Reader Case Study: Advanced! Looking to maximize savings efficiency

[nawhite]

I've done a lot of questions on here about how to allocate money once I get the spending down and every time the responses come back "depends on your situation." So here is my full situation as a case study. I'm not looking for advice on how to decrease spending. I also side with arebelspy on the "you should not pay down the mortgage because it will save you money in the long term" side of things. I don't care about having debt if it means I'm statistically likely to come out ahead in the long term. I also don't care about speculating about future legislation changes as I'm looking at a retirement around 60 years long, I'm gonna have to roll with the punches one way or another. I'm looking to maximize the efficiency of my savings given today's opportunities.

About: Me 26, DW 25, looking to have 1-2 kids sometime around FIRE in ~10 years

Income: Me: $115k, DW $32k

Current expenses: Not including student loan payments, for the total lets say $40k/year which includes:
$1100/month for Mortgage, property taxes, home insurance
$84/month in PMI
$7500/year in DW's grad school tuition

Assets:
House: Fairly accurate Zestimate is $238,000
2 cheap, efficient, paid off cars (current value: honda civic $4000 and pontiac vibe $6000)
42k in traditional IRA
4k in 401k
~10k in emergency fund

Liabilities:
Mortgage: $192k @ 3.75%
Student Loans:
$5k @ 6.8% fixed
$7k @ ~5% fixed (but currently in subsidized deferment so 0%)
~$85k @ 2-3.5% variable

Specific Question(s): What order should I put our money so that I maximize the efficiency of our savings? Good sounding options include:

1. 401k. Match is 3.5% if I put in 6%. I could max out at $17k/year
2. Employee Stock Purchase Plan. Can put up to 20% of my income in. I get 15% off the lower of price today and price 6 months ago.
3. Pay down the Mortgage until I am down to 80% equity, get an appraisal and kill the PMI payment. Yes I have checked the documentation and I know this is allowed.
4. 6.8% Student loans.
5. Roth IRA. Could put up to $11,000/year. Right now I don't like the Roth vs the traditional because I'm in the 25% tax bracket now and will have an effective rate around 9% in retirement in 10-15 years. Maybe I'll use this once I'm maxing out 401k, killed the PMI and killed the high interest student loans.

Options I don't believe are going to work out the best but I maybe could be convinced:

1. Taxable investment accounts (A Roth is better in every way while its available)
2. Variable rate student loans (I could pay them all off in <3 years if interest rates spiked so for the moment there are better options)
3. Continue paying down the mortgage even after I killed the PMI. I really don't think you're going to convince me this is a good idea.

Let me know what you think and if you need any other information.

[Lans Holman]

All of the above?  It looks like you've got ~100k a year to work with.  17k 401k, 11k IRA, 23k stock purchase, 5k to kill that loan, whatever it takes to kill the PMI, and you might still have some left over.
Nice problem to have.

[nawhite]

I guess you're right about being able to fund all of this in a year. I guess it just always feels like I need to maximize things in the short term because there are only a couple thousand in the checking account at any one time. So lets move out a year, variable rate student loans or taxable accounts?

[amha]

Agreed with the above! Pay down the 6.8% loan (and the 5% one once you start needing to make payments), but since you seem to be a diligent saver, there's no rush to kill the two other loans---you'll very likely be making more by investing it. Do the stock purchase plan, but sell the stock as soon as you can and buy index funds for diversification---the cool thing about the ESOP is not owning the stock but profiting of the 15+% difference in the price you pay and the price the market pays.

If you have $$$ left over, you should go for a taxable investment account. Even with taxes, you'll probably be able to make more than you would by paying down the loan/mortgage. It's not a certainty (the market could tank), but it's probable.

[seattlecyclone]

Do the stock purchase plan, but sell the stock as soon as you can and buy index funds for diversification---the cool thing about the ESOP is not owning the stock but profiting of the 15+% difference in the price you pay and the price the market pays.

I would agree with maxing out the ESPP. That 15% discount (or more if the stock went up in the past six months) is free money just like the employer 401(k) match. Get them both. Do be aware of the tax consequences of selling the stock right away vs. holding on to it for the qualifying period (usually 18 months). If you sell before the holding period ends, any gain over the amount you paid for the stock will be taxed at your regular income tax rate (which you say is currently 25%). If you wait long enough, your gain will be taxed at the lower 15% capital gains rate. Selling right away is a fine decision if you think your employer's stock has a good chance of underperforming the market, or if you just feel squeamish about having your investments tied up in the same company that signs your paycheck. Otherwise you may want to plan to build up a pipeline of sorts where you hold on to the shares for a while. Every six months you'll invest in a new batch of shares and shortly thereafter you'll sell the ones you bought 18 months ago.

