Author Topic: Allocating monies amongst 401k/IRA/Mortgage  (Read 6973 times)

bo_knows

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Allocating monies amongst 401k/IRA/Mortgage
« on: September 20, 2012, 06:17:47 AM »
Mustachian's,  I have a saving dilemma that I'd like some input on.

Wife and I live in the DC suburbs (high COL, not the best mustachian area) and reap the benefits of a robust Federal government job market here by grossing ~$140-150k despite my wife being at 60% full-time currently to ensure that our son doesn't have to be in daycare.

I can give more details if necessary, but the jist of my problem is this:  After basic expenses an minimum mortgage payments, I'm not entirely sure that we can both max 401ks, both max IRA's, AND try to pay down the mortgage.  We're refi'ing to a 15yr loan soon, with the plan of leaving in 5-7 years for a place with a yard.  Part of me wants to really hammer at the mortgage so that the transition to another home will be easier (especially if it costs a little more for a yard), but the math side of my brain says "a 2.75% mortgage is practically free money! max out those 401ks at all costs!".

I know that this is a classic battle of math vs. the psychology of paying down a mortgage, but what do you think?

If it matters at all, the long term plan is to have another kid in 2-3 years, and my wife will go back to 100% work when the youngest is school-age (so, maybe 6 years from now?) in which case we'll be grossing ~$180k+

bo_knows

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Re: Allocating monies amongst 401k/IRA/Mortgage
« Reply #1 on: September 20, 2012, 06:40:46 AM »
I realize that this is somewhat disjointed, so I did some more digging on mint.

Average non-mortgage expenses (over past 6 months):  $2450/mo
Minimum mortgage payment (if we refi to 15yr):               $1934/mo
Total Expenses:                                                                 $4384/mo

Total net income (if maxing out 401k):                               $6781/mo
Potential IRA contributions:                                                $816/mo

So, it seems like we can max our 401k's, max our Roth IRA, and throw some extra money at the mortgage.  I feel like I'm in analysis paralysis.

arebelspy

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Re: Allocating monies amongst 401k/IRA/Mortgage
« Reply #2 on: September 20, 2012, 06:59:51 AM »
Keep in mind that the 401k can be borrowed against, and the Roth principal can be withdrawn penalty free, but the house equity is trapped (more or less, barring a HELOC).

Other than that, if you can max the 401k and Roth AND the. Pay down the mortgage (and you'd rather do that than grow taxable accounts for whatever psychological reasons), that's awesome and I see no reason not to do so.
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bo_knows

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Re: Allocating monies amongst 401k/IRA/Mortgage
« Reply #3 on: September 20, 2012, 07:02:12 AM »
Keep in mind that the 401k can be borrowed against, and the Roth principal can be withdrawn penalty free, but the house equity is trapped (more or less, barring a HELOC).

Other than that, if you can max the 401k and Roth AND the. Pay down the mortgage (and you'd rather do that than grow taxable accounts for whatever psychological reasons), that's awesome and I see no reason not to do so.

I know that Roth contributions can be taken out at any time, but aren't there stiff 401k withdrawal penalties? I thought it was essentially trapped until retirement (whether it be normal distribution, or 72t)?

arebelspy

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Re: Allocating monies amongst 401k/IRA/Mortgage
« Reply #4 on: September 20, 2012, 07:09:12 AM »
Yes, withdrawal.  Note that I said the 401k can be borrowed against. :)

50% or 50k.
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Re: Allocating monies amongst 401k/IRA/Mortgage
« Reply #5 on: September 20, 2012, 07:44:34 AM »
Some thoughts....

Your non-mortgage expenses seem high, especially with no day care.  Are there places you can cut?

Borrowing against the 401k depends on the employer.  Many do not allow that.  If you were to lose or change your job, you could no longer borrow against it anyway.  In my view, HELOC's are risky as substitutes for savings.  I prefer a sizable savings account as my emergency fund.

I assume you want to sell your current residence when you move, correct?  Paying a lot off on the mortgage likely puts you in the position of having to sell before you buy.  I would rather have the down payment for the new house in savings so I can buy when I find what I want.

Finally, what's your long term plan?  Are you going to go all out and get to FIRE ASAP?  That makes a big difference in how you should approach your savings and investing.

bo_knows

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Re: Allocating monies amongst 401k/IRA/Mortgage
« Reply #6 on: September 20, 2012, 07:54:40 AM »
Some thoughts....
Your non-mortgage expenses seem high, especially with no day care.  Are there places you can cut?

