How are we doing? & Put 25% bracket into 457?

[runner9]

My wife and I have 2 questions about our finances we’d like opinions on; neither is related to asset allocation.

My wife has some, albeit limited, interest in our finances/investments/mortgage etc. I watch Suze Orman each week, as much for entertainment as anything else, as I rarely learn anything from it these days. My wife watches “Can I Afford It” and often is in the room during other parts. Increasingly lately she reacts that she doesn’t think we’re doing well enough, saving enough, etc. I offered to get some opinions here and she agreed.

We replaced her car at the end of June, 2012 (all cash) and refinanced to a PenFed 5/5ARM, closed in late August, 2012. With that done we decided to continue fully funding our Roths and put everything else towards the mortgage.

This has allowed us to take the balance down from $83K to $57K. (Some was refund of payments made after the refi application; realistically we’re paying 3-4K a month to it since November)

Having just preliminarily filled out our taxes we have income in the 25% bracket and I’m questioning if we should put everything (after funding Roths) to the mortgage or try to use some tax advantaged space to have less income taxed at 25%.

Some numbers:

2012 Gross 2012 Income: 104K
-$13K in itemized deductions for 2012
-$11.4K in Exemptions
Taxable Income: $80K

33/31 years old
$500 in Flex Spending for healthcare
$5K in Flex Spend for daycare
3 year old son with 8K in 529 (adding $250 a month)

Emergency Fund steady at $37.5K, all excess going to mortgage. E.F. is broken into:
20K Ally 5 Year CD earning 1.88%, matures November, 2017
10K ibonds, issued June, 2012
7.5K in checking and savings
This is probably 10-12 months of expenses including 1500/month mortgage.

76K total in our Roths
57K mortgage at 3%, at current payment amounts will have paid off sometime in the May-October 2014 range.

Two cars, 2008 and 2013, planning to keep many years to 100K+ miles.
Forever home, purchased May, 2007 for $180K with $140K original mortgage (now 57K, see above)

We are both in education, and are enrolled in Ohio STRS, we have 10% withdrawn pretax from paychecks (going up to 14% over a few years) for a defined benefit plan that will pay 60something% of final 5 year average when we retire with 35 years worked and age 60. (currently 66%, can’t find the new exact percentage)

As teachers, we have access to 403b and 457 options. Looking at them I believe the best, by far, is the Ohio Public Employees Deferred Compensation Program http://www.ohio457.org as it has several Fidelity and Vanguard funds, with ERs of many options from 0.04 to around 0.41

My wife is paid over 20 pays, and not in the summer unless she teachers summer while I am paid 26 pays.

Questions:

1. How are we doing? I know we’re doing far better than before we got serious with funding retirement a few years ago (balance at end of 2007: 23K) Could be better I’m sure but could be a lot worse too. I don’t think we can compare ourselves to others, especially Suze guests making 145K a year and renting, etc.

2. Slow down the mortgage prepay to get under 72.5K in taxable? We’re debt adverse and I know the classic mortgage prepay vs. investment debate. As summer pay is different and we’d still like to pay down the mortgage faster I’m thinking we want until summer and reassess as we may be pregnant will have a better idea of total 2013 income, etc. Then: fund a 457 to the max or enough to get taxable income below $72.5, the start of the 25% bracket. As my wife’s Roth is currently a smaller amount and she gets more per paycheck this would probably be in her name. Last year she brought home $22K after taxes from when pay resumed in August until the end of the year. This would give us $4.25K in tax savings to put towards the mortgage as well.

We don’t know what our taxable income will be when we retire or tax rates, etc. That’s why I’m thinking hedge against that by continuing to fund Roth IRAs. (There is no 457a Roth option with Ohio DC as far as I can tell)

All the contributions would be in the last quarter, but I don’t think we’re comfortable funding to the max now and are more focused on the mortgage.

Thanks in advance for advice. If I’ve left out any info that would be helpful please let me know.

[Wizze]

Not 100% sure how Ohio state taxes work here (as the tax rate structure appears to be a flat rate dependent on your income), but it appears you will save approximately 4.7% Ohio taxes on top of the 25% federal tax rate on the dollars you send to the 457 as opposed to the mortgage.

Would you rather make roughly $7500 in extra payments to your mortgage this year, or contribute roughly $10670 (equivalent to the $7500 after your fed/state taxes are removed) to the 457?

If you still like the idea of paying down the mortgage better, I would consider changing your contributions from Roth to a tradational IRA. This would still save you approximately 30% taxes on those contributions.

I am in a very similar position as you financially. I may have a bit more in retirement accounts saved than you (165k), but only my wife will have a teacher pension. All things considered (We are 5 years older than you all, have 1 more child, and do not have as much in EF), I feel you are in a better financial situation than we are as a whole. But like you, I feel that I am not where I would like to be, and am still struggling to find more income to sock away at retirement. Hence my recommendation to save taxes, as this is more income that can be utilized for your future.

