Case study: Rent vs Buy at 39/FIRE (for a late bloomer)

[late_stache_bloomer]

Hello all and thank you in advance for any helpful advice. Pull no punches and let me know how I am (in actuality or potentially) screwing up. Following the post for recommended information I'll list particulars below and then offer details of the situation. I know most of you, especially ones who take the time to offer well-thought-out advice, are more in the know than I, so it's truly much appreciated. OK:

Life situation: Married this July, haven't filed taxes together yet. No kids, but trying now. I'm 39, wife is 34. Live in FL.
Gross salary: I put myself back through school recently and am now a RN. It depends on how much you work and other factors, but I'm on track to earn about 77K this year. Wife is a school teacher making about 45k including base and tutoring/clubs extra pay. She also babysits for one single mom to the tune of about $225/month (maybe 12 hours per month, not much).
Pretax deductions: Can't be sure on this one for the wife, but she has a 3% contribution to 3% match for the Florida Retirement System plan and contributes $100 each pay period ($2400/year) to a newly created Roth. She also has lump sum payment of $500K coming at retirement, as she opted against the pension payment. The FRS account has about $75k in it. Roth is brand new. I contribute the 6% to get my 403b company match (3% and 1.25% salary contribution) since we are saving for our first house. It's going to be about $5,000. This year my company is offering a HDHP w/ HSA ($500 match) that I plan to contribute fully to at $2950. I'm debating the merits of this vs putting more to the 403b since I started so late (and a lot of my younger/healthy years are behind me. Fingers crossed, I'm in good health and take good care of myself, but still...39). Any insight on this would be much appreciated. My 403b balance is 8500 and Roth is 6800.
Other income: none, just the bit of babysitting for the wife.
Taxes: We're at 25% with our income. No state income tax here in FL.
Current expenses: wife and I keep accounts separate save for a small joint for bills/groceries/entertainment. We each contribute $500/mo to this account and it typically covers everything. That's cable (which is getting cut to internet only this month!!!!), joint phone plan, water/sewer, electricity and groceries. IF we go over, it's an unexpected expense like doctor bill. NEVER for dicking around like bars or restaurants. Rent is $870/month in a small one bed secured through next February (weird 20-month lease). We split that. Our car insurances are about $600/year each and we each keep a bit from each check to pay for fuel/miscellaneous stuff, probably $75 every two weeks. For me, a lot of that is fuel. I do commute 25-30 minutes 4 days/week. Wife's drive is 10 minutes. We also deposit $75/check ($50 me and $25 her) to vacation and future car funds. We made a promise to see the world together but will do so on a budget at all costs.
Estimated ER expenses: possibly small mortgage (depending on advice here :)) and health insurance. That could be covered, though, since I plan to keep working at least part-time because I'm lucky enough to LOVE my work. And part-timers are still eligible for coverage. That would mean me working 2 days per week. Other than that, same monthly expenses that apply now.
Assets: 2013 Honda CR-V 48k miles, 2012 Honda Civic 50k miles. $20,000 emergency fund ($10k from each of us) that is currently in a high-yield savings account at my credit union earning 1.1%. That money is combined with $20,000 house fund, for $40,000 total cash.
Liabilities: None. Rent each month, I suppose, but no debt.
Specific questions: I'm terrified of getting too far into the weeds here, especially given the details above, but my question is mainly whether I should rent or buy given the age--38 pretty much--that I started making real contributions to my retirement. This also plays into whether I could retire early (for me). I could go on forever, but I was young and dumb and living in one of the most expensive places in the country until I put myself back through school. Once that was done, I started earning more and my curiosity is off the charts now for all things finance. I realize how f**ked my decision making has been before now, but...water under the bridge and all that. So, here I am.

At $77,000/year, I could easily afford to max out 403b/Roth and still have substantial money left over after bills/rent for taxable account investing. I would love to retire even earlier, but at 57 my wife will be 52 and that's when she's fully vested in her retirement (lump sum and FRS account described above). She loves her gig and has tons of time off so has no anticipation of quitting before then.

My quandary is that homes in a good neighborhood that we love (near Orlando, and where we currently rent) are $350k. These are 3/2 concrete joints with not much frills, in case there's any hint of desire for lavishness here. However, schools are top notch, close to the houses and a huge park with tons of fields and family-friendly stuff. There's also a wonderful bike trail. I cycle and my wife runs. It's steps away from anywhere in this neighborhood. All of this requires $85,000 down counting 20% and closing costs. We're pretty damn frugal and it's probably $25-30k/year we're able to save, putting us 2 years away from buying. That puts me at age 41. Then it's 10-15 years of putting everything at the mortgage and being able to be debt free. I wouldn't want to budge from at least maxing Roth and matching company 403b during that time.

