Author Topic: Case study - Max bad 401(k), extra mortgage principal, or open brokerage account  (Read 2229 times)

jkwings

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Thanks very much for your time and expertise.

Life Situation: I'm 31, my wife is 32, filing jointly, two kids (9 and 6), living in Michigan.

Gross Salary/Wages: Mine = $123,000, my wife’s = $57,500

Pre-tax deductions: We max out my 401(K) every year and my employer doubles the first 5% = $12,300/year. Other pre-tax deductions = $409/month health insurance, $45/month dental, $40/month FSA, $60/month parking for work.

No other ordinary income, taxable investment accounts, or rental income.

Current expenses:
Mortgage (15 year, 3.375%, $165,500 left, current home value ~$245,000) P&I = $1,409/month
Property taxes = $5,500/year = $458/month
Homeowner’s insurance = $730/year = $61/month
Groceries = $980/month
Health insurance = $409/month (pre-tax deduction)
Entertainment/shopping = $400/month – inflated this year because of 10th anniversary trip to Mexico with the Mrs., sans kids. First of its kind and last until we ring in the big 2-0.
Food away from home = $250/month
Target = $200/month = mix of groceries, clothes, gifts
Gifts = $200/month
Kids Activities e.g. summer camp, babysitting = $160/month
Gas/Electricity = $145/month
Gas = $130/month
Charity = $120/month
Car Insurance = $105/month
Medical expenses = $70/month (big dental expense this year)
Car maint/repair = $60/month. (2002 Nissan Sentra, 2004 Chrysler Impala spend a decent amount of time in the shop)
Internet = $65/month
Family gym membership = $62/month
Home furnishings = $60/month
Work parking = $60/month (pre-tax deduction)
Life insurance = $55/month ($750K 20 yr. term for me, $500K 20 yr. term for my wife)
Utilities – water = $55/month
Alcohol/bar = $50/month
Dental insurance = $45/month (pre-tax deduction)
Flex Savings Account = $40/month (pre-tax deduction)
Long term disability insurance for me = $30/month
Supplemental life insurance for me = $20/month (Additional $500K policy through my work)
Misc. = $125/month

Assets:
TIAA-CREF 401(a) = $100,000, 70% equities, 30% intermediate term-bonds, all index funds. 10% employer contribution.
TIAA-CREF 403(b) = $70,000, 80% equities, 20% intermediate term-bonds, all index funds. Maxing out.
Son (9 yrs old) 529 = $15,000, gets $450/month. Target date fund aligned with college years.
Daughter (6 yrs old) 529 = $11,000, gets $350/month. Target date fund aligned with college years.
Vanguard Roth IRAs for me and my wife = $32,600 total - VASGX. Maxing both.
Ally.com online savings = $26,000
PNC free checking account = $4,000 average balance

Liabilities:
Mortgage: originally 30-year term, 4.625%, purchased Sept. 2013 for $227,500 with 10% down. Zero-cost refinance June 2015 when balance was $198,875 to 15-year term, 3.375%. Current balance = $165,500 because we’ve been pounding the principal.

Specific Question:
At our current spending level, we have ~$2,000 leftover each month after fully funding my 401(k), both of our Roth IRAs, and contributing $800 to our kids’ 529s. If early retirement is our primary financial goal, but we expect to make a final move in 4-5 years and spend ~$375,000 on a house located within walking distance of both of our jobs, what is the best plan for those extra funds, both before and after the move? My wife’s employer offers a bad 401(k) plan with no match and high-expense funds (cheapest index fund = 0.5% + mandatory 0.8% advisor fee) so it’s a bitter pill to swallow. I’m also not sure that we should continue to max her Roth vs. go with a Traditional IRA because of our tax bracket. 
« Last Edit: September 25, 2016, 05:50:59 AM by jkwings »

MDM

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Liabilities:
Mortgage: originally 30-year term, 4.625%, purchased Sept. 2016 for $227,500 with 10% down. Zero-cost refinance June 2015 when balance was $198,875 to 15-year term, 3.375%. Current balance = $165,500 because we’ve been pounding the principal.