$2400/mo of non-mortgage expenses, doesn't seem that high to me (even after reading MMM) for a suburb of an expensive  city (DC).  We've cut cable entirely, reduced our eating out to nil (which is easy with a newborn), and cut in some other places over the last few months.  Our biggest expense is groceries, in which we don't skimp and eat a lot of meat. Also, this average takes into account a few irregular costs of the last few months (plumbing disaster: $500, car maintenance: $400, 2 8hr driving trips with a cheap motel layover). So, take that as you want.

Quote
I assume you want to sell your current residence when you move, correct?  Paying a lot off on the mortgage likely puts you in the position of having to sell before you buy.  I would rather have the down payment for the new house in savings so I can buy when I find what I want.

I think that's the plan.  In an expensive housing market, I'm not sure that I want to tie up SO much of our net-worth in real estate.  I can see what you mean about the down payment though.  If, for some reason, our current house can't sell at the exact moment we want to buy another home, we'd be in the lurch if we depend on that for a down payment.  I wonder if a compromise would be to build post-tax savings to a level of a downpayment, and then shift our focus to the mortgage?

Quote
Finally, what's your long term plan?  Are you going to go all out and get to FIRE ASAP?  That makes a big difference in how you should approach your savings and investing.

I would not say that our plan is to FIRE "ASAP". We're 31, and we want to provide at least partial funding for a college education for our kid(s). I've ran the numbers, and feel like it's well within our reach to be out of the corporate world and "retired" before 50.  When my wife returns to 100% work in a few years, we'll see if its possible to get there by 45.

If we didn't have a family, it'd be an entirely different story. I feel like we'd be FIRE'd in <10 years.  But, for now, we like the area we are in because of family, and I wouldn't want to uproot the kid(s) once they're in school.

I still think we're doing alright ;)
« Last Edit: September 20, 2012, 08:10:43 AM by bo_knows »

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Re: Allocating monies amongst 401k/IRA/Mortgage
« Reply #7 on: September 20, 2012, 08:24:50 AM »
I'm not criticising, just trying to figure out what I would do in your shoes.

First, how secure are your jobs?  The level of job security makes a huge difference in what I would do.

What's your car situation?  Are you both car dependent for commuting?  Are the cars a big part of the monthly expenses?  Can you reduce these expenses?  Usually, cars are a great place to find expenses that can be cut.  If my goal was to buy another house, I would look to cutting here to save more money faster.

In calculating my expenses, I include the usual recurring expenses and a monthly amount for the anticipated periodic expenses such as car maintenance, insurance and property tax.  Since I maintain savings to cover unexpected expenses such as the plumbing disaster, I just lump those under savings.  It probably does not make much difference in your case.

Based on what you have said so far about your current situation and goals, I would max out both 401 k's and IRA's first.  When your wife goes back to 100 percent, you may not be eligible to contribute to the IRA's.  I would refinance to a 30 year loan if there was a significant benefit in rate reduction, because I am risk-averse and I want to maximize my flexibility with my income.  Then I would save a lot of cash toward the down payment on the next house and throw everything else into taxable investments.  This gives you a lot of flexibility and a big cushion should your job or family circumstances change.

bo_knows

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Re: Allocating monies amongst 401k/IRA/Mortgage
« Reply #8 on: September 20, 2012, 08:44:01 AM »
I'm not criticising, just trying to figure out what I would do in your shoes.

No worries. I consider this forum to be generally friendly :)

Quote
First, how secure are your jobs?  The level of job security makes a huge difference in what I would do.

Hers: Very secure. Worked her way into a "Team Lead" role, company has been doing well for decades, and is very accommodating to alternative schedules (thus the 60%).

Mine:  Fairly secure. Government contracting job. Our contract was just up for re-bid, and our company won the prime over the incumbent. Bad part: Sequestration provides a lot of unknowns.

Quote
What's your car situation?  Are you both car dependent for commuting?  Are the cars a big part of the monthly expenses?  Can you reduce these expenses?  Usually, cars are a great place to find expenses that can be cut.  If my goal was to buy another house, I would look to cutting here to save more money faster.

2 cars, long paid off.

2009 Mini Cooper - My daily driver for commuting.  Commute is 14mi, not conducive to mass transit at all, and has terrible biking options (I used to bike to work 13/mi each way, but this particular route is not that safe).