[Wizze]

In addition to the above, one other consideration to make (as you are close to the 15%/25% tax brackets like we are):

I choose to contribute to the traditional IRA for the tax savings. However, starting next year, every other year I will be able to itemize my deductions and keep me lower into the 15% bracket. I plan to convert some of the traditional IRA monies to Roth, to fill the 15% bracket for those years.

In effect, I am just postponing the Roth contribution, but minimizing the tax cost to do so.

[Default User BR]

Were it me, especially at your young ages, I would stop any extra to mortgage and concentrate of tax-deferred savings. You're missing the most critical time to be invested that you will ever have.


Brian

[NYBoglehead]

Here's my take: you could knock yourself down to the 15% bracket by contributing to the 403b and 457. But, you will be getting 2 DB pensions in retirement. How much 15% space are you likely to have once you have no mortgage and 2 pensions filling up the lower brackets? Just something to consider, obviously you need to run your own numbers.

In all honestly, I like the idea of being completely debt-free, including the mortgage. Your itemized deductions are not that much higher than the standard deduction, so the tax benefit of deducting mortgage interest is not as great as many might think. 3% is a very low interest rate but much higher than you could safely get in the market right now. And your balance is low enough where the final payment is not that far out of sight. You will still be very young to have a paid off mortgage and your monthly surplus will be even greater than it is today.

If you're not 100% certain of either approach I'd go right down the middle: 50/50 between mortgage payoff and 403b/457.

I think you are doing quite well, and I don't think there is a wrong answer here.

[Default User BR]

In all honestly, I like the idea of being completely debt-free, including the mortgage.

To me, that makes no sense for a 30 year-old to be worrying about that. Getting invested and getting tax-advantaged space filled is a much better goal to me.


Brian

[pingo]

1. If the 403b and/or 457b offer matching that makes it a clear choice for me: get the free money!

2. It would be interesting to see if one can elect to make Roth 403b contributions (or Roth 457b, but I don't know if it exists), if you feel that having more Roth assets would be of greater benefit.

3. Check whether either account option allows after-tax contributions and (and only and) regular in-service withdrawals of after-tax contributions, as this would be a way to increase Roth assets by directing/rolling over that money into your Roth IRAs. Here are three links:

After-Tax 401(k) & Backdoor IRA.

A post where I attempt to explain it.

After-tax 401(k).

Note that for some organizations, a 403b is used instead of 401k, but they are equivalent.

4. You didn't ask for portfolio advice, but I have to say that your 457 has great options! In case you aren't already aware those LifePath Index target funds are excellent, excellent, excellent. (I like them as much as Vanguard Target Retirement Funds.) The individual asset class funds also have great expense ratios (TISM 0.13%, TBM 0.07%, etc.) but you might only save yourself a few basis points over using the LifePath funds when you also consider that most of your portfolio will be in the Roths for the time being. Using a single target fund in each and every account is simple and effective.

[NorCalDad]

In all honestly, I like the idea of being completely debt-free, including the mortgage.

To me, that makes no sense for a 30 year-old to be worrying about that. Getting invested and getting tax-advantaged space filled is a much better goal to me.

I agree with this. I am surprised by how many 30-somethings prepay their mortgage while letting tax-advantaged space go unfilled. Though I would say that since the OP has a dual pension household, there's less pressure to fill tax-advantaged space than for those of us who lack pensions.

[rr2]

In all honestly, I like the idea of being completely debt-free, including the mortgage.

To me, that makes no sense for a 30 year-old to be worrying about that. Getting invested and getting tax-advantaged space filled is a much better goal to me.

I agree with this. I am surprised by how many 30-somethings prepay their mortgage while letting tax-advantaged space go unfilled. Though I would say that since the OP has a dual pension household, there's less pressure to fill tax-advantaged space than for those of us who lack pensions.

I believe that most such state DB plan earnings are not covered by social security. Thus OP will likely not get SS income in retirement from this job.

[NorCalDad]

In all honestly, I like the idea of being completely debt-free, including the mortgage.

To me, that makes no sense for a 30 year-old to be worrying about that. Getting invested and getting tax-advantaged space filled is a much better goal to me.

I agree with this. I am surprised by how many 30-somethings prepay their mortgage while letting tax-advantaged space go unfilled. Though I would say that since the OP has a dual pension household, there's less pressure to fill tax-advantaged space than for those of us who lack pensions.

I believe that most such state DB plan earnings are not covered by social security. Thus OP will likely not get SS income in retirement from this job.

