Author Topic: $68,000/year surplus -- Invest vs. save for a down payment? Help me spend my $.  (Read 2504 times)

Fi365

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Greetings,

We're about to embark on a new chapter, and we need your insights.

***Summary: Do we save for a down payment on the next home OR invest in retirement?***

The Life Updates
Baby #2 is due in a few months, the husband is leaving his job to become a stay-at-home dad (so I'll support the 4 of us on my one-woman-LLC income), and we're moving back into our paid-off rental condo an hour away.

The Human Side
- We're down-sizing from a 2,500 sq ft townhouse with 2-car garage into a 1,100 sq ft condo with zero garage space.
- We're moving because I hate the town we're living in, and since we're no longer stuck here for my husband's job, I CAN'T WAIT to move back to the college town where we own a rental home.
- Having no mortgage payment will be a major bonus!

The Math Side
- Since I'm self-employed, my income varies. I'm conservatively estimating that I'll earn $100,000 net next year (after taxes and business expenses are deducted).
- Once baby #2 arrives and we move into a paid-off condo, our "bare bones" (borderline deprivation) budget is $25,000/year for a family of 4. Our very, very comfortable budget is $32,000/year (basically adding back travel and alcohol).
- If I make $100,000 and we spend $32,000, then we'll have $68,000 to play with.

The Questions
- We're committed to living in our condo for at least 3 years while we figure out "what's next." We're currently in Virginia and might move out west (Utah, Colorado, Nevada, Montana?) but need time to search and decide.
- We could save/invest $68,000 x 3 years = $204,000 during those 3 years.

Do we....
a) Throw everything into retirement accounts? Investing would lower our taxable income and earn sweet sweet interest. We've got $200,000 invested now at age 32, so we're not behind, but we're not ahead. The husband is "retiring" to his dream job of being a stay-at-home dad, and I already "retired" from salaried employment to my amazing self-employment, so we're content with me working, since it's my hobby that happens to make nice $ too. In other words, we're drawn to FI but not RE side. My math brain LOVES this choice. But, we'd move in 3 years and have a mortgage again, which would turn my working-mostly-for-fun mindset into a working-to-pay-bills mindset. Quality of life matters a lot, otherwise, why bother with any of these changes?
b) Throw everything at a down payment for the next place?. There are plenty of wonderful places in the country where you can purchase a home for $204,000 cash. My human side LOVES this choice. The husband is also a fan.
c) A mix of investing and saving for a hefty down payment? If we choose this route, do you have tips for deciding how much to invest vs. how much to save for a down payment? e.g., 50/50? And where's the best place to store the down payment? We have a taxable account with Vanguard, but I know 3 years is very short, and who knows when our bull will turn into a bear.

If you're interested, our financial spreadsheet is here: https://docs.google.com/spreadsheets/d/1oDfc1-QBNuoO84IO7XaXZe9SIa1llUcZJiJ-tQRkGdQ/edit#gid=0 It's a living breathing Google doc that I update regularly, so don't read into the exact numbers too much, as they often change.

Thank you, o wise ones.

P.S. Any additional tips for families transitioning from a 2-income household to a 1-income household? Or tips for a working parent who's about to transition into a stay-at-home parent role?



jlcnuke

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I'd go with A, but with some of it just going to a taxable account. Get your $18.5k into a 401k, and your $5.5k into an IRA (husband too if he has enough income to do so) and invest the rest in a regular brokerage account. With a 3-year time-frame I'd generally recommend fairly conservative investments in your taxable account but you may not need to go conservative since:
1. You don't plan to stop earning money so the likely worst case scenario is that your account values drop with a market downturn and you need a mortgage if you do move as planned, but the mortgage wouldn't likely be a major financial burden.
2. You may change your plans in the next 3 years and not move.
3. Even if you did move, it's very likely that you're taxable accounts could be used to just pay off the home if you really didn't want to take advantage of the leverage a low-interest mortgage can provide you.

RWD

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Take a look at the Investment Order post, if you haven't already. You should focus on maxing your tax-advantaged accounts first. I would recommend against planning to pay cash for your next house. Any extra beyond tax-advantaged accounts should probably go in brokerage account invested according to your IPS until you have more clear plans as to a house buying time frame.

Fi365

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I'd go with A, but with some of it just going to a taxable account. Get your $18.5k into a 401k, and your $5.5k into an IRA (husband too if he has enough income to do so) and invest the rest in a regular brokerage account. With a 3-year time-frame I'd generally recommend fairly conservative investments in your taxable account but you may not need to go conservative since:
1. You don't plan to stop earning money so the likely worst case scenario is that your account values drop with a market downturn and you need a mortgage if you do move as planned, but the mortgage wouldn't likely be a major financial burden.
2. You may change your plans in the next 3 years and not move.
3. Even if you did move, it's very likely that you're taxable accounts could be used to just pay off the home if you really didn't want to take advantage of the leverage a low-interest mortgage can provide you.

jlcnuke,

Awesome, thanks so much for your insights.

Your vote is to max all the possible investment avenues, and put the rest in a taxable account?

Since I'm self-employed, we have LOTS of retirement options.

I could my husband as either a contractor or employee. He does a ton of business errands and record-keeping for me now, anyway. I couldn't officially employ him in past years because he works for the Federal govt and the paperwork was complicated.

