Author Topic: Best use of money after maxing out tax advantaged accounts  (Read 3459 times)

Buckeye in TX

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Best use of money after maxing out tax advantaged accounts
« on: March 13, 2015, 11:45:30 AM »
I posted a "case study" in a different thread and received a number of great suggestions on reigning in my family's expenses.  But one question popped out of that discussion that I would like further guidance on. We currently max out our tax advantaged accounts (401k, IRA, HSA), pay extra toward student loans and have approximately $1,500 remaining in our budget (hoping to grow this number based on the suggestions from the other thread). We've been investing the remainder in a taxable account, but the consensus seems to be that we would be better off paying down the loans.  Now I need some help prioritizing our debt payments.

Mortgage - $375,000 @ 5.25% ($2,800 /month; home value is $400,000)
Student Loans - $105,000 @ 4.5% ($1,450 /month)

We currently make extra payments averaging $950 /month on the student loans. Our initial plan was to prioritize taxable savings (for ER) and knock out the student loans in 4-5 years. Someone suggested that we instead aggressively attack the mortgage to reach 20% equity and refinance to a lower rate.  I like this idea.  Would it make sense to put the $1,500 taxable investment savings and the extra $950 student loan payment toward the mortgage instead?  And then after refinancing the mortgage, finish off the student loans with the same extra payments ($1,500 + $950)? My concern would be that stopping the taxable investments for a few years would push back our timing for ER.

Thanks in advance for any suggestions.


forummm

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Re: Best use of money after maxing out tax advantaged accounts
« Reply #1 on: March 13, 2015, 12:07:39 PM »
I haven't looked at available interest rates lately, but it seems like you could cut your mortgage rate down to 3.X without paying any points if you can pay it down to 80% LTV. That would save you $6.4k per year in interest on a $320k balance (which you could plow right back into your student loans or investments).

Paying down your mortgage instead of putting that money towards taxable investments shouldn't slow down your time to ER. Paying down your mortgage is the same as buying a 5.25% bond. But in this case, it has an even better return because when you can refinance with 80% LTV, you get to drop your interest rate on the remaining $320k. So a $55k investment would yield you the 5.25% on that amount, plus the $6.4k in saved interest. So it would be yielding you almost a 17% return. You aren't going to find that kind of return anywhere else in this market.

After you can refinance the mortgage, then you have a harder call between paying off your student loans and buying stocks. I would personally put about half in each because I would want to increase my investments outside tax-advantaged accounts (in case I needed the money before I was ready to pull from retirement accounts) but also would want to decrease the required monthly payments on my student laons and I also would enjoy working towards being debt free. Your interest rate is right on the edge of where I would want to pay it off fast vs not pay it off any faster than required. My own loans are under 3% so I've kept them and invested instead.

trammatic

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Re: Best use of money after maxing out tax advantaged accounts
« Reply #2 on: March 13, 2015, 12:16:45 PM »
It all depends on what you think the market will do over time, and your potential to reduce risk in ER.  Most people estimate the market will return 8% or so over time, thus even with potential 15% capital gains/dividend taxation, you're still looking at 6.8% return.  You can get tax deductions for both student loan interest (above the line) and mortgage interest (when itemized), which has the effect of reducing interest rates on your loans even further.  You'd be paying north of 18k on mortgage interest, which is greater than the 12.6k MFJ standard deduction already, so you'd itemize.

See: http://forum.mrmoneymustache.com/investor-alley/paying-off-mortgage-early-how-bad-is-it-for-your-fi-date/

So, basically, you'd make off better not paying any extra on those and putting it all in the taxable account.  There is something to be said for having a less expensive retirement, however, so you have to prioritize accordingly.

hodedofome

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Re: Best use of money after maxing out tax advantaged accounts
« Reply #3 on: March 13, 2015, 12:21:36 PM »
Forum gives good advice here. Pay down the mortgage to refinance, and then it's a toss up.

Personally, I would pay down the student debt after the refinance just because I like being debt free. But 50/50 investments/debt pay down is fine too.

Another idea is to pay down the debt until the market experiences 10-20% pullbacks, and then throw money into investments for a little bit while the market is down. Then when the market rebounds, go back to paying down debt. The goal is not to squeeze out the maximum return but rather to only invest when you have a better chance of making 5%+ returns. In this current environment there's no way to believe you have a great chance of doing better than that.

seattlecyclone

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Re: Best use of money after maxing out tax advantaged accounts
« Reply #4 on: March 13, 2015, 12:22:05 PM »
First off, when you have loans and are planning to put extra cash toward one of them, you should almost always put the extra payments toward the loan with the higher interest rate. In your case this would be especially valuable because paying off your mortgage down to 80% could let you refinance to reduce your mortgage interest going forward. At that point your student loan will then (likely) be your highest-interest loan, so it would make sense to start prioritizing that one again.

But once your highest-interest loan is below 5%, some people prefer to invest in stocks instead because markets tend to return more than that on average. It's up to you, and how much debt weighs on your conscience.

GizmoTX

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Re: Best use of money after maxing out tax advantaged accounts
« Reply #5 on: March 13, 2015, 12:35:30 PM »
Refinance your mortgage to get the interest rate lower. Rates won't stay this low forever. Plan on knocking out PMI ASAP.

If you have any credit card or auto loan debt, kill those. Pay any subsequent charges off in full every month. Then tackle the student loans.


Buckeye in TX

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Re: Best use of money after maxing out tax advantaged accounts
« Reply #6 on: March 14, 2015, 01:44:57 PM »
Thanks for the advice.  The plan going forward will be to throw as much money at the mortgage as we can, and it looks like we should be able to get down to the 80% level at some point in the second half of 2016. Hopefully rates stay low until then.

DavidAnnArbor

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Re: Best use of money after maxing out tax advantaged accounts
« Reply #7 on: March 15, 2015, 01:30:03 PM »
I think rates will stay low because Europe will continue to remain a weak economy which will affect us here.