How to divvy up my monthly surplus to different accounts?

[Froogmeister]

Hey Folks!

I'm looking for a bit of advice.  While my wife and I save a good portion of money each month, we have absolutely no idea how to split it up.  Below are the potential areas with their current monthly allocations.  Our main goal is to become financially independent, roughly eight years out, but I will probably be 'pre-retired' and work part-time to keep me occupied until I pick up hobbies.  This money will really only be accessed for medical expenses in the HSA, if we don't make enough in pre-retirement to cover all our expenses, or decide to completely stop generating income after the FI point.

1) 401k ($600) - Includes max employer match.  The funds available have high expense ratios (~1% each).
2) Roth IRA ($500) - In the process of switching Roth, Traditional, and Taxable accounts to Vanguard and plan to have a three-fund, 80/20 portfolio.
3) Traditional IRA ($0) - We stuck $4000 in this last-minute last year to qualify for the Saver's Tax Credit and get an extra $1000.
4) HSA ($100)
5) Taxable ($2500)
6) Extra mortgage payment ($75) - Mortgage rate of 4.25%

Total: $3775

My thought is that we should be maxing our Roth IRAs, but I loved having the flexibility at tax time.  This year I think we'll be far enough away from any of those 'close-to-it' credits or deductions unless we max the 401k.  Our pre-tax income is a bit over $80,000.

Thanks!

- Froog

[Froogmeister]

One thing I forgot to mention - my wife and I are hoping to have two to three more kids, so there will be some medical expenses in the future.

[Riceman]

Is your employer maxing your HSA?

If you have an HDHP (which you must have if you have an HSA), your #2 priority should be maxing the HSA, as it has all of the advantages of a ROTH IRA and a traditional IRA.

Here's how I would prioritize

#1  401k up to employee match

#2  HSA

#3  Taxable accounts if you don't have enough for an emergency.  Also, you sound like you are in the 15% marginal tax bracket.  You realize that capital gains at that level are 0%, right?  It's basically like having a roth account for all of the gains that qualify (if you have a gross adjusted income of 65k, and the marginal tax bracket is 72k, you can sell stocks/funds with up to 7k of capital gains and pay no taxes on them).

#4  Roth IRA for you and your wife (so 11,000 per year) as long as you are in the 15% bracket.

#5 Taxable, Extra Mortgage, 401k  -->  I don't think any of these stands head and shoulders above the other if you are in the 15% bracket and your mortgage is 4.25%.  If you are in a state with a high state income tax now but won't be in retirement, that's a point for the 401k.  If you want flexible money for early retirement, that's a point for taxable.  If there are significant tax bonuses for paying more for your mortgage, could be point for that.

[Froogmeister]

Thanks Riceman.  I had known about the capital gains having to do with tax brackets, but that never really registered in my head.  Big thanks for pointing that out.

With regards to the HSA - my employer pays $700/year toward it.  My understanding is that there is no way to access that money without incurring a 20% penalty on top of income taxes, unless it is for qualified medical expenses or you have reached age 65.  That is my only concern, as I don't see us incurring $6450/year in medical expenses over our lifetime.

[thepokercab]

My wife and I have an HSA and I think of it as having a Traditional IRA on top of a our Roth IRA.  The expenses do need to be medical related, but once you turn 65 you can spend it on anything.  You can also just go ahead and invest that money in your HSA. My HSA funds go straight to TD Ameritrade where we invest in Vanguard ETFs. 

Then, if something medical related does come up, i simply don't invest that month's contribution to the account, or reimburse myself later. 

[Sweet Betsy]

I also recommend that you max out your HSA each year...even if you don't feel that you'll need it in the near future.  You can use your HSA funds for dental and vision as well as medical expenses.  If you are going to have kids...you'll already have braces and glasses covered.  We had an HSA for four years...we fully funded each year until the last year that we had it.  (We were diverting those funds to paying down the mortgage.) In hindsight now that we have a traditional health plan I wish we had continued fully funding our HSA.  Even with really good healthcare coverage we still have dental and vision expenses that are burning through our HSA funds faster than I'd like.  Worst case scenario you won't use your HSA funds and you'll have an extra IRA-like account at retirement. 

[suntailedshadow]

This article single handedly made me fall in love with HSA's:

http://www.madfientist.com/ultimate-retirement-account/

Also, with multiple kids coming up you will have plenty of opportunities to dip into that medical fund. Just be sure to keep good documentation over the years!

[arebelspy]

This article single handedly made me fall in love with HSA's:

http://www.madfientist.com/ultimate-retirement-account/

Also, with multiple kids coming up you will have plenty of opportunities to dip into that medical fund. Just be sure to keep good documentation over the years!

Have you thought about what will happen with them in regards to the ACA?

EDIT: Please don't turn this political for/against universal heath care/ACA/"Obamacare" - just looking to discuss what will happen to the HSA as an investment vehicle after ACA goes into effect.

[suntailedshadow]

This article single handedly made me fall in love with HSA's:

http://www.madfientist.com/ultimate-retirement-account/

Also, with multiple kids coming up you will have plenty of opportunities to dip into that medical fund. Just be sure to keep good documentation over the years!

Have you thought about what will happen with them in regards to the ACA?

EDIT: Please don't turn this political for/against universal heath care/ACA/"Obamacare" - just looking to discuss what will happen to the HSA as an investment vehicle after ACA goes into effect.

I hadn't so I read a couple of articles on it. My first thought is that it is highly likely that all existing HSA's will be untouched so it makes perfect sense to contribute as much as you can while you still can. As for the future? Who knows, but from the articles that I read it appears that HSA's will still have a place in the new ACA controlled world of health care because in most cases they meet the bronze minimum of 60%. Lets hope no major changes are made to the HSA structure, I don't want to give up a good thing ;-)