As to the other options, I agree with Lans Holman who said you should just do all five of the things in the top group. You should be able to afford to max out your 401(k), Roth IRA, ESPP, and kill the high-interest student loan in the next year for sure, and getting to 20% equity in the house should also be achievable. After you do that, you'll have to move into some of the options in the bottom 3. Of the choices, investing in a taxable account probably provides the best average return. If you do decide to pay off debt instead, the mortgage has a higher interest rate than the variable student loans (at least for now), so why not attack that first?

[willn]

Do the stock purchase plan, but sell the stock as soon as you can and buy index funds for diversification---the cool thing about the ESOP is not owning the stock but profiting of the 15+% difference in the price you pay and the price the market pays.

I would agree with maxing out the ESPP. That 15% discount (or more if the stock went up in the past six months) is free money

Only if the price is right. I'd suggest not maxing the ESP, a few percent might be appropriate but it reduces diversity since you also get all your income from that same company you invest in.  And 15% discount isn't much considering the volatility of the average stock over the long term cap gains window.

[nawhite]

Only if the price is right. I'd suggest not maxing the ESP, a few percent might be appropriate but it reduces diversity since you also get all your income from that same company you invest in.  And 15% discount isn't much considering the volatility of the average stock over the long term cap gains window.

Can you explain this? I'd probably sell as soon as possible and just take the tax hit so I don't think I'd be invested at all in the company that pays my income. If I do get fired and I have 15k waiting for the next purchase window, the plan says they'll pay that out to me so I'm not risking losing any money (other than the possible gains I could get on that 15k for instance).

[seattlecyclone]

If you plan to sell immediately there's no risk of losing money. If the stock went down 90% in the past six months (say from $100 to $10), you're still investing at a 15% discount to what it's worth on the day you invest (or $8.50). Sell right away and you get $10 for every share you bought for $8.50, netting you a 17.6% profit before trading commissions and taxes. The tax is only charged on your profit, so you can't go negative. Suppose instead that the stock doubled in value in the past six months (from $10 to $20). Then you're paying $8.50 for a share and flipping it for $20, an instant 235% profit (again, before trading commissions and taxes are taken out).

[Mazzinator]

Is it possible to max out the 401k and tIRA for both of you? $46k total at 25% tax rate is $11.5k tax savings. Also, do you have access to any other tax helpers? HSA? Seems like this would help the most...unless i'm missing something?

[Sweet Betsy]

Specific Question(s): What order should I put our money so that I maximize the efficiency of our savings? Good sounding options include:

1. 401k. Match is 3.5% if I put in 6%. I could max out at $17k/year
To max out your 401K you need to be contributing about 15% to reach the yearly max of $17,500.to  Your employer's contributions don't count toward your maximums.  If you wife has access to a 401K, she should max out hers as well.   

[nawhite]

Is it possible to max out the 401k and tIRA for both of you? $46k total at 25% tax rate is $11.5k tax savings. Also, do you have access to any other tax helpers? HSA? Seems like this would help the most...unless i'm missing something?

We're unfortunately not eligible for an HSA. Its complicated. As for the IRA, what do people think about doing traditional vs Roth contributions for the 11k in IRA contributions?

[This_Is_My_Username]

have you considered using a higher-risk / higher-return strategy with your emergency fund?

specifically, I recommend not having an emergency fund.  Any 'emergency' can be paid with your $8000/month savings rate. 

Most(all) unexpected bills can be deferred by 30 days(?).  You will save $8k in 30 days, and can use that to pay for the emergency.

If there is an emergency that cost more than $8k  (medical maybe?), then you can negotiate a payment schedule.  worst case scenario, you may need to redraw from the home mortgage loan.

under this scenario, you can 'invest' your 10k emergency fund in one of your student loans, or in superannuation, or in direct purchase of a vanguard index fund.

You will benefit from a higher rate of return.

What do you think?

[chicagomeg]

Is it possible to max out the 401k and tIRA for both of you? $46k total at 25% tax rate is $11.5k tax savings. Also, do you have access to any other tax helpers? HSA? Seems like this would help the most...unless i'm missing something?

We're unfortunately not eligible for an HSA. Its complicated. As for the IRA, what do people think about doing traditional vs Roth contributions for the 11k in IRA contributions?

The AGI limit for TIRA contributions is $95k, excluding your contributions. So you probably aren't eligible.

[Mazzinator]

Is it possible to max out the 401k and tIRA for both of you? $46k total at 25% tax rate is $11.5k tax savings. Also, do you have access to any other tax helpers? HSA? Seems like this would help the most...unless i'm missing something?

We're unfortunately not eligible for an HSA. Its complicated. As for the IRA, what do people think about doing traditional vs Roth contributions for the 11k in IRA contributions?