2003 VW Jetta - Her car, lowish mileage for the age (80k), her commute is 5mi to mass transit, then subway in to work, 2 days/wk.  This car also acts as our travel car (quite literally impossible to travel with 2 adults, 1 kid, and luggage in a Mini Cooper).

I think that if we really wanted to lower costs in this department, we'd have to sell both cars, get a slightly bigger-than-Jetta sedan, and have my wife take the bus to work.  This would leave her at home with the kid and without a car though.  I've thought about having her drive me to work in the morning and drop me off, but the high-security nature of my job doesn't allow this.

Typing that all out sounds like a bunch of excuses.

Quote
In calculating my expenses, I include the usual recurring expenses and a monthly amount for the anticipated periodic expenses such as car maintenance, insurance and property tax.  Since I maintain savings to cover unexpected expenses such as the plumbing disaster, I just lump those under savings.  It probably does not make much difference in your case.

I mean, we do something similar.  I've never really calculated ONLY regular recurring expenses, as I find it easier just to click "Last 6 months" on Mint and average it out.  We have plenty of savings accessible for the aforementioned plumbing disaster.

Quote
Based on what you have said so far about your current situation and goals, I would max out both 401 k's and IRA's first.  When your wife goes back to 100 percent, you may not be eligible to contribute to the IRA's.  I would refinance to a 30 year loan if there was a significant benefit in rate reduction, because I am risk-averse and I want to maximize my flexibility with my income.  Then I would save a lot of cash toward the down payment on the next house and throw everything else into taxable investments.  This gives you a lot of flexibility and a big cushion should your job or family circumstances change.

You'd be right about the IRA after my wife goes back to work.

I've been struggling with the idea between a 15yr refi and a 30yr refi for awhile. I suppose that I never really took into consideration the possibility of trying to move and not being able to sell the house right away (I always considered that we'd only move if it was financially sound, but forgot to think of the feasibility of actually selling the home regardless of the value).

I appreciate all the input.

arebelspy

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Re: Allocating monies amongst 401k/IRA/Mortgage
« Reply #9 on: September 20, 2012, 08:47:48 AM »
I wouldn't count too much on the future going perfectly according to plan, specifically with regards to your wife's job.

my wife will go back to 100% work when the youngest is school-age

Her (and your) desires on this may change at some point.

Quote
First, how secure are your jobs?  The level of job security makes a huge difference in what I would do.

Hers: Very secure. Worked her way into a "Team Lead" role, company has been doing well for decades, and is very accommodating to alternative schedules (thus the 60%).

Her employer may change on this in the 4-5 years that she takes off.

Maybe it will work out perfectly that she wants to go back and steps exactly into the role and salary she had before. Maybe not.  Either way, I'd count that as a hopeful, but not certain, possibility.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
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bo_knows

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Re: Allocating monies amongst 401k/IRA/Mortgage
« Reply #10 on: September 20, 2012, 08:55:24 AM »
I wouldn't count too much on the future going perfectly according to plan, specifically with regards to your wife's job.

my wife will go back to 100% work when the youngest is school-age

Her (and your) desires on this may change at some point.

Quote
First, how secure are your jobs?  The level of job security makes a huge difference in what I would do.

Hers: Very secure. Worked her way into a "Team Lead" role, company has been doing well for decades, and is very accommodating to alternative schedules (thus the 60%).

Her employer may change on this in the 4-5 years that she takes off.

Maybe it will work out perfectly that she wants to go back and steps exactly into the role and salary she had before. Maybe not.  Either way, I'd count that as a hopeful, but not certain, possibility.

It is very possible our minds might change on her going back full-time. We shall see.

Normally, I would agree with you about her job security regarding a 5ish year lapse in full-time status.  However, her company is a company that consults on benefits plans and retirement plans for large corporations, and prides itself on its own benefits.  One of which is alternative work schedules to accommodate family life.  Many examples of this have happened on her very team over the past 9 years she's worked there (people go part time for family and come back to full time). 

So, I at least have some degree of certainty here. :)

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Re: Allocating monies amongst 401k/IRA/Mortgage
« Reply #11 on: September 20, 2012, 09:37:08 AM »
First, since you lose the ability to contribute if your wife returns to full time, I would make the Roth contributions a high priority.  An extra $50-$70,000 plus earnings in retirement accounts with no taxes on the earnings ever is especially helpful for someone with your future tax bracket.  It can also help you to bridge the gap between when you retire and when you can take regular distributions from your other retirement accounts.

