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Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: RabStache on January 17, 2014, 05:52:59 AM

Title: Case Study: Mortgage vs Student Loans vs Investing
Post by: RabStache on January 17, 2014, 05:52:59 AM
Background: My wife and I have been out of college for ~2 years.  I work in an IT related field and she works in education.  I am 24 and she is 25.  Our goal is to make intelligent decisions with the money we are earning this year.

Income:
My Salary: $61,000
Her Salary: $35,000

Assets:
Checking Account: $16,000
House: $129,000
My Work Retirement Account: $13,000 - I currently put 8% of my income into a Roth 401k.  My company matches 6% into a Traditional 401k.  It's one account (and this confuses me a little bit).
Her Work Retirement Account: $2,600
Vehicles (no payments):
Total: $165,600

Loans:
Mortgage: $103,200 @ 3.625% (Just paid down to no-PMI, yahoo!)
Student Loans:
My Loans:
Her Loans:  All of her Direct Loans are under one provider and are paid as a group but she is able to allocate more money into specific loans as long as the minimum is met for all of them.

Total: $142,920

Specific Question(s):

Let me know if you need more information.  I had specific questions but I am open to advice if you think of anything I should be doing that isn't related to my questions.

Thanks!
Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: Thegoblinchief on January 17, 2014, 06:22:36 AM
At your income level, a traditional 401(k) will net you more, since you're being taxed at a higher rate than you will in retirement.

I would pay the loans off first, or at least heavily weight your savings towards those. Say, 75/25 student loans and taxable accounts. Vanguard Total Stock Market is the simplest investment option. You can also split that between US and the International version.
Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: RabStache on January 17, 2014, 07:18:25 AM
What kind of vanguard account should I open?  I was thinking a general so that way we could withdraw the earnings during our early retire years.  I dont know enough to know though!
Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: RabStache on January 17, 2014, 09:37:44 AM
Another question I just thought of:

Since I can contribute to a Roth 401k or Traditional 401k (same account), is the maximum still 17.5k for both combined?

For example (not real):  If I contributed 10k to the Roth 401k and my company match was 7.5k to the Traditional 401k - that would be maxed?
Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: dandarc on January 17, 2014, 09:57:58 AM
Since I can contribute to a Roth 401k or Traditional 401k (same account), is the maximum still 17.5k for both combined?

For example (not real):  If I contributed 10k to the Roth 401k and my company match was 7.5k to the Traditional 401k - that would be maxed?

Not quite - you have a 17500 combined limit for your contributions.  The maximum that can be put in total is 52K.  So you could put in up to 17.5K yourself, and your employer can match on top of that.

You should be able to allocate your 17500 contributions any way you wish between the Roth and Traditional.  Employer match will go to the traditional only.

And I second Thegoblinchief's opinion that you should be contributing to the Traditional side and not the Roth, if you are serious about keeping your expenses down.  Took me many years to realize that is the better way to go - probably cost us tens of thousands of dollars in extra taxes.  Your retirement income should be based on your expenses, which should be considerably less than your pre-retirement income.
Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: RabStache on January 17, 2014, 01:13:59 PM
So after maxing out the employer 401k, what would be the next best account to create and invest in?
Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: nottoolatetostart on January 17, 2014, 01:51:43 PM
If I were in your shoes now, knowing what I know now, I would max out both traditional 401K's first to save on taxes. A portion of your money is already in the 25% tax bracket since your mortgage is so low (25% > 6.8%).

After that, I would put it in a traditional or Roth IRA, depending on where your tax bracket would be. You could always withdraw the Roth contributions without penalty if you really needed to (using that as your emergency fund).  See if you can still fund 2013 IRA's (you have until April 15 as long as you have not yet filed your taxes) and then do 2014 IRA's.

If had anything leftover, I would pay down the SL's with the highest rates first. Sell stuff that is just sitting around, cut your expenses A LOT, eat in, find those extra bucks everything. You should be able to find the money to get rid of those loans quickly.

