Save for Retirement vs. College vs. Emergency Fund

[britri3650]

I need advice and don't have money to pay an advisor. I want to do the right thing by saving as much as possible but right now my wife is a homemaker for me and my two kids (10 and 8). Until she returns to the workforce we must rely on my civil servant salary alone. This limits our ability to pay our mortgage and save for things like retirement, college, and an emergency fund. So which has priority over the others? Right now we can keep about $5K in our checking account month-to-month. We have saved a couple of thousand in two 529 plans, and we have about $325K saved in mostly 401K type accounts (I save 5% of salary into a 401K, with a 5% match). My wife and I are both healthy and in our mid-40s and live in a high cost suburban city. Our only revolving debt is our mortgage ($355K 30 yr. @ 3.375%, monthly PITI is $1,956) which we just refinanced in early 2013. I make about $8k/month pre-tax, withholding, and deductables, about $6k/month post-tax, withholdings and deductables.

I don't think I can afford to pay down my mortgage and max-out my 401K (let alone contribute to a Roth) and build 6 months of emergency fund, all while saving enough to pay a substantial amount for my kids' college. So what should I be doing? Thanks.

[twinge]

Here's my thoughts:

1. I wouldn't pay down the mortgage ahead of schedule at this point because it's a fairly low rate.

2. If you have sufficient equity in your home you could open up an Home equity LOC as part of your emergency fund plan instead of having to build up so much cash.  However with two kids and owning a home I would want a little more buffer than 5K, but that's my own comfort level.  Maybe a good family goal could be to cut expenses and save enough to build up at least an extra 5-8K there? Or your wife could take on some part-time work during the school day until that's built up?   But other people here feel less in need of emergency funds, so ymmv.

3. Retirement is generally advised to take precedence over college savings (esp. since you're in your mid 40s), but calculate out using something like www.firecalc.com what you will actually need based on what you want to retire.  That will tell you how much you need.  For instance, when I enter in 325K savings assuming you'll retire in 20 years without adding a penny more to the accounts, not counting social security or any pension, and assuming you'll live a long time (i.e., 55 more years) it gives you a 95% chance that you'll be able to generate about 35K a year of inflation-adjusted income. 

4.You could use a Roth IRA as a flexible retirement/college savings vehicle since contributions can be withdrawn without penalty for anything, and there are some options to draw on earnings for college without penalty too.  Currently this is generally advised to be not tapped until the last year of college because it then counts as "income" for financial aid purposes when it's uncounted as a retirement asset previously.  (529 plans are counted as regular parental assets, but often offer state tax deductions as well as tax-deferred growth).

5. Think about when is a reasonable time for your wife to re-enter the workforce and if there's anything she could be doing now to improve her success then (e.g., practicing software, researching options etc.)

[jrhampt]

I would definitely prioritize retirement over college savings, as twinge said.  I also wouldn't speed up mortgage paydown until you are maxing out all your retirement savings vehicles (401k, IRA).  So in my mind, that comes first.  Without knowing how much you spend monthly, it's hard to know how large your emergency fund should be.  Assuming your wife isn't homeschooling the kids, is there any reason why she hasn't already re-entered the work force?  Seems like a really long hiatus to me.

[secondcor521]

My decision on priorities was:

1.  Emergency fund
2.  Kids' college
3.  Retirement
4.  Pay down mortgage

Most people would recommend switching #2 and #3 in the above list, which I can understand.  I have my own reasons for doing it my way, but they're not really relevant to your question.

[MtnGal]

My opinion: Try to slowly build up an emergency fund and slowly increase your 401k contribution.

For your emergency fund, put $3k of that $5k into your savings account. Make it through the month without having to pull anything out of it. Then start adding to it. Make it your goal to never pull money out of it for monthly expenses or "one time" purchases like clothes or kids events, etc. I have about 20% of my paycheck (after taxes, deductions, etc) direct deposited into my savings account every month, but it took me a couple years to figure out the right amount. Most months I slip a bit more into there when trying to build up EF money, but on months when my car insurance payment money is due or another big annual bill, I do not have to dip into the savings account.

For your 401k, try increasing it by 1% to 6%. I bet you will not notice the $80 decrease in your take home over the month (if you get paid twice a month). Every couple months see if you can try to up it 1%.

[britri3650]

Thanks to all who replied so far. I like the idea of not prepaying my mortgage at this point and instead slowly adding to my emergency fund and also increasing my 401k contribution every few months or so. We should be able to ramp-up our retirement savings, emergency fund savings, and college fund contributions once my wife re-enters the workforce. BTW, she's been earning some cash by babysitting neighborhood kids, which helps pay for some things. I probably have monthly expenses, including mortgage, of about $4k. So I should be able to save $2k/month. As far as retirement savings, should I continue to contribute up to my employer's 401k matching percentage, then contribute to a Roth 401k, or a Roth IRA? Or should I just increase my pre-tax 401k contribution to take advantage of the pre-tax accumulation of earnings? My current effective tax rate is low, about 6%. Last year my adjusted gross income was $99K and my taxable income was about $59k. Total federal taxes were $6k and state taxes were $5,200. Of course I don't know what taxes will be in retirement, but when my wife goes to work our taxable income may push us into a higher tax bracket. Should I contribute to a Roth 401K or IRA now to take advantage of my lower tax rate, then switch to the 401K when our income increases substantially?

[twinge]

Given your currently lower tax rate, my vote would be for:

1. 401k up to employer match
2. Max out Roth IRA (5500 for you, 5500 for spouse) as a hedge for future tax increases and its flexibility for use as penalty-free emergency fund/college savings supplement if needed.
3. if there's any money left, split between greater 401k contributions and 529 contributions.

[britri3650]

Thanks. That seems to make a lot of sense.