Case Study, sorta

[dude]

Not really looking for "cut this, cut that" suggestions, as I know we still have some facepunch worthy spending (though mostly it's on vacation travel), so I'm leaving out the expense side of things, save for one specific thing.  Looking more for thoughts on what to do with "extra" money.

Combined Income: $215K - $225K (depending on amount of wife's bonus)

Current annual savings (not incl. pension, SS):
401k (me) - $17,500 ($24,440 w/ match)
401k (wife) - $8528 ($14,274 w/match - currently; wife just got a nice raise, so she is going to increase this, just not sure how much yet)
Savings - $13,200
Mortgage principle - $7,500

Assets:
Home - $485K-$500K
401k (me) - $460,000
401k (wife) - $70,000
IRA (wife) - $63,000
Savings - $45,000

Liabilities:
Mortgage - $406,500 (4.25%)
Student loans - $20,000 (2.35%)

Currently dropping $1,000/month into student loans ($955 is going toward principle).  Plan is to continue this until the end of this year, then pay off the balance, which will be around $15,000, from our savings account.  Now, I know that mathematically, this doesn't make a ton of sense, i.e., paying off a 2.35% loan over a 4.25% loan, or investing the money in the market instead since both are low interest rates, but I want that student loan albatross off my neck more than anything.  Been paying it for 16 years (@$80K initial loan value), but just got serious about paying it down in the last 3-4 years.

The plan after that is to divide the $1,000 monthly "windfall" (if you will) between catch-up contributions to my 401k (I turn 50 next year so can start catch-ups in January) -- @$500/month -- with the other $500/month going toward either additonal savings contributions or mortgage paydown.  I don't expect to be mortgage-free when I FIRE (and wife is likely 5-7 years behind me on that front), and have factored my share of the mortgage payment into my FIRE calculations.  But I would like to build the equity up and pay less interest in the long-run (then probably downsize to something we can pay cash for with the proceeds from selling current house down the road, maybe 10-12 years from now).

I want to build the savings account up into a suitable cash (or equivalent) buffer for covering expenses in a market downturn, so I can avoid withdrawing from the 401k, which should only require between $13,000-$15,000 annually (the remainder of my share of expenses will be covered by my pension), but I also want it to serve as an emergency fund for other things as well (if wife were to lose job, expensive home repair, new car, etc).

The question is, how much is enough in that account?  In my mind, I've always wanted to have $100,000 in that account, but I'm starting to think that's overkill.  Perhaps $50K-$75K is sufficient and we should then divert not only the "windfall" money from no more student loan payment, but also the current $1100 monthly addition to savings, to either the mortgage or a taxable investment account.

So the related question is, once the cash (or equivalent) savings is "enough," what to do with the money currently going there?

I hope this is enough info to get the suggestions I'm hoping to get from you all.

edited to update wife's 401k contributions; previous numbers were old data

[MDM]

Any reason wife doesn't put $17.5K (plus match) into 401k?  With a gross income of $220K, putting $35K (or higher next year) into 401ks should be doable.

Perhaps $50K-$75K is sufficient and we should then divert not only the "windfall" money from no more student loan payment, but also the current $1100 monthly addition to savings, to either the mortgage or a taxable investment account.

Yes, either should be better than cash.  One might lean toward "invest" based on historical average returns, but saving 4.25% in interest is still better than earning 1% or less (assuming that's what your cash is earning).

[mak1277]

This will be a very non-technical/financial response...

Are you planning on staying in your existing home (or renting it) once you and your wife both RE?  Personally, as soon as I FIRE I aim to move and downsize my residence.  The proceeds from the sale will cover my existing mortgage and (by then) should allow me to purchase a new home mortgage-free.  Because of this, I'm not all that concerned with paying down my mortgage and I am diverting extra $$ into taxable accounts.

If I were planning to stay in my home, though, I'd be more eager to pay off the note first.  Again, I caveat this by assuming this is mainly a psychological preference and not necessarily a practical one.

[Cpa Cat]

Now, I know that mathematically, this doesn't make a ton of sense, i.e., paying off a 2.35% loan over a 4.25% loan, or investing the money in the market instead since both are low interest rates, but I want that student loan albatross off my neck more than anything.  Been paying it for 16 years (@$80K initial loan value), but just got serious about paying it down in the last 3-4 years.

