can withdraw my contributions without triggering taxes or a penalty. As a first-time home buyer, I can also take an additional $10,000 out as a qualified withdrawal, which doesn’t trigger income tax or the 10% tax penalty for being under 59 and 1/2. Given that my SEP IRA is the one upon which my retirement calculations are built, I don’t see an issue with gutting my Roth IRA for a much shorter-term financial goal than retirement.
The alternative to raiding any of my retirement accounts is the tried-and-true method of aggressively saving by reducing discretionary spending. Not being one for the monastic life, the other option is to reduce discretionary spending modestly while focusing on ways to increase income and ultimately, savings. That's a spot where self-employed people may have an edge: We may not have employer matches, but we may be able to increase our incomes faster than our traditionally employed counterparts.
© 2024 Bloomberg L.P.