The math is detailed (see https://docs.google.com/spreadsheets/d/1oDfc1-QBNuoO84IO7XaXZe9SIa1llUcZJiJ-tQRkGdQ/edit#gid=323651400 if you want to geek out), but I think our household could contribute $64,000/year into retirement accounts, leaving $4,000/year of our $68,000 surplus for a taxable account.

Like you mentioned, the worst case scenario is that we do need a mortgage, and that's not so bad. We'd also have $700/month net profit from our rental home coming in. I'd love to keep the mortgage on the next place as low as possible, ideally $700/month, so that we still essentially have no bills.

So much to consider. Thanks for your help!!


Arbitrage

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If you contribute $64k into retirement accounts, won't you have quite a bit more than $68k surplus?  Your taxes should drop by quite a bit.  I didn't look at your spreadsheet to see if you'd accounted for that, but it shouldn't be a static number available for taxable vs. tax-deferred investing.

Fi365

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If you contribute $64k into retirement accounts, won't you have quite a bit more than $68k surplus?  Your taxes should drop by quite a bit.  I didn't look at your spreadsheet to see if you'd accounted for that, but it shouldn't be a static number available for taxable vs. tax-deferred investing.

Abitrage,

Yes, the more money we put into retirement accounts, then the less we'd pay on taxes.

I'm trying to figure out the math now...

I love spreadsheets but this part's tricky because I need to figure out where employer contributions into 401K would go. (I could hire my husband as a contractor or as an employee so that he could put $18,500 into a 401K and I could put an employer contribution into his 401K, which would count as a business expense, and therefore lower our taxable income. I just need to double-check where all this goes on the tax forms. The fewer taxes, the better!)

Thanks for your input. It's so helpful.

« Last Edit: July 18, 2018, 01:19:40 PM by Fi365 »

terran

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For solo 401(k) contributions see the "Deduction Worksheet for Self-Employed" at https://www.irs.gov/publications/p560

I was playing around with my spreadsheet built off of that worksheet and it looks like your husband could max out the $18500 limit while still maxing a 20% "employer" match with an income of $33,200 resulting in a contribution of $24,671. Going over this wouldn't be any better than keeping the income in your name since you'd both receive the same match, but going under this would lower the overall contribution as he would still have space in the $18500 limit while you would not, so he could contribute a higher percentage than you could. Of course, you need to balance with with whether he can do enough work in the business to justify that salary, and you'll also have to consider the possibility of increased self employment tax if the income would otherwise be over the limit.

It looks like you before tax income from the business is projected at $150k (not sure if that already includes business expenses, so I'll say it does). So subtracting your husbands $33,200, your $116,800 of income would support $40,210 of contributions.

Do your own math based on that worksheet of course, but I thought I'd throw out some numbers what using a solo 401(k) might look like.

On the other hand, you might want to look at what electing to file as an S-corp might look like as that could save you some self employment taxes, but would reduce the amount you can put in a solo 401(k). You should also consider the new pass-through deduction that can do funny things to the S-corp math.

erutio

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I would definitely do A, and maximize the amount of tax-advantage space you can use, which as stated above, will be a lot considering you're self employed.  Will also lower your current taxes.
As far as saving for a down payment, if your condo is paid off, couldnt the equity in your condo to pay for the new place, or at least the down payment? 

nurseart

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Going from two incomes to one LLC income with little kids I personally would have a pretty hefty emergency fund. You are in great shape with the mortgage being paid off. I would consider tucking away 25k, your bare bones annual spend.

World events may be making me crazy conservative at the moment :)

Fi365

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Going from two incomes to one LLC income with little kids I personally would have a pretty hefty emergency fund. You are in great shape with the mortgage being paid off. I would consider tucking away 25k, your bare bones annual spend.

World events may be making me crazy conservative at the moment :)

I'm so glad to meet a fellow fan of emergency funds!

Thanks to my nervousness re: where my next paycheck is coming from, we piled up $110,000 in a boring old savings account last year.

I'm trying to be comfortable with $45,000 now (our current 6-month safety net).

When we move in a few months, I'm going to try and be comfortable with $25,000-30,000 (a 12-month safety net).

Things will bounce up and down a lot each month, because my business expenses, income, and self-employment taxes vary a ton. But in general, I'm aiming to be comfortable with around $25,000. I know FI people will laugh at a 12-month emergency fund and want me to invest more, but peace of mind matters a lot when you're the only income-earner.

Fi365

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I would definitely do A, and maximize the amount of tax-advantage space you can use, which as stated above, will be a lot considering you're self employed.  Will also lower your current taxes.
As far as saving for a down payment, if your condo is paid off, couldnt the equity in your condo to pay for the new place, or at least the down payment?

Hi Erutio,

Okay, Plan A it is! It sounds like our best course is to max all the tax-advantaged options and then think about a down payment.

We're not planning to sell our rental condo. We've owned it for 11 years and plan to own it until we die.

But, yes, we could sell the condo for ~$150,000 and put that money towards a ~$200,000 house. ($200,000 is the maximum amount I'm currently comfortable paying for another home, since there are so many great places to live within a $200,000 budget. We're not trying to move to Manhattan or San Francisco or anything.)

If we don't sell our rental condo, it will still bring in ~$700/month net profit (our average over the past decade, after accounting for HOA dues, repairs, etc.). The $700 mostly-passive rental income will be a huge chunk of a mortgage.

Ideally I would have zero mortgage ever again in my life. One day!

Thanks so much.

 

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