A quick Bankrate calculator estimation at 6% contribution until 57 (when mortgage is paid off and wife would be retired), my 403b would be just over $333k, given 7% return and 3% annual raises. This is also assuming a salary of $70,000, which is less than I make now but allows for less overtime/part-time work in the future at a higher hourly rate than I earn now. My Roth would be about $232K. Then there's the HSA, which I'm unsure of whether to max out or not. Either way, I think I could do that comfortably and live within our means. My wife would at that time have $500k lump sum and $363K in FRS account (7% return, $45k annual salary w/ 2% raises). She'll also have in the neighborhood of $80-90K in her own Roth assuming same 7% and never wavering $100 contributions per check.

This is not awful, given the fact that I can still work part-time and it's not really too much of a strain on my schedule. But if I wanted to be really retired at this time I'd have concerns with making it the 2 years until I could access retirement funds w/o penalty. Perhaps the 55 and over rule would apply, but only if I quit the company? And I'm sure I'm missing some other available loopholes here? However, the wife would have access to her full nut at this time, so there is that. And I could always man up and make room for taxable savings despite everything. The obvious pro is a paid off house in a good neighborhood and decent savings.

The alternative, RENTING, would mean no hammering away at a mortgage for 15 years starting at age 41. But I'd still have to worry about buying something later, or the continued cost of renting throughout life. In this scenario, I'd be able to max out the 403b and Roth for the duration of the 18 years until age 57. Bankrate says to expect $829K in the 403b and the same $232K in the Roth. I'd also continue to max the HSA.

Verrrrrrrry conservatively, this would leave me alone with about $1200/month extra to invest in taxable accounts. This isn't counting what my wife could contribute. Say we have a kid/s and other unforeseen expenses, etc.., and the wife can give nothing...over 17 years the calculator is showing to expect around $380k assuming 7% return on a $1,200/month investment.

Good news is my crappy math tells me we will be alright no matter what, given our frugality, resolve and level of savings. But I'm truly torn whether buying and dumping the money into a house is the right call versus bulking up all possible reserves and worrying about a permanent place to live down the line. Any and all advice is welcome! I'm happy to add anything or answer anything I failed to relate in the initial post.

[Ben Kurtz]

Congratulations on the wedding!

My advice would be to hold off on buying a house until one kid is safely delivered and you have another on the way. Most likely another 3 to 4 years, I would guess. Part of this is to do with age -- at 34, your wife is certainly not past her childbearing years, but in many cases things will take longer than they would have at age 24.

At your current rate, your liquid savings will hit your down payment goal in less than 2 years, which is probably faster than you need. Meanwhile, unused retirement account space each year is lost forever.

So my retirement and savings account advice is this:

First, max out your and your wife's Roth IRA accounts. It looks like there's a good $8,500 per year of contribution capacity that you are not using. You can always withdraw principal from a Roth IRA  tax and penalty free, so treat this for now as your shadow house fund. Overweight the portfolio towards short term bonds in the amount of the house savings that your are hiding in this account, to buffer out short term volatility.

Second, amp up your 403(b) -- at least another $10,000 per year worth of contributions, which gets you close enough to maxing it out. At a marginal 25% tax rate, that's a $2,500 bonus Uncle Sam just paid you. Sweet.

Third, set aside the rest in your real taxable house fund.

Fourth, go ahead and re-do your expense reports: With a gross household income of around $125,000, your income and social security taxes should be $25,000 to $30,000 per year on a a household basis. Which leaves $95,000 per year take-home. Are there car payments you are not reporting, health plan premiums not in your report? Travel? Expensive hobbies? Student loans from your RN training? I'm having a hard time tallying up your true yearly expenses given the format in which you've reported them, but the numbers you state suggest something like a $25,000 to $30,000 in yearly household expenses, so you should be saving up cash at the rate of $60,000 to $70,000 per year, not $25,000 or $30,000. Something doesn't quite tally in your account, so I'd ask that you re-work the numbers to get a clearer picture of the finances.

