Reader Case Study: Pay down student loans or invest more?

[ThePhilosopher]

My wife and I are working towards financial independence, and I wanted to make sure that we are allocating our money properly. In particular, I'm not sure whether we should be placing all of our spare money towards her student loans, or whether we should upping my 401k, HSA, or taxable accounts. I know we need to put significant amount on her loans, but the thought of investing nothing in a taxable account makes me feel like an earlier retirement may be difficult. Anyways, our stats are below. Please feel free to ask any additional questions and thanks for reading :)

Life Situation: Wife and I with no other dependents. We will be filling as a married couple.

Gross Salary/Wages: Husband - ($76,000 per year), $4,200 post-tax per month. Wife - ($41,000 per year), $2,320 post-tax per month.

Post Tax Total: $6,520 per month.

Monthly Retirement Contributions:

• Husband - 401k @ 7% and company contribution 9%. Total 16%
• Wife - Pension @ 6%

Total: $1,200 per month.

Assets:

Investments/HSA:

• Taxable Vanguard account: $29,000
• Husband 401k - $29,000
• Wife Pension/401k - $8,000
• Wife HSA: $3,000

Bank Account/Liquid Cash:

• $38,000.

Liabilities:

Debts:

• Wife's student loans: $54,000 @ 5.68%
• Mortgage: $119,000 @ 4.0%
• Car lease: $1,150 remaining on lease

Monthly Expenses:

• Mortgage: $1,100
• Car Insurance (2 cars): $173
• Food: $300
• Eating out/entertainment: $90
• Water Bill: $75
• Energy Bill: $120
• Internet: $30
• Student Loans: $660
• Gas: $150
• Traash Removal: $30
• Misc: $120
• Phone + phone bill for wife only (husband doesn't pay for phone): Service - $40 and Phone - $20. We are paying $20 on the phone for a total of 20 months. (There was a credit of $300 applied when we purchased it, and there was no monetary incentive to purchase the phone in cash. As a result, we opted to simply pay the monthly installments.)
• Teacher Union: $80
• Wife's car payment: $230

Total: $3,303.00

Insurance:

• Husband: high deductible plan with a $3,300 out pocket maximum. Employer pays for plan.
• Wife: medium deductible plan with a $1,500 out of pocket maximum. Employer pays for plan.

We are both responsible to pay any deductibles until our out of pocket maximum is met.

Specific Questions:

We have ~$3,200 of excess cash per month which could put in various locations. Where should we put it? Also, I feel like we may be holding too much cash on hand - perhaps some of that should be placed on loans too?

Any general comments are also welcome!

- Philo

[Peachtea]

With that high of interest on the SL + low SL balance + high available assets & cash flow, I would kill the SLs. I would take 30k of the cash and 24k of taxable account to wipe it out. Then rebuild your efund. When deciding how much of an efund you need, keep in mind that your wife has a stable job that (w/o SL payments) is only short of covering your monthly expenses by a few hundred a month. Then max out all your tax advantaged accounts, like your 401ks. There are ways to pull that money out early (before the 59.5 year mark) which is why people planning on retiring early still max them first. Then go back to your taxable account.

Here’s some resources:
https://forum.mrmoneymustache.com/investor-alley/investment-order/

https://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

https://www.madfientist.com/how-to-access-retirement-funds-early/

Also, look into lowering your wife’s cell phone bill with MNVOs like MintSim, TotalWireless, etc. I use MintSim, it runs off the T-Mobile network. $15/month for 2GB $20/month for 5GB and unlimited text/talk. TotalWireless runs off Verizon’s network and has a 5GB unlimited talk/text for $35/month. There are also options that run off AT&T and Sprint.

[Tuskalusa]

I agree with aggressively paying off student loans.

[Freedomin5]

Why is the car payment not in the debt section? How much do you owe on your wife’s car, and what is the interest rate? How many more years before you pay off the car?

And what is “Granger”?

And why do you have no health insurance?

[ThePhilosopher]

Why is the car payment not in the debt section? How much do you owe on your wife’s car, and what is the interest rate? How many more years before you pay off the car?

And what is “Granger”?

And why do you have no health insurance?

I updated the original post. The car payment is for a leased vehicle; there is ~$1,150 remaining on the lease. The buyout on the car is reasonable ($12,700 on 2016 Hyundai Sonata), so we were thinking of using some of our banked cash to purchase the vehicle. At that point, we would own both cars and have no car payments.

I accidentally typed "Granger" instead of city trash removal. That has been updated. I'm glad you brought this up, we could definitely reduce the size of our trash can, which in turn would reduce this payment.

We do have health insurance, however, my insurance plan high deductible plan(max out-of-pocket is $3,300) and her plan is medium deductible (max OOP $1,500). Our employers pay for the plan, so there aren't any of of pocket expenses for the insurance itself. I'll update the original post to include that information. Also, I have the potential to setup an HSA to cover the my deductibles. My wife already has her HSA $3,000, so she has stopped contributing to hers for the time being.

[Peachtea]

I wouldn’t let the future car purchase stop you from wiping out the SLs. You have about 5 months on the lease, right? If you knock out the SL now, you would have a 3800+ extra cash flow, and it will only take you a little over 3 months to save for the car purchase. With no SL and car payment, your expenses are then low enough that you can save a 6 month efund in a couple months (if you include some of the 8k in cash left over as also part of the efund). Essentially, less than six months from now you could have no debt outside your mortgage, two paid off cars, a full efund, and now 4000k/month to throw at your investments.