I know where you're coming from. A few months ago, I was ready to put a check in the mail to pay off my student loans, when - that very same day - I got a letter saying that my interest rate was down to 2.35%. Plus a front-page tax deduction, knocking that interest rate down further. I immediately tore up my check and continued making the minimum payments.

It just doesn't make sense to pay it off. In my life, that's basically free money. Everywhere you look, you can put money away for a better return than paying off the SL.

What's the timeline on paying off your mortgage? At your age, it would be nice to have that house at least halfway paid off within 10 years so that you can feel confident that you can sell and downsize for mortgage-free living.

[dude]

Any reason wife doesn't put $17.5K (plus match) into 401k?  With a gross income of $220K, putting $35K (or higher next year) into 401ks should be doable.
[

She may be soon.  Raise just happened combined with an additional bonus -- her 401k numbers were for prior to the raise.  I'd like to get her maxed out, believe me, but she's far spendier than I am, and it's taken baby steps to get her on board with me.  But she understands we're likely to get killed with taxes if we don't shelter much of her new earnings, so hopefully I can get her close to the max.

[Middlesbrough]

Agree with cpa cat. That 2.35% loan isn't going anywhere. Pay off the others if you must and put that portion toward your other goals. The day you decide to FIRE, go ahead and cut that check, but no need to do more than the minimum until then. Instead of using the money on the loan, try to see if the wife can max out the 401k instead.

[dude]

This will be a very non-technical/financial response...

Are you planning on staying in your existing home (or renting it) once you and your wife both RE?  Personally, as soon as I FIRE I aim to move and downsize my residence.  The proceeds from the sale will cover my existing mortgage and (by then) should allow me to purchase a new home mortgage-free.  Because of this, I'm not all that concerned with paying down my mortgage and I am diverting extra $$ into taxable accounts.

If I were planning to stay in my home, though, I'd be more eager to pay off the note first.  Again, I caveat this by assuming this is mainly a psychological preference and not necessarily a practical one.

I see us in there for another 10-12 years.  I will "retire"* in 5 years, and hopefully I can get her to join me 5-7 years after that.  After that, I could see us possibly downsizing to another part of the state, but can't say for certain that will happen, because we do like where we are.  I've always figured we'd likely sell at some point and use the proceeds to buy something cheaper with the cash we'd make from selling, but there's definitely some uncertainty there.

* by "retire" I mean quit my current full-time gig for The Man, and monetize a passion of mine part-time after that

[dude]

Agree with cpa cat. That 2.35% loan isn't going anywhere. Pay off the others if you must and put that portion toward your other goals. The day you decide to FIRE, go ahead and cut that check, but no need to do more than the minimum until then. Instead of using the money on the loan, try to see if the wife can max out the 401k instead.

I know this is the logical thing to do, but the psychological boost from slaying that student loan demon is something I'm just longing to experience.  Also, the loan rate resets every July 1st (Direct Loan), based on T-Bill rates, so at some point in the future, one has to expect the rate will go up.  My payment currently is only $179/month (for another 14 years!).

But maybe I should re-think this.

[Middlesbrough]

Agree with cpa cat. That 2.35% loan isn't going anywhere. Pay off the others if you must and put that portion toward your other goals. The day you decide to FIRE, go ahead and cut that check, but no need to do more than the minimum until then. Instead of using the money on the loan, try to see if the wife can max out the 401k instead.

I know this is the logical thing to do, but the psychological boost from slaying that student loan demon is something I'm just longing to experience.  Also, the loan rate resets every July 1st (Direct Loan), based on T-Bill rates, so at some point in the future, one has to expect the rate will go up.  My payment currently is only $179/month (for another 14 years!).

But maybe I should re-think this.

As somene with student debt as well, I feel your slay the dragon idea. I have multiple little ones compared to you and they are all fixed. Each high interest one gone is a shackle removed.

Considering you have a variable one taking it out may make more sense long term. A sudden pop in interest rates could hurt. Without doing anything to help persuade your wife, your side of the equation seems to be in order with your future plans.

[rmendpara]

Agree with cpa cat. That 2.35% loan isn't going anywhere. Pay off the others if you must and put that portion toward your other goals. The day you decide to FIRE, go ahead and cut that check, but no need to do more than the minimum until then. Instead of using the money on the loan, try to see if the wife can max out the 401k instead.