The AGI limit for TIRA contributions is $95k, excluding your contributions. So you probably aren't eligible.

Oh snap! Sorry, dude.... That sucks. They really know how to stick it to ya.

I still say (and agree with the others) to max out both (if she has one) 401k.

Is there a phase out/partial deduction of the tIRA? Your tax bill has got to be a shit ton!

[Bruinguy]

Not specific advice, just issue spotting, I think.  It sounds like you will be reaching FI a lot earlier than the age that you can withdraw from your retirement accounts.  Do you have an amount in mind to keep outside of your retirement accounts so you can access it (and its income) when you want to, before reaching retirement age? 

[chicagomeg]

Is it possible to max out the 401k and tIRA for both of you? $46k total at 25% tax rate is $11.5k tax savings. Also, do you have access to any other tax helpers? HSA? Seems like this would help the most...unless i'm missing something?

We're unfortunately not eligible for an HSA. Its complicated. As for the IRA, what do people think about doing traditional vs Roth contributions for the 11k in IRA contributions?

The AGI limit for TIRA contributions is $95k, excluding your contributions. So you probably aren't eligible.

Oh snap! Sorry, dude.... That sucks. They really know how to stick it to ya.

I still say (and agree with the others) to max out both (if she has one) 401k.

Is there a phase out/partial deduction of the tIRA? Your tax bill has got to be a shit ton!

It phases out from 95k to 105k, but I don't really think it's worth getting a partial deduction. I'd rather just do the Roth & then not pay taxes again.

[nawhite]

Is it possible to max out the 401k and tIRA for both of you? $46k total at 25% tax rate is $11.5k tax savings. Also, do you have access to any other tax helpers? HSA? Seems like this would help the most...unless i'm missing something?

We're unfortunately not eligible for an HSA. Its complicated. As for the IRA, what do people think about doing traditional vs Roth contributions for the 11k in IRA contributions?

The AGI limit for TIRA contributions is $95k, excluding your contributions. So you probably aren't eligible.

Our AGI will be around 115k/year so I would not be eligible for a Traditional IRA however:

"if you are married filing jointly and your spouse is covered at work, then your deduction limits start phasing out at an AGI of $178,000 and top out at $188,000."

So my wife could contribute to a traditional IRA but I could not because I have a 401k available to me. We've been lobbying my wife's work to offer a 403b plan but seeing as she and the director at the school are the only people who would likely participate it will be an uphill battle. So do we have my wife do a traditional or a Roth IRA?

@Bruinguy - We're going to do the "backdoor roth" withdrawls and possibly 72t withdraws. We'll need 5 years of expenses to get that primed and I guess now the plan is use the money we used on the ESPP for those 5 years. If we are buying 20k/year in stock and selling immediately after 10 years, that money becomes the "taxable investment" money which we can use for those 5 years (and then some with the gains from the ESPP and appreciation). That combined with any money leftover after we've paid off the student loans and the mortgage to 20% and I think we'll be good on money outside retirement accounts.

[Mazzinator]

Here's what helped me. I would vote for tIRA because of your high tax bracket now vs in ER. But it is a small amout compared to your entire amount saved each year. Good luck!

http://www.bogleheads.org/wiki/Roth_versus_Traditional

http://www.madfientist.com/traditional_ira_vs_roth_ira/

[chasesfish]

You're doing really well, all options are good.

Knock out the 6.8% loan

Fully fund the 401k

Pay down the mortgage two the point where PMI goes away.

That should keep you busy for a few months.

[msilenus]

1) Max the 401(k).  Pretax money is free money.  You say your bracket is 25%.  Take the 25%.
2) Max the ESPP.  More free money.  Take the 15%.
3) Max Roth for 2013.  (Maxing Roth for 2014 will take this spot toward the end of next year.)
4) 6.8% debt and PMI.  Order is a math question.
5) Don't kill the free debt until it stops being free.  Kill it right away then.  Your variable debt is cheap enough to be approximately free right now, but I could see you being spooked by the variability and the balance is on the high side.
6) Try to keep savings in tax-advantaged accounts wherever possible.  If your 401(k) investment options don't suck, and offers an after-tax option, look into it.  Also look into Roth conversions.

Roths are great.  Once money is in a Roth, you'll only ever pay taxes on the earnings if you do something wrong.  (Don't do something wrong.)  Getting extra years of contributions into Roths should be a very high priority.  Once you let a chance to max your Roth for a given year slip by, you'll never get it back.

If Uncle Sam offered to let me move my taxable investments into my Roth accounts for $748 for every $11,000 moved, I'd take it.  (Just to be clear, that's 6.8% of $11,000.  Your highest debt service cost times the amount of a max Roth contribution.)