Specific Question:
At our current spending level, we have ~$2,000 leftover each month after fully funding my 401(k), both of our Roth IRAs, and contributing $800 to our kids’ 529s. If early retirement is our primary financial goal, but we expect to make a final move in 4-5 years and spend ~$375,000 on a house located within walking distance of both of our jobs, what is the best plan for those extra funds, both before and after the move? My wife’s employer offers a bad 401(k) plan with no match and high-expense funds (cheapest index fund = 0.5% + mandatory 0.8% advisor fee) so it’s a bitter pill to swallow. I’m also not sure that we should continue to max her Roth vs. go with a Traditional IRA because of our tax bracket.

jkwings, welcome to the forum and excellent case study post!

Do you expect to need all 20% * $375K = $75K in cash for the down payment, or do you expect some of that $75K to come from the sale of your current home?  Either way, consider putting the part of the down payment not coming for the existing house sale (plus closing costs, moving expense, etc.) into one of The 5 Best Online Savings Accounts - MagnifyMoney.

After you have that short term cash need settled, you could stop paying more on the 3.375% mortgage and invest in a taxable account instead.  Fidelity, Schwab, and Vanguard all have good low fee index fund or ETF options.  E.g., see Three-fund portfolio - Bogleheads.

I'm sure you'd love to deduct a tIRA but the IRS won't let you.

That is a poor 401k, but see http://forum.mrmoneymustache.com/investor-alley/to-401k-or-not-to-401k-that-is-the-question-43459/ - it might still be advantageous.  Note that, due to the reduction in child tax credit phaseout, the last $12K of the $36K 401k+403b contributions has a higher marginal savings rate than the first $24K.

I got ~9.5 years for your "time to FI" using your OP and the case study spreadsheet.  Of course, that assumed current expenses continue unchanged, ignored the new house option, etc., so YMMV....

Again, very well organized post and it appears you are doing great.  Good luck!

jkwings

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Thanks so much for taking the time to review our information! Also, considering this was my first post I appreciate your kindness in not calling out the more anti-mustachian eyesores in our current spending. I thought we were doing OK but putting it all in one post and reviewing in the sober light of day really highlights how much room for improvement we have.

Our plan was to use the equity from the sale of the house to completely cover the down payment on the next house. In fact, somewhat arbitrarily I've been assuming that we will use 100% of the equity which will likely be more than $75K to make the down payment as large as possible but it may make more sense to put a chunk into a brokerage account.

Am I correct that if my wife doesn't participate in her 401(k), she could choose a tIRA rather than the current Roth? At our marginal tax rate, I wonder whether we should stop Roth contributions for her and move those $ to a tIRA?

Lastly, I feel foolish because I didn't realize until yesterday that my employer also offers a 457(b). It's through TIAA-CREF and also has access to Vanguard index funds. I assume maxing that out should take precedence over extra mortgage principal and any taxable investing as well as participating in my wife's less than ideal 401(k), correct?

Able was I ERE

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Yes max out the 457b if you can. It should take precedence over everything except the 401k up to the max match. 

If your wife doesn't have access to a retirement plan, then different rules apply for deducting Traditional IRA contributions.  If she has access, but doesn't participate, the usual rules apply, I believe. I stand corrected, see MDM's post below for correct answer.
« Last Edit: September 24, 2016, 11:27:54 PM by Able was I ERE »

MDM

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If she has access, but doesn't participate, the usual rules apply....

Not quite.  See https://www.irs.gov/retirement-plans/are-you-covered-by-an-employers-retirement-plan.  As long as neither she nor the employer contributes any money at all to an employer's retirement plan then she is "not covered" for that year. 

Thus if she wanted to forego $18K of pre-tax investment room in order to gain access to $5.5K, she might be able to do so.

MDM

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Am I correct that if my wife doesn't participate in her 401(k), she could choose a tIRA rather than the current Roth? At our marginal tax rate, I wonder whether we should stop Roth contributions for her and move those $ to a tIRA?

As noted in the previous post, yes (assuming the employer doesn't contribute anything at all) should could deduct $5500 for a tIRA contribution instead of $18K for a 401k contribution.  Given that due to the reduction in child tax credit phaseout the last $12K of $36K pre-tax contributions has a higher marginal savings rate than the first $24K, however, are you sure you want to do this?