[late_stache_bloomer]

Ben, thank you for the advice. First off, you're spot on with your very first point. We have encountered some fertility issues. Thankfully, our prospects are good, but there have been doc visits. Bills have been minimal to this point (a few hundred after insurance) and our fingers are crossed. That being said, it sounds like you're proposing a compromise of sorts on the timeline, which is doable despite a serious house fever :)

I also have broached the topic of maxing out my wife's Roth, but hadn't considered doing so to stash potential house money. I guess as a newbie, the idea of pulling money out of a Roth before it's had years to work for me sounded off! And I hadn't invested the money we do have for the house $20,000 thus far (first contribution came on 1/12/17) because I was worried about short-term volatility. So the bonds idea is great, thank you. She's just starting the Roth, so was hesitant to pull $211 off the top of what aren't exactly enormous checks. I'll work on convincing her it's the right plan.

Same goes for my 403b...especially if we decide to put off buying a few years, I would really love to max it out or close to it. I would still be able to save some despite all that.

Lastly, your point about expenses really got me thinking! So I'm taking quick stock. We did get married in Ireland--just the two of us--and spent 20 days total in Europe traveling. However, my parents gifted us $5,000 for the trip and while I didn't exactly keep receipts, I'm fairly certain the rest of the trip wasn't more than $7,500 out of pocket. It was all paid for using available money. So I should be adding that to what we should be able to save. We each get extra pay checks in December, so I'm confident the house fund will be $25,000 at year's end. That would mean $32,500, roughly, if we had no wedding. But something is still amiss. We have no debt and while my cycling with repairs and tires and flats might be a few hundred a year, it's hardly an expensive hobby. She's a runner; costs nothing. No loans of any kind; cars and student debt were paid off more than a year ago.

So, 77k and 45k=122k gross. Assume pretax $5,000 for my 403b and $1,350 for her 3% FRS that's $115,650 remaining Taxed @ 25% leaves $86,737. Expenses:
--$12,000/year @ $500/month each for bills/entertainment/groceries. We've put in a bit extra a couple months to cover docs or something unexpected, but not much.
--$870 rent x 12=$10,440.
--$5,500 to my Roth and $2400 to hers=$7,900.
--$75/check x 26 checks to both vacation and future car funds=$3,900.
--$1,500 for fuel for the year, assuming approximately 17,000 miles @ 30mpg combined x $2.50/gal.
--$1300/year to insure both vehicles. At second glance, our policies are about $650/year each.
--A rough estimate, but probably $2,600/year ($50 or so each per check for miscellaneous stuff). The odd lunch/snack/whatever. I spent a crap ton on sunscreen, as an example, with my cycling. That type of stuff that's specific to us we buy on our own. I had previously included fuel here, but this is probably more accurate.

Subtract all that and you have $47,097. Either way, you're right. We're leaving money out there and my best guess is it's getting spent on a lot of little dumb things we aren't accounting for versus any large glaring things. The other possibility is that the wife did put a large sum of her emergency fund out to pay off car and spent some replenishing that. I have noticed that these last few months she's brought much more to the house fund than the first part of the year.

Thank you so much again!!

[Ben Kurtz]

I am sorry to hear about the fertility trouble. That can become emotionally taxing, and sometimes financially taxing as well. If you end up using medical assistance, techniques such as IVF can run into the tens of thousands of dollars per child born (and that's real costs, not fake inflated price tags used for insurance negotiation purposes). There are cheaper and lower impact techniques out there, which are appropriate in some cases, but IVF is a realistic worst-case scenario for many couples facing fertility problems. Also, in many states and in many health plans, fertility treatments aren't covered, and even routes such as adoption can cost thousands in legal fees. Bottom line: I hope and pray you can avoid all that.

As for investing the house fund: The conventional wisdom is to favor stability and liquidity for money you intend to spend within the next 5 or so years. And I think that's right. Getting into the weeds for a moment on optimizing your tax advantaged accounts: For house savings in regular accounts, your credit union rate is not much lower than what you'd get on a short-term tax-free muni fund; on the numbers you'd be ahead with moving that cash into something like VWSUX (yielding 1.16% tax free), but given your moderate tax rate a taxable short term corporate fund may even be a bit better after tax. Still, the credit union rate is good for that sort of account, and if the deposit guarantee helps you sleep at night then stick with it, no regrets. Within your Roth accounts, where taxes can be ignored, don't even bother looking at muni funds: any "shadow" house money can be invested in a short term corporate bond fund like VSCSX, which yields 2.28% -- enough in my view to make it worth stomaching the small but non-zero price volatility of such a fund. And while pulling principal out of a Roth early is not the best thing, it still beats forgoing the contribution entirely, which is what your current option is -- at least the 2.28% per year of earnings will stay in there until you retire, and if you don't end up needing to pull out quite as much as you thought, even better for your retirement! Think of your current strategy as contributing the max each January, investing most of that sum in a money market fund that returns 0.01%, and then automatically withdrawing an amount each December equal to the amount of unused capacity that you habitually let go each year ($8,000 or whatever), even though you aren't buying a house just yet. You're sticking that $8,000 withdrawal in a taxable cash account just so it can sit there. Don't you feel extra silly pulling a stunt like that?

