Savings question

[hermoninny]

We set a goal for 2015 to save $25k for a "future fund" that will eventually be used to buy a house.  However, we're looking to be killed in taxes this year.  I *almost* max out my 401(k), but DH has never contributed to one.  He is currently self-employed, so we would have to set up an Individual 401(k) for him.  Would you max out the Individual 401(k) to save on taxes knowing that you wouldn't be able to use it to buy a house in the future (4-5 years, probably), or would you continue to save the money in taxable accounts and just eat the tax liability so you could buy the house? 

[zolotiyeruki]

A couple questions might clarify things:
1) what's your total combined income? (so we know in what tax bracket you reside)
2) do you know what kind of home you want to buy (i.e. how much it'll cost)?

[hermoninny]

Our gross income for 2014 looks to be just under $190k, but I haven't gotten any of DH's 1099's yet, so the number may change for tax purposes because I budgeted on an accrual basis.  Income for DH varies wildly from month-to-month, depending on what projects he's working on. 

The house question is more complicated.  I originally had it all written out in the post and then deleted it because it all sounded very convoluted.  If we stay in Los Angeles, we're looking at a 3-4 bed/2 bath, 1500-1700 sq ft, mid-century home for at least 800k, maybe closer to 1M depending on where the market is at when we finally get to a point of purchase.  The complicated part comes in that 4-5 years down the road when we save the $$ for a down payment on a ridiculously expensive home here in SoCal, we may decide to say, "Screw Hollywood" and pay cash to build a home on family land in Tennessee.  There are a lot of factors that would go into that decision, of course.

[Earthling]

I think the general rule is always max out your retirement accounts first. Although everybody's situation is different, making rules of thumb such as this susceptible to exceptions, I'd never sacrifice retirement savings for other forms of savings (here, saving the down payment for a house).

While your house may be deemed an "investment" in some scenarios (e.g., a rising real estate market over time that would enable you to liquidate equity upon sale), and while it is also true that the value of your home (net of mortgage) is typically part of a net worth calculation, it is prudent to view your house merely as a place to live, not as an investment.

[hermoninny]

While your house may be deemed an "investment" in some scenarios (e.g., a rising real estate market over time that would enable you to liquidate equity upon sale), and while it is also true that the value of your home (net of mortgage) is typically part of a net worth calculation, it is prudent to view your house merely as a place to live, not as an investment.

This is the part that gets me.  We previously owned a house.  We, unfortunately, bought at the height of the market and when DH needed to relocate for work, ended up having to short-sell the house for half what we paid.  So neither of us have much faith in the real estate market. 

For me...it's more about not having to calculate rent/mortgage in our FI numbers.  Ideally we would own a house that's paid off when we're finally FI.  In CA, this is extremely difficult due to HCOL.   We're also not even sure this is where we want to stay - jobs and family keep us here right now, but that may not always be the case, especially as the little ones become school-aged and have to enter Los Angeles schools.  Hence option #2 of moving to TN.

[MrMoogle]

I would max out his 401k. 

If you look at net worth, you'll have to take the house value into account as "rent" when you retire.  Say you have $2m net worth, but $1m is in the house.  That's the same as spending $40k/year on rent, and getting $40k/year on other expenses because that $1m is tied up.  If you get a $100k house (like in TN), that's 4k/year on rent, and then 76k/year for other expenses with that same $2m net worth.

It's better to have your net worth in tax advantaged accounts than it is a home.

TN has a ton of financial benefits over CA when retiring, so you'll be able to retire sooner if you move to TN than CA. 

It sounds like you have family in TN and CA, so maybe the family thing is a wash?

[hermoninny]

If you look at net worth, you'll have to take the house value into account as "rent" when you retire.  Say you have $2m net worth, but $1m is in the house.  That's the same as spending $40k/year on rent, and getting $40k/year on other expenses because that $1m is tied up.  If you get a $100k house (like in TN), that's 4k/year on rent, and then 76k/year for other expenses with that same $2m net worth.

I'm not quite sure I understand, but I think I get it *enough*

TN has a ton of financial benefits over CA when retiring, so you'll be able to retire sooner if you move to TN than CA. 

YES!  This we definitely know and are thinking about.  We've been trying to make our way there for 10 years, but it never quite works out.

It sounds like you have family in TN and CA, so maybe the family thing is a wash?