I know this is the logical thing to do, but the psychological boost from slaying that student loan demon is something I'm just longing to experience.  Also, the loan rate resets every July 1st (Direct Loan), based on T-Bill rates, so at some point in the future, one has to expect the rate will go up.  My payment currently is only $179/month (for another 14 years!).

But maybe I should re-think this.

Didn't know about the reset! Yes, take advantage of your low interest rates and pay it off... it would be different if it was fixed rate and term SL.

Regardless, with your income, you can afford the "psychological" benefit of paying off your debt.

Given that income, unless you live in NYC/SF/Chi/D.C., you two are very spendy. If saving $35k in 401k's is a challenge, I think that needs to be revisited, especially depending on what kind of lifestyle you want to live once you retire early (and continuing into your golden years). You need to save and invest more, not less, to retire early.

[dude]

Agree with cpa cat. That 2.35% loan isn't going anywhere. Pay off the others if you must and put that portion toward your other goals. The day you decide to FIRE, go ahead and cut that check, but no need to do more than the minimum until then. Instead of using the money on the loan, try to see if the wife can max out the 401k instead.

I know this is the logical thing to do, but the psychological boost from slaying that student loan demon is something I'm just longing to experience.  Also, the loan rate resets every July 1st (Direct Loan), based on T-Bill rates, so at some point in the future, one has to expect the rate will go up.  My payment currently is only $179/month (for another 14 years!).

But maybe I should re-think this.

Didn't know about the reset! Yes, take advantage of your low interest rates and pay it off... it would be different if it was fixed rate and term SL.

Regardless, with your income, you can afford the "psychological" benefit of paying off your debt.

Given that income, unless you live in NYC/SF/Chi/D.C., you two are very spendy. If saving $35k in 401k's is a challenge, I think that needs to be revisited, especially depending on what kind of lifestyle you want to live once you retire early (and continuing into your golden years). You need to save and invest more, not less, to retire early.

I hear you, dude.  Like I said, we spend a lot on vacations (3/year together, +2 I do solo -- I have more vacation time than she does!).  But the thing is, I have the luxury of a pension five years from now that will cover 40% of my current salary, which will in essence cover close to 80% of my pre-retirement expenses.  With current 401k balance + continuing contributions + catch-up contributions, I should have close to $800K in there 5-6 years from now. So I should have more than enough to cover 100% of my share of expenses, and then some.  And I'll be 54, which is an early enough retirement for me. Also, yeah, we're in Boston -- it's not NYC or SF, but it's not far behind.

It's my wife's side of the equation that needs work, and I'm working on it with her.  She's coming along, but slowly.  She likes "to have nice things." (her words)  But she is progressing steadily.  She's agreed to bank/save this raise she just got.  I'm now thinking, since the majority of the $1100 that's being put into our savings account is from my check, that maybe I ought to get her maxed out into her 401k and subsidize her weekly check from that money so she doesn't feel the hit too badly. 

Appreciate the thoughts, keep 'em coming.

[Cpa Cat]

It's not as if there's going to be a sudden run up on T-bills. That interest rate will be low for awhile, and when it starts to rise, you have $45,000 sitting in savings to pay it off.

[dude]

It's not as if there's going to be a sudden run up on T-bills. That interest rate will be low for awhile, and when it starts to rise, you have $45,000 sitting in savings to pay it off.

Yeah, you make a good point.  Just realized too, that today is July 9, so I went and checked to see what happened when rates reset on July 1.  Turns out my rate dropped from 2.35% to 2.33%, where it will remain until July 1 of next year.

[GGNoob]

It's not as if there's going to be a sudden run up on T-bills. That interest rate will be low for awhile, and when it starts to rise, you have $45,000 sitting in savings to pay it off.

Yeah, you make a good point.  Just realized too, that today is July 9, so I went and checked to see what happened when rates reset on July 1.  Turns out my rate dropped from 2.35% to 2.33%, where it will remain until July 1 of next year.

You could just keep paying the minimum until the rates go high enough to make you want to pay it off. That's what I would do anyhow. My wife's SL is 5.25%, so we'll probably pay that off in one lump sum within the next year. But if it was in the 2% range, I'd let that ride forever!

Even the mortgage rate isn't bad, so you could almost just ride that out as well.

For the emergency fund, maybe you should look into investing it. Either have your taxable investment account be your emergency fund or create 2 taxable accounts and have one be less risky. But as long as its invested, it will continue to grow with you as long as its not needed.