Nice job! I so wish I was on top of my game when I was your age.

Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: RabStache on January 17, 2014, 02:54:39 PM
Thanks for the advice nottoolate.  Here is where I'm a little confused.  Shouldn't I be investing some money into a non-retirement account for withdrawal money during the early retirement years?

What do people live off of if they only invest in retirement accounts and then retire early? (40-45)
Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: dandarc on January 17, 2014, 02:55:29 PM
Roth IRA's are fantastic for early retirement because you can withdraw the contributions (not earnings) tax free at any time.  Currently you and your spouse can each contribute $5500 - that's 11K per year.  Do that for 10 years and you've got 110K (plus inflation adjustments to the contribution limits).  That could, by itself, cover 2 to 8 years depending on your spending.

So the general advice is usually:

1.  401K's or similar up to the employer match

2.  Roth IRA's

3.  Back to 401K's to maximum

4.  Taxable Account

Just go up the list until you run out of money.

This of course is just a general plan.  If you have a 457 plan available (your wife is in education - you might), that is probably the best of the retirement plans out there.  It is tax deferred like a 401K, but the only requirement to avoid penalties on withdrawal is that you separate from the employer - doesn't matter how old you are.  If you keep your expenses low in retirement and are careful about which accounts you withdraw from, taxes can be near zero on withdrawals, regardless of when you retire.

As far as where to fit in paying off the debt - I view that as more of a personal choice, but certainly the higher the interest rate, the more you want to lean towards paying it off.  My wife and I went the 15% to retirement, then pay off the house route Dave Ramsey espouses and it works just fine.  Our interest rate was higher than yours due to timing and the small size of our loan (was under 50K at origination), so this made sense to us.  Now that that is done, we get to do more of the fun stuff - investing!

Wish we had done more of this stuff when we were your age - just by thinking about this and being intentional you will be very far ahead of most.
Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: dandarc on January 17, 2014, 03:06:29 PM
What do people live off of if they only invest in retirement accounts and then retire early? (35-45)

There are ways to get to your "retirement" accounts early without paying penalties.  SEPP is one, the "Roth Pipeline" is another.  There are many threads on these forums about both of those options.  You are right that a taxable account is probably the easiest way to withdraw before you are 59.5, but I would do everything I can to reduce my tax bill now first, given that there are ways to get to the money later any way.
Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: TomTX on January 17, 2014, 03:07:03 PM
Ugh, waaay too many loans to track for my tastes.

My approach would be:

1) Enough into the 401(k) to get the full employer match.

2) Pay off student loans. Pay off the highest interest first. If they are the same rate, pay the smallest off first.

I wouldn't even look at generating more accounts until I whittled down the student loans a lot. At least kill off the ones at 6% and higher.
Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: RabStache on January 18, 2014, 10:22:20 AM
Thanks for all of the advice - awesome information.  What is the advantage to a Roth IRA over a general investment account through Vanguard?  My thought was an investment account you could withdraw the earnings during the early retirement years.
Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: dandarc on January 18, 2014, 10:35:19 AM
The big advantage of the Roth IRA is that the money grows tax free.  You can withdraw the amount of your contributions at any time, and after 59.5 all withdrawals are tax free.

In a taxable account, you pay taxes on dividends and capital gains every year which eats into your returns.

Don't get me wrong - the taxable account is not a bad place to put your money, but I personally think the Roth IRA is a better place.  It is also not necessarily an either / or discussion - once your loans are paid off you'll have a LOT of money to invest if you keep your expenses down.
Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: dandarc on January 18, 2014, 10:58:08 AM
The point being - you seem to have the following tax-advantaged space:

1.  401K - 17.5k each

2.  Roth IRAs - 5.5k each.

That comes out to 46K total this year.  Now, you may not have 46K / year to invest in the next couple of years, particularly with paying down the loans.  However, in another 5 years or so, you most likely will have paid off the student loans and possibly your mortgage.  Add on top of that your income will likely go up (My wife and I are pretty similar to you and your wife - I'm in IT, she works in government and we are about 6-7 years older than you - we gross about 170K total now, but our first jobs out of college were more like 70K or 80K combined).