Yes, family in both places.  Not quite a wash, but it's complicated.  DH says that once his parents are gone, there's nothing that pulls him to TN (he's an only child and only has one cousin that he's not super close to).  I have family in TN too, but it's about 4 hours away from where we would live.  I'm the same way about CA...if my mom were gone, I really don't care about staying.  I have a huge family here, but nobody I'm super close to other than my mom.  Plan #3, in case DH's parents are gone before we can leave CA, is to go somewhere else entirely, like maybe WA or OR.  My mom has said she'd move there too, especially because my brother and SIL are considering it once SIL's mom is gone.

[MrMoogle]

If you look at net worth, you'll have to take the house value into account as "rent" when you retire.  Say you have $2m net worth, but $1m is in the house.  That's the same as spending $40k/year on rent, and getting $40k/year on other expenses because that $1m is tied up.  If you get a $100k house (like in TN), that's 4k/year on rent, and then 76k/year for other expenses with that same $2m net worth.

I'm not quite sure I understand, but I think I get it *enough*

Basically, you don't take your house into account when using the 4% rule, only things that produce money.  So if a lot of your money is tied up in your house, you'll have to live on less than if it was in stocks. 

To take it to the extreme, if you bought a $1m house, and that was all your net worth, you couldn't retire and spend $40k/year (4% rule) because you'd have to sell your house to access that money.  So that "$40k/year" is really your "rent" for the house.

[hermoninny]

I'm not quite sure I understand, but I think I get it *enough*

Basically, you don't take your house into account when using the 4% rule, only things that produce money.  So if a lot of your money is tied up in your house, you'll have to live on less than if it was in stocks. 

To take it to the extreme, if you bought a $1m house, and that was all your net worth, you couldn't retire and spend $40k/year (4% rule) because you'd have to sell your house to access that money.  So that "$40k/year" is really your "rent" for the house.
[/quote]

Ah!  Gotcha!  I always thought of FI like that anyways.  You can't spend your house, but having it paid off is a reduction of expenses, therefore a reduction in the amount of investments you need in order to produce your 4%.

[terran]

At least with vanguard you can't open an individual 401k for 2014 anymore. Not sure if this is a legal thing or a vanguard thing though. You could still open a SEP IRA.

[hermoninny]

This would be for 2015, so we're good!


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[zolotiyeruki]

I'd say max out your retirement accounts, and plan to retire somewhere cheaper.  Look at the opportunity cost.  If you retire with $2m in assets, in TN that would mean $1.8M in liquid assets and in CA that would be $1.2M.  4% of the difference ($600k) is $24,000 in extra available income.  That would pay for a LOT of trips back to see family in CA (or vice versa).

[hermoninny]

I'd say max out your retirement accounts, and plan to retire somewhere cheaper.  Look at the opportunity cost.  If you retire with $2m in assets, in TN that would mean $1.8M in liquid assets and in CA that would be $1.2M.  4% of the difference ($600k) is $24,000 in extra available income.  That would pay for a LOT of trips back to see family in CA (or vice versa).

Definitely all part of the equation! 

[Spondulix]

I'd second the SEP IRA suggestion - it'll lower his tax liability. I was freelance for years (in LA) and most years I only contributed a lump sum if I was having a good year. In retrospect, that was a horrible way of doing it. Even doing a small amount (but consistently) will make a huge difference in the long run.

The housing market here is starting to get the same frenzy as before the crash. There was a sale in my neighborhood last year where I literally laughed at the agent when I heard their listing price - and they got above asking. If you're 4-5 years out from buying, who knows what the market will be like, or your life circumstances, or if a big earthquake will hit and change the game completely.

One of my pet peeves (sorry) is when people say they can't get a house under a million. It's a lifestyle choice to buy a house for $800k+. The median home price in LA is $529k, and that doesn't happen because 80% is Compton. When you take a step back, owning a home here is completely doable - it just takes time, exploration and being open minded. Our view of money gets so skewed here because of the money we see every day (we have the 1% here - not just 1% US rich, but international crazy rich). There's also a LOT of people who live on the very edge of their means, and it all drives up prices in high demand areas. My house is worth half million and my mortgage is $1400 (the apartments around here are more than that!) and our savings rate was less than yours. Can you imagine having a $3-4k monthly mortgage?? $10k a year in taxes? My neighborhood is quieter/safer than my friends with million dollar homes in WeHo or Los Feliz. It takes me as just long to get home from Beverly Hills as a co-worker who lives in the Hollywood Hills. There are options!

[hermoninny]

I agree you can get a house in LA for less than a million and that there are choices we've made that makes *our* housing prices so high.  For example, neighborhood.  We live and work in Burbank.  It's where we want to live for a variety of reasons, mostly because police and fire, and schools, are completely separate from LA County.  Housing prices here don't fluctuate as much as other areas do.  We first moved here 3.5 years ago and prices were much lower then.  We're not confident in market prices at all...another reason we're hesitant to buy. 