[dude]

Re: the mortgage, a friend pointed out that, when you consider the tax deduction, the rate is closer to 2.8-3.0%.  So the difference between the mortgage and student loan (for which i get no deduction), is negligible.

Making the market the best play?  I would probably not hesitate to do that if the market got a big correction, which it certainly seems due for.  I know it's market timing to think this way, but it's hard to commit more than I already have in the market when it's as overvalued as it currently appears to be.

Decisions, decisions.

[Cheddar Stacker]

Max her 401K and subsidize the difference if you have to out of your funds.

After that is there something stopping you from "funding" this endeavor now??

* by "retire" I mean quit my current full-time gig for The Man, and monetize a passion of mine part-time after that

[dude]

Max her 401K and subsidize the difference if you have to out of your funds.

After that is there something stopping you from "funding" this endeavor now??

* by "retire" I mean quit my current full-time gig for The Man, and monetize a passion of mine part-time after that

Cheddar, this is exactly the conclusion I came to after taking in everyone's suggestions -- subsidizing her from my paycheck!  I told her that today.  If we can get her to the max, then next year between hers and mine + catch-ups, we can shelter $40,500 of taxable income from Uncle Sam.  That's a pretty big deal.

As far as funding the post-"retirement"* endeavor, no there's nothing stopping me.  In fact, I've got the ball rolling on it pretty solidly already.

You guys have all really made me re-think my urgency to pay off the student loans.  Gonna give it some more thought, but definitely coming to terms with the fact that 2.33% is practically free money.

* it is an actual retirement inasmuch as I'll be saying sayonarah to my current career and will start collecting a pension, but not retirement in the usual sense, as I'll be "working" at something I love, at my own leisure.

[desrever]

Re: the mortgage, a friend pointed out that, when you consider the tax deduction, the rate is closer to 2.8-3.0%.  So the difference between the mortgage and student loan (for which i get no deduction), is negligible.

Unless you have a lot of other itemizable deductions anyway, it's not quite that good: you pay maybe 17200 in mortgage interest each year, which is fully deductible, but by itemizing you lose the 12200 standard deduction. So your taxable income is reduced by 5000, meaning your tax is reduced by 28% of that. So your effective interest rate is something like (4.25%) * ((1-.28) * 5000 + 12200) / 17200 = 3.9% after the federal tax deduction ... Maybe you get a state tax benefit too on top of this.

[Cheddar Stacker]

Re: the mortgage, a friend pointed out that, when you consider the tax deduction, the rate is closer to 2.8-3.0%.  So the difference between the mortgage and student loan (for which i get no deduction), is negligible.

Unless you have a lot of other itemizable deductions anyway, it's not quite that good: you pay maybe 17200 in mortgage interest each year, which is fully deductible, but by itemizing you lose the 12200 standard deduction. So your taxable income is reduced by 5000, meaning your tax is reduced by 28% of that. So your effective interest rate is something like (4.25%) * ((1-.28) * 5000 + 12200) / 17200 = 3.9% after the federal tax deduction ... Maybe you get a state tax benefit too on top of this.

It's a good point desrever but at that income I'm sure they're paying a hefty state income tax as well, plus high RE taxes with the big mortgage/house. I would bet Dude's state income tax alone eats up the entire standard deduction, or damn close if not the whole thing.

[dude]

Re: the mortgage, a friend pointed out that, when you consider the tax deduction, the rate is closer to 2.8-3.0%.  So the difference between the mortgage and student loan (for which i get no deduction), is negligible.

Unless you have a lot of other itemizable deductions anyway, it's not quite that good: you pay maybe 17200 in mortgage interest each year, which is fully deductible, but by itemizing you lose the 12200 standard deduction. So your taxable income is reduced by 5000, meaning your tax is reduced by 28% of that. So your effective interest rate is something like (4.25%) * ((1-.28) * 5000 + 12200) / 17200 = 3.9% after the federal tax deduction ... Maybe you get a state tax benefit too on top of this.

It's a good point desrever but at that income I'm sure they're paying a hefty state income tax as well, plus high RE taxes with the big mortgage/house. I would bet Dude's state income tax alone eats up the entire standard deduction, or damn close if not the whole thing.

Ugh.  Yeah, we had over $36K in itemized deductions last year.