You can see how in a few years, you'll probably be able to fill up your tax-advantaged accounts and still have quite a lot of money to invest in a taxable account.  And as prior mentioned, even if all of your investing is in 401Ks, when the time comes you can always set up a Substantially Equal Periodic Payments Plan (SEPP) or a Roth Pipeline.  The key to retiring early is to keep your expenses down and invest your money - it almost doesn't matter whether you are in taxable or tax-advantaged accounts.

I guess I am dispensing advice to my younger self here - had we been smart enough about this stuff as you are at your age we would probably be retiring in 2 or 3 years or less vs our now 8 to 10 year timeline.
Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: AccidentalMiser on January 18, 2014, 12:12:42 PM
I'm with TomTX on this.  I would put in whatever is needed to get the employer match then start killing off those student loans.   

You are definitely asking the right questions about how and where to save, but you need to get rid of that student debt as soon as possible (in my opinion.)

Congratulations on coming so far, so fast.  Keep to your plan and you'll be living the FIRE life before you know it.
Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: TomTX on January 18, 2014, 06:37:52 PM
Yeah, saving is great - but you need to dig yourself out of debt.
Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: RabStache on January 19, 2014, 08:25:09 AM
After reading through all of the advice, here is the potential plan I came up with:

Let me know where my plan succeeds/fails.  I'm concerned about holding off on the Vanguard accounts but I think it might be the right move.  Also, my wife has access to a 403b instead of a 401k.  Are there any differences we should be aware of?  Should she contribute to that as well (currently she just gets a small amount per paycheck from the school).
Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: RabStache on January 19, 2014, 04:50:27 PM
That's a good thought I like the idea of killing off the loans.  Does anyone have any thoughts on the 403b?  Is it similar to a 401k?  Currently my wife isn't contributing anything but we could change that. 
Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: dandarc on January 19, 2014, 06:52:47 PM
From your perspective, the 403b is pretty much exactly the same thing as a 401K.  Does the employer match there as well, or is it just your money?

I know I've been spewing retirement account stuff for a couple days, but paying off your debt should be a priority - 6.8% is not cheap money and paying it off is a guaranteed return.
Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: RabStache on January 20, 2014, 04:33:19 PM
Her 403b is no match, just her money.  My 401k is a 5% match which is why I have been investing in it.  I recently increased the contribution to 15% and changed to a Traditional contribution.  I think We are going to start attacking the student loans heavily.  I'm a little concerned about not putting money into Vanguard accounts for 2013 but I imagine the student loans will be a better ROI?
Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: RabStache on January 22, 2014, 05:53:37 AM
I changed my 401k elections to the following:

Is this intelligent?  What would be your recommendations?  I can provide a list of options if that would help.
Title: Re: Case Study: Mortgage vs Student Loans vs Investing
Post by: rocksinmyhead on January 29, 2014, 11:37:47 AM
here's something to ponder re. maxing 401k/403b contributions vs. paying off student loans... I am facing the same tradeoff. I always assumed I was doing the right thing by contributing enough to get employer 401k match, and then throwing the rest at my student loans in order of interest rate.

NOPE! this forum blew my mind wide open yesterday! check out this thread: https://forum.mrmoneymustache.com/ask-a-mustachian/u-s-tax-withholding-questions/ (https://forum.mrmoneymustache.com/ask-a-mustachian/u-s-tax-withholding-questions/)

I think you are in the 25% marginal bracket rather than 28%, but our SL interest rates are similar. might be worth it to run the numbers.

also re. your most recent question, I am not investment-knowledgeable (yet, this forum is totally helping) but I'm guessing people are going to want some more info, like the expense ratios.