There are a ton of factors that go into every decision.  I can't list them all.  But I understand why you would see it the way you did!


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[DoNorth]

Definitely set up the solo 401k; Vanguard's plan looks like a lot of paperwork, but it's really only 7-8 pages.  He can apply for a tax ID with the IRS (required if you want to do a 401k) and then he can contribute $18000 in individual deferred contributions and then a percentage above that in employer contributions (use one of the solo 401k calculators to determine how much).  My wife makes about $50K/year in free lance income.  About half of that goes to the 401k....another few thousand to self employment tax and there is very little income tax liability after that.  If you don't do it, like you said, you're going to have some pretty substantial tax liability in future years.

We set a goal for 2015 to save $25k for a "future fund" that will eventually be used to buy a house.  However, we're looking to be killed in taxes this year.  I *almost* max out my 401(k), but DH has never contributed to one.  He is currently self-employed, so we would have to set up an Individual 401(k) for him.  Would you max out the Individual 401(k) to save on taxes knowing that you wouldn't be able to use it to buy a house in the future (4-5 years, probably), or would you continue to save the money in taxable accounts and just eat the tax liability so you could buy the house?

[Spondulix]

I agree you can get a house in LA for less than a million and that there are choices we've made that makes *our* housing prices so high.  For example, neighborhood.  We live and work in Burbank.  It's where we want to live for a variety of reasons, mostly because police and fire, and schools, are completely separate from LA County.  Housing prices here don't fluctuate as much as other areas do.  We first moved here 3.5 years ago and prices were much lower then.  We're not confident in market prices at all...another reason we're hesitant to buy. 

There are a ton of factors that go into every decision.  I can't list them all.  But I understand why you would see it the way you did!


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Sure, I know Burbank well. You're right that it's quieter, better city services, etc... but one thing to keep in mind is that your perception of cost (for value) changes when you're seriously looking to buy. When you're renting, you can afford to be picky because it might only be a couple hundred dollars/month more to get into a nicer neighborhood or better complex. For example, it might only costs you $2-5k more a year to live at the Avalon in Burbank vs a new apartment in the NoHo Arts district. No brainer if you hate LA county services. But if you wanted to buy in those two neighborhoods, there'd be a big difference in monthly mortgage cost, additional property tax cost, increased mortgage interest, etc. Yearly mortgage interest on a 800k loan (at 4%) is about $20k a year. Is it really worth paying $300k to avoid 10 hours a year of being annoyed at LA County? 5 minutes more of commute? Obviously there's a lot of factors and it's a personal choice, but I'm bringing it up because standards completely change the time frame of when you can buy. It doesn't matter where you live - as soon as you start looking at houses, many of those "must haves" become negotiable. You'll consider living on a busy road to save $100k. You'll consider being a few miles away to gain 500 square feet. You'll find everything you wanted in a house... but in Sun Valley or Van Nuys.

I'm wondering... how much are you paying in rent in a year, and how much is it going up every year? I would factor that into your numbers when deciding about the 401k investment, because rent is more or less a loss. I just looked it up and the median home price in Burbank is $644k, and there are a lot of condos on the market under half million (I know the condo market is really competitive there). I totally get it's a personal choice, and certainly not worth buying if you're not going to stick around long enough to recoup all the closing costs, fees, etc (unless you're viewing it as an investment that later would be a rental opportunity).

[hermoninny]

We pay $30k in rent for a 3-bd 2ba house with a great backyard.   We've been here 3.5 years and our rent has stayed the same.  We're unsure if it will increase in Oct when we plan to sign another 2-yr lease. 

You make some extremely valid points!  We have owned a house before in another HCOL area (north jersey, outside NYC) and we compromised on a lot in order to buy at a lower price.  While we liked the neighborhood, our neighbors, and our mortgage was perfectly manageable, we found out the hard way that some compromises are just not worth it.  We bought on the wrong end of the housing bubble and when DH got a job out in CA, we did everything we could to negotiate with the bank in order to sell the house and ended up short selling.   

DH and I had a long talk a couple nights ago.  We're going to see how taxes come out for 2014 (and also what happens to our rent this summer) and then decide for sure, but we're leaning towards investing in the 401k and just not buying a house here.  We both feel that it's not where we want to be long-term so why go through it all.  We'll keep working toward FI and then see where we are. 


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