Your cars do not sound that unreasonable for your commute situation in suburban DC.  I guess if you really wanted to go all out, you could sell the Mini and get something cheaper, but to me it's not that significant with your income and goals.  Insurance is expensive where you live.  Are you shopping the insurance and making sure the older car is not over-insured?  Are you paying for parking at the subway?  If so, is there a way around that?

Have you considered keeping your current property as a rental when you move?  Would that make financial sense?  It could help you, especially in the earlier years of retirement. 

In general, I would start thinking how I am going to fund retirement between the 45 to 50 year-old retirement goal and the time I could draw from those fat retirement accounts I'm going to have by fully funding them today.  A rental house, the Roth contributions, and taxable accounts can all contribute to that.  For the house purchase goal, I would save the down payment.  You can always pay down/off the current house if your goals change or you can use the money as part of the retirement income bridge.

bo_knows

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Re: Allocating monies amongst 401k/IRA/Mortgage
« Reply #12 on: September 20, 2012, 09:50:06 AM »
Insurance is expensive where you live.  Are you shopping the insurance and making sure the older car is not over-insured?  Are you paying for parking at the subway?  If so, is there a way around that?

Just changed insurance companies last year, got a much better rate than previously.  Wife does pay to park at the subway, not much of a way around that, but she gets her commuting costs pre-tax via her employer.

Quote
Have you considered keeping your current property as a rental when you move?  Would that make financial sense?  It could help you, especially in the earlier years of retirement. 

I wouldn't be totally opposed to it, but as I hinted at earlier, I would be somewhat concerned in trapping a lot of our "net worth" in real estate.  It's an expensive housing market, so floating 2 properties sounds a bit scary.  How can you really tell if it's "worth it"? The alternative is to carry one home only, and invest the rest in the market.

Quote
In general, I would start thinking how I am going to fund retirement between the 45 to 50 year-old retirement goal and the time I could draw from those fat retirement accounts I'm going to have by fully funding them today.  A rental house, the Roth contributions, and taxable accounts can all contribute to that.  For the house purchase goal, I would save the down payment.  You can always pay down/off the current house if your goals change or you can use the money as part of the retirement income bridge.

I've read a lot about 72t distributions for pre-59.5 retirees. A rental home would help a lot in this instance.  As I mentioned before, how much "net worth" in real estate is too much?

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Re: Allocating monies amongst 401k/IRA/Mortgage
« Reply #13 on: September 20, 2012, 11:35:45 AM »
First, I'm a lot older than you, and my background is in real estate, so I am comfortable with investing in real estate.  Not everyone is suited to be a landlord, and you will have to think about that as well as the financial aspects.

Having said that, I do not know enough about your property to tell you what I would do if I were in your shoes.  You indicate your mortgage payment would be $1,934 if you refinanced to a 15 year loan.  You don't say whether that includes taxes and insurance and you have not said whether there is an HOA.  Also, I have no idea what market rent is.  However, even without that information, I would give some thought to holding on to this property as a rental.  Here's why.

1.  You already own this property.  There are no acquisition costs to pay before putting this asset in service.  However, selling this asset involves substantial disposal costs.  The transaction costs can exceed 7 or 8 percent of property value, depending on commission, transfer taxes, title insurance, and settlement costs.  That's money out of your pocket.

2.  You are in a financing environment that is historic in nature.  Never have I seen interest rates this low and I don't think we will see them again in my lifetime.  You have the opportunity to refinance this property today at an owner occupied interest rate of 3.5 percent or less for 30 years and 2.875 percent or less for 15 years.  I would not pass up this opportunity to leverage something I wanted to rent out in 5 to 7 years at today's owner-occupied rates.  The leverage may be what makes this plan feasible, especially if you go for the 30 year loan.

3.  You live in an area where employment is likely going to go up.  The federal government (and all of its' contractors) is not an employer that will shrink anytime soon.  Over time, rents and values will likely continue to increase.  If you live in a neighborhood with good schools, easy access to public transit, and a low crime rate, the rent and value of your property will go up as fast or faster than the average.  Demand for rentals will be high because of the high and increasing cost of buying.  Prices and rents could be substantially higher when you are ready to move.

4.  You will likely qualify to shelter some or all of the income from this property once you convert it to rental use.  Talk to your tax person about this.

5.  If you refinance today and rent in 5 to 7 years, your tenants will likely be paying for the house until you are ready to retire in the 9 to 12 year time frame after that.  During that time, you will benefit from the equity build-up through mortgage paydown by your tenants, as well as any appreciation in property value that occurs.  You can decide to sell the property to pull out the equity or keep it as a rental when you retire.