And when the time comes, I'd suggest "trading" (in your mind) the cash emergency fund for bond fund savings in the Roth. That is, if you have $60,000 in short term assets in regular accounts and $35,000 in your Roth (and a record of $35,000 in Roth principal contributions), I would advise AGAINST spending $50,000 from regular and $35,000 from Roth to make your down payment (leaving $10,000 in a savings account as your "emergency fund"). Rather, I would suggest spending all $60,000 from the regular account, and $25,000 from the Roth, leaving your $10,000 emergency money invested in short term bonds in the Roth until your cash emergency fund is replenished, at which point you can re-balance that cash into a conventional retirement portfolio (such as 60/40 split between stock and long-term bond indexes). If life continues as normal, you don't permanently lose space in your Roth; if an emergency strikes at that time, the money will be there in your Roth and you can take it out tax free.

As for hunting down those unaccounted shadow expenses: There are plenty of apps and websites and programs recommended in the forums here -- things people find useful for real-time expense tracking. Mint and You Need a Budget (YNAB) are popular.  I'd also look again at your automotive spending. At 17,000 miles per year on the not-very-old but fairly sensible cars that you drive (although the CR-V is a bit silly), your all-in costs should be in the $8,000 to $9,000 range -- fifty cents a mile is a very good rule of thumb based on IRS studies into appropriate business travel deduction rates. That figure is meant to account for fuel, insurance, depreciation / replacement reserve, maintenance (oil changes, tire changes, brake pads), car washes and everything else. But in your budget I only see $1,500 in fuel, $1,300 in insurance and up to $3,900 in replacement reserve (how much of that is really vacation money, though?), which adds up to $6,700 per year or less. So I'd guess there's $2,000 to $4,000 per year in hidden automotive costs baked into your lifestyle somewhere or another.

If your wife's commute is only 10 minutes, it might make sense to trade the CR-V for a Vespa (if her commute is confined to slower local roads), or at least a 7 to 9 year old Civic to match the 5 year old one. The proprietor of this site would suggest plain old biking for her commute, but being in swampy Florida (I once lived in SoFla) and with her trying to get pregnant I'll give you a free pass on that. There's at least $10,000 to $12,000 of value depreciating on your driveway in the form of that late-model CR-V, and if you replaced it with a sightly more modest $3,500 piece of depreciating machinery (a somewhat older Civic) you could make a nice sized one-off contribution to your house fund and probably knock a few grand off your ongoing yearly expenses, which might give you enough headroom to fully max out your 403(b) -- a goal worth considering. For my part, I drive around in a 20 year old station wagon bought used a few years back at a three figure price tag (and I do a fair bit of the maintenance myself), despite also having a six-figure family income. But I'm widely regarded as slightly nuts, so I try to make the advice I dispense to others a little bit more comfortable and mainstream than the choices I'd make myself. Civics are very reliable cars, so take your time, pick a well-maintained one, get it checked out by an independent mechanic, set aside an extra $500 to $1,000 to replace some of the older parts during the first year of ownership, and I'm sure you'll come out well ahead.

Also, when estimating you taxes, you're better off looking for an online calculator to estimate your liability, rather than using the overly simplified calculation you present in your post. On the one hand, only your marginal income is taxed at 25% -- most of your earnings will be taxed at a lower rate (the first $20,800, being your two personal exemptions plus the standard deduction for a couple, is effectively taxed at a 0% rate), so your income tax estimate is overly high. On the other hand, you also have to consider employee-side payroll / social security taxes (6.2%) on top of income taxes, which isn't yet in your calculation. Net-net, I would estimate your family's income and payroll taxes as being $3,000 to $5,000 lower than the ~$30,000 you calculate. Which means there are a few other hidden expenses to ferret out!

And again -- good luck on starting a family! We're rooting for you...