[ThePhilosopher]

One thing I'm not understanding: why aren't you contributing more to the HSA?  For a married couple, the contribution limit is $6,900. Remember that money is pre-FICA, so you are avoiding 7.65% tax, plus whatever your marginal tax rate is.  It's the "Ultimate Retirement Account," right?  Particularly, if you have a way to invest the HSA monies, I think that part is a no-brainer. 

I suspect that one of you also has access to a 457 account, which is like a 401K/403(b), except that you can typically access those funds  when you separate from employment.  So if you're concerned about sufficient cash liquid to fund early years of your retirement, then I would see if you can fund a 457, and prioritize it.

I would max out all the tax advantaged accounts before I attacked the student loans. 

In my family, we max out 401k, 403b, 457, and HSA.  Not everyone has sufficient cash inflows to be able to do that, but if you can, I highly recommend it.

I'm somewhat new to all of the various investment options, I appreciate all of the information! I've taken your advice and did some research into how HSAs and 457 (which my wife does have access to) work. We will definitely be fully funding our HSAs and increasing 457 contributions. I'm thinking that after tax advantaged accounts are maxed, all left over money should go towards student loans (opposed to taxable accounts). Would you agree?

I wouldn’t let the future car purchase stop you from wiping out the SLs. You have about 5 months on the lease, right? If you knock out the SL now, you would have a 3800+ extra cash flow, and it will only take you a little over 3 months to save for the car purchase. With no SL and car payment, your expenses are then low enough that you can save a 6 month efund in a couple months (if you include some of the 8k in cash left over as also part of the efund). Essentially, less than six months from now you could have no debt outside your mortgage, two paid off cars, a full efund, and now 4000k/month to throw at your investments.

That is extremely tempting to cash out my taxable accounts to pay off the student loans. I'm stopping all of my taxable account contributions and shifting them towards paying off student loans. My taxable account returns ~7% per year, and the student loans are less than that. Does it really make sense to sell my taxable accounts and pay interest on the capital gains to remove a debt of a lesser percent? It very well may, but off of first look, a higher percentage return appears to be more beneficial in the long run.

[Peachtea]

I wouldn’t let the future car purchase stop you from wiping out the SLs. You have about 5 months on the lease, right? If you knock out the SL now, you would have a 3800+ extra cash flow, and it will only take you a little over 3 months to save for the car purchase. With no SL and car payment, your expenses are then low enough that you can save a 6 month efund in a couple months (if you include some of the 8k in cash left over as also part of the efund). Essentially, less than six months from now you could have no debt outside your mortgage, two paid off cars, a full efund, and now 4000k/month to throw at your investments.

That is extremely tempting to cash out my taxable accounts to pay off the student loans. I'm stopping all of my taxable account contributions and shifting them towards paying off student loans. My taxable account returns ~7% per year, and the student loans are less than that. Does it really make sense to sell my taxable accounts and pay interest on the capital gains to remove a debt of a lesser percent? It very well may, but off of first look, a higher percentage return appears to be more beneficial in the long run.

Because paying off the SLs is a guaranteed, risk-free 5.68% return right now. 7% is an average return after inflation over time and not risk-free. Reasonable people can (and do) disagree over what is the cut off for when a 7% return with risk is better than x% risk-free return.

My cutoff is roughly 5%, although I think the circumstances are also important. A 50 something with no retirement savings and low cash flow, really needs every bit of time/extra cash towards retirement. So there I’d probably say to put it in retirement rather than pay off the loan; the risk of not being able to retire at all tips the scale. But here you have a high cash flow that will make paying the loans a blip on your path to FIRE and getting rid of the debt further (and significantly) improves your cash flow.

[ThePhilosopher]

This.  The only caveat, which you already hit upon: I might not take the full capital gains tax hit.  I would redirect contributions and gains/dividends (from your taxable) to student loans at a minimum.  But that's just my perspective.  Either way, I would tackle the student loans ASAP.

Also, since you mentioned it, you may want to reconsider spending so much on a car.  That's a decent-size chunk of your annual take-home pay and a large portion of your annual savings.  You could spend that much on a car, but every dollar you spend could be sitting income-tax-free in your 401k instead, where you also won't be paying capital gains.  You could make more compromises in that direction at a minimum.  @Ben Kurtz has some great posts on vehicle costs v. income.

Could you explain what impact the full capital gains tax hit and how I might avoid it? I've never had sell stocks yet, so I'm not entirely sure what the tax implication is. I know that you are taxed on any capital gains, but that occurs on a yearly basis, correct? And I'll definitely be holding off on any contributions to this taxable account going forward.

Regarding the car: I read a few of Ben Kurtz posts after your recommendation. It seems that he generally recommends the combined value of your vehicles to not exceed 10% of your combined income (~$11,000). My vehicle cost $6,000, so that would leave another $6,000 for the second vehicle. I'm generally a fan of older, used cars (hence my 2007 Toyota Prius), but having a newer car (2016 Sonata) with ~36,000 miles for $12,700 seems like a good deal. A car with that mileage, and supposed longevity, could last 10+ years with no additional car payments. In my area, used cars (2007-2012) cost anywhere from $5,000 to $12,000 with most car mileages over 70,000. I also place some value on knowing the car's history.

 I've mainly been looking at Toyota Carmy and Corolla, Honda Civic and Accord, and Toyota Priuses, however, I'm open to other vehicles as well. My wife prefers cars larger than a Honda Fit (which I would like) due to safety and children in the future.

[RWD]

• Car Insurance (2 cars): $173

Have you shopped around for this? We're paying $103/month for two sports cars.

[ThePhilosopher]

• Car Insurance (2 cars): $173

Have you shopped around for this? We're paying $103/month for two sports cars.

We have shopped around. We live in Michigan, we tends to have expensive insurance. This is the best we've found so far.