To determine if this makes financial sense, you need to know what market rent is for your property today and what all of your expenses would be if you were to rent it out now.  If the net cash flow is hugely negative, this idea may not make sense, even with a stabilized low interest loan payment.  However, if the numbers are not that far off, in your shoes, I would keep this plan on the menu, refinance, and re-examine the situation as I got closer to buying a new house.

bo_knows

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Re: Allocating monies amongst 401k/IRA/Mortgage
« Reply #14 on: September 20, 2012, 11:45:40 AM »
Again, I appreciate all the detailed responses.

The specific area is Fairfax, VA. $285k mortgage value on an approximate $380k value. That figure was not including taxes (~$3300/yr) or insurance (don't know that one off the top of my head, as the wife pays it).

A quick search on craigslist reveals townhouse rentals in my area with 3-4 bedrooms to be $2000-2500.  At a 30yr mortgage refi at 3.375% (todays rate at my credit union), that's only a $1200/mo payment, which is pretty sick.  It almost begs the question: Why not move out to an upgraded house before the rates go up? Ha!




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Re: Allocating monies amongst 401k/IRA/Mortgage
« Reply #15 on: September 20, 2012, 12:01:14 PM »
@Another Reader

Great point on converting the existing house to a rental. This is exactly what I would do.

@bo_knows

There is no hurry to pay down the mortgage, the extra money should be better invested in 401K, Roth IRA or save as a down payment for your next house.

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Re: Allocating monies amongst 401k/IRA/Mortgage
« Reply #16 on: September 20, 2012, 12:30:14 PM »
What's the HOA?

P&I  ($285,000 @3.375) $1,260
Taxes  $275
Insurance (guess) $75
HOA???

$1,610 plus HOA. 

If yours could be rented at $2,000 today and rents go up 3 percent annually over 7 years, you will be looking at market rent of $2,460.  At 5 percent, $2,814.  Your taxes, insurance and HOA will go up along with the rent.

In your shoes, I would refinance for 30 years and keep an eye on prices and rents.  Fund the retirement accounts, the taxable accounts, and savings in the meantime.  When it comes time to move, do the math and then decide.

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Re: Allocating monies amongst 401k/IRA/Mortgage
« Reply #17 on: September 20, 2012, 12:35:14 PM »
What's the HOA?

P&I  ($285,000 @3.375) $1,260
Taxes  $275
Insurance (guess) $75
HOA???

$1,610 plus HOA. 

If yours could be rented at $2,000 today and rents go up 3 percent annually over 7 years, you will be looking at market rent of $2,460.  At 5 percent, $2,814.  Your taxes, insurance and HOA will go up along with the rent.

In your shoes, I would refinance for 30 years and keep an eye on prices and rents.  Fund the retirement accounts, the taxable accounts, and savings in the meantime.  When it comes time to move, do the math and then decide.

Thanks for the perspective.  HOA is currently $110, but it's under some sort of 3 year increase to pay for the private roads in our community (in which it's supposed to drop back to $75, but I won't hold my breath).

I think that the wise move isn't to plow money into paying off a cheap mortgage, but to save in a post-tax vehicle for the next residence, and tax advantage of these low rates.  I had it in my head that paying off the mortgage would be of paramount importance, but it just doesn't add up in the long run.

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Re: Allocating monies amongst 401k/IRA/Mortgage
« Reply #18 on: September 20, 2012, 12:42:38 PM »
Agreed.  If the credit union interest rate is significantly lower than your current rate, I would lock that rate and get the paperwork in ASAP.  More cash today for your other investments and more choices on the menu when it's time to move.

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Re: Allocating monies amongst 401k/IRA/Mortgage
« Reply #19 on: September 20, 2012, 08:53:01 PM »
This hasn't been mentioned yet, but there are no limits on income for rollovers to a Roth.  So effectively although they would not be able to directly convert they could contribute to a traditional (non-deductible) IRA and immediately roll over to a Roth, paying taxes only on the growth.  In 1 day there shouldn't be any growth!

Anyways, Google "backdoor Roth" for more detailed information.  I gather this is a fairly simple process, but there are a few pitfalls to avoid.

Also, if you can max out both your 401-K's and Roths, do it.  You'll never get back that tax advantaged space once the next year comes along.  You can take out contributions from Roths at any time, so it's relatively easy to use that for a downpayment if other savings are not up to par yet.