Reader Case Study - Retirement in 6 years

[bmcewan]

Hi Mustachians,

I own a consulting business. Due to a recent business win, we had an unexpected increase in our income, and we now have about $10k a month to contribute to savings/debt elimination. My question is the best way to apply this to our current situation to get to retirement in six years. Once we retire, we sell our house and most of our stuff, and reduce our expenses per the Mustachian Way. We're still negotiating what we need (I think we can get by on less), but for current purposes, assume we need $60k a year in retirement. I know, I know!

Expenses/Liabilities:
mortgage, 3k a month, owe $300k at 4.7% on a 340k loan. Of that, $180/month is PMI, which offends me. Top priority to pay this down.
car loan, owe $20k, $550/month at 3%.
truck loan, owe $6k, $450/month at 4.5%
no short term debt or other loans

Assets:
Tax deferred Retirement accounts, $350k
Emergency fund, $20k

Current plan:
We have $10k a month disposable for the next six years, after expenses. Eliminating the car loans takes this to $11k.

1. Contribute max $52k a year to my IRA, and $10k a year to hers. As business owner I can make tax deferred employer contributions to my account, but she can't. This is ~$5k/month.
2. (4 months at 5k/month) Pay down $20k of mortgage to eliminate the PMI.
3. (1 month at 5k/month) Pay off truck loan
4. (4 months at 5k/month) Pay off car loan

In 9 months, we're now at 11k/month, with $5k to IRA's and $6k available.

5. (3 months) Increase emergency fund to $50k
6. ... Now what?

I'm already maxing out my tax deferred retirement accounts. I could dump the remaining $6k/month into a taxable index fund and call it a day. At 7%, this gets me to about $1.3m in six years, which is a retirement income of $52k at 4%. Or, I could pay down the mortgage an extra $6k a month. The loan is pretty cheap at 4.7%.

So - any problems with this plan? Any advice on steps 1-5? And what would you do at step 6, in a year? Thanks!

[marblejane]

Two things to look at- once you pay down your mortgage & car loans, it might be worth refinancing your mortgage. 4.7% is an ok but not great interest rate right now.

The other thing that I would look at is setting up an HSA. I imagine that you have some flexibility with your health insurance since you are self-employed. Check out this article on using HSAs as an investment vehicle: http://www.madfientist.com/ultimate-retirement-account/

[nobody123]

Congrats on the big win!  Is this boost in income guaranteed (contractually) for the foreseeable future?  If you have the new cash flow guaranteed, do it in whatever order lets you sleep the best at night.

If it isn't, I would treat each month's $10K as a separate windfall event and follow whatever plan you have today.  If I know I only had a one-time 10K, I would probably knock out the truck loan and put the rest towards the house, and use the freed up $450/month to accelerate the mortgage paydown to the point of eliminating PMI.  If my good fortune continued, I would then proceed with maxing the IRA, then pay off the car. 

The 4.7% is not cheap for a mortgage, but if you're not planning on staying for the long term, a refi might not make sense.

Personally, my biggest concern for you is to avoid lifestyle inflation.  From your comment about getting by on less, I can only infer that your partner might not share your views on the finances, and might not want to devote the entirety of your income to debt elimination.  A sudden shift in lifestyle that coincides with your retirement might not go over well, either.

[bmcewan]

Marble - thanks for your reply. I did look at refinancing the mortgage, but I cannot refi today because lenders require two years of self employment, and I only have a year. By the time I have two, I'll be four years away from selling, and the ROI on refinance is about four years at today's rates (rates will likely increase a year from now). To get around the two years requirement, I would have to pay a higher rate, which isn't worth it. Good suggestion, though.

Regarding HSA - fascinating idea! I did read the article (and the one on this blog) but not sure it would help in my situation. My family buys our insurance through the NY Health Insurance Exchange, we pay a lot for a platinum plan due to some long term health issues. So, a high deductible plan usually isn't worth it for us, we get a plan with a low max out of pocket cost, and end up hitting that within the first 3-4 months of the year. I think the HSA requires a high deductible plan. Worth more research.

Nobody, thanks for your reply. The income is contractually guaranteed for six years (thus the six year retirement target), BUT, nothing in this world is ever guaranteed, and there are out clauses for certain unlikely circumstances. For purposes of this exercise, let's assume that it will last six years. It could go away tomorrow or could expand further, too. If those things happen, I just build a new plan with new assumptions.

Regarding lifestyle inflation. Good call, we've been there, done that, and we're now unwinding the effects of earlier affluenza. We aren't quite there yet (which is why we still have car loans), but we killed all our student loan and credit card debt years ago when we were making much less, and we're both now fully committed to the freedom that comes from an early retirement. The only question is, how much is enough income for retirement? That's where we disagree at the moment, where I say we need about $40k, and she says about $75k. As we get closer to the date, our results will help us decide whether I should keep working for another year, or shift to a more leisurely lifestyle. The end of the contract in 2021 will be a good point to make that decision, too.

Thanks!