Not trying to get political here, but I'm not really factoring SS income into my retirement plans 30 years down the road. If it's there for me, great. Though I suppose one could take the same fatalistic view about pensions, too.

[rr2]

In all honestly, I like the idea of being completely debt-free, including the mortgage.

To me, that makes no sense for a 30 year-old to be worrying about that. Getting invested and getting tax-advantaged space filled is a much better goal to me.

I agree with this. I am surprised by how many 30-somethings prepay their mortgage while letting tax-advantaged space go unfilled. Though I would say that since the OP has a dual pension household, there's less pressure to fill tax-advantaged space than for those of us who lack pensions.

I believe that most such state DB plan earnings are not covered by social security. Thus OP will likely not get SS income in retirement from this job.

Not trying to get political here, but I'm not really factoring SS income into my retirement plans 30 years down the road. If it's there for me, great. Though I suppose one could take the same fatalistic view about pensions, too.

Not to digress too much but the pension is likely to be a better deal than SS as it replaces 60% of income after 35 years of service. For SS to replace that much of income, the earnings would have to be quite low. I suppose the fact that SS only withholds 6.2% while the OPs DB plan withholds 10% currently and goes up to 14% in a few years might even out the two.

[Novine]

Are you both vested in the pension system? I would factor my pension into my investment decisions but until you're vested, you can't assume that it's going to be there at retirement. Life happens and until you actual vest into the pension program, I would be putting money into the 457 "just in case".

[runner9]

Thank you for all of the responses thus far. There's a lot here for us to think about, talk about and investigate.

Just to clear up one thing: there is no SS involved. We contributed a little bit from part time jobs before teaching, but don't contribute anything to it. We don't have anywhere near enough to be eligible for SS, but wouldn't get it/much anyway with the Windfall Elimination Provision.

[Grt2bOutdoors]

In all honestly, I like the idea of being completely debt-free, including the mortgage.

To me, that makes no sense for a 30 year-old to be worrying about that. Getting invested and getting tax-advantaged space filled is a much better goal to me.


Brian

As much as I like debt repayment, I've got to agree with you. Fill up the tax-deferred buckets now to benefit from the compounding.

[Mudpuppy]

The advantage of most government 457b plans, which does not exist with IRAs, is that if something were to happen that would cause one or both of you to have to retire early (such as an accident or illness), you can access the funds in the 457b plan without penalty before age 59.5 once you have separated from the employer.

[pingo]

The 457 plan is offered instead of SS. <--My mistake!

[Sandman62]

Are you both vested in the pension system? I would factor my pension into my investment decisions but until you're vested, you can't assume that it's going to be there at retirement. Life happens and until you actual vest into the pension program, I would be putting money into the 457 "just in case".

And even then, you can't assume. My wife's RI teacher pension went from 65% at age 52 (3 years away) to 40% at age 59, thanks to our Gen. Treasurer riding in on her white horse and "saving" the state by breaching longstanding contracted benefits - in trade for filling her run for governor coffers with bribes (I mean "campaign contributions") along the way. We will obviously be watching the court battles the next couple years quite closely. I suggest that all public employees counting on a pension watch RI closely too, as it could very well set a national precedent.

[AustenNut]

What happened in Rhode Island is quite scary, and is something I'm trying to plan for. My husband and I are both vested in the pension system in Louisiana, but have about 23 years to go before we'd be eligible to retire. Like Ohio, we don't have Social Security. Unlike Rhode Island, there are some contractual protections included in our state constitution. But right now it's something of a waiting game until some of these pension cases make their way to the Supreme Court to see exactly how much we need to be saving. My husband and I were talking about this very issue a few days ago. In some ways, the earlier we find out what kind of a changed system there will be, the better we can plan our own finances. On the other hand, the longer there's a delay, the more benefits we'll accrue (which under our state constitution can't be taken back), but the less time we'll have to invest in our retirement.

Runner9, I agree with Wizze about the benefits of putting in enough money into your 457 to get you down to 15% as that tax savings will outstrip any mortgage interest savings. Dropping your mortgage repayments by $7500 a year will still get your mortgage paid off in less than 2 years ($3k/month for 2 years is $72k, and your mortgage is currently $57k), which would be give you much more economic freedom.

In comparison with most people (including my husband and I, who are around your ages), you're doing remarkably well. Your house is nearly paid for, you have DB pensions lined up, and an excellent start on a separate set of retirement funds. You're doing a very good job; keep it up.

[Peter Foley]

I too would agree with funding the 457 at least to the point where you are not in the 25% bracket. Having some funds in a deferred account gives you flexibility with respect to income tax brackets in retirement. In addition, you are 25-30 years from retirement and a lot can change with respect to your pension, taxes, your exclusion from participation in social security, etc. With that many variables I would prefer to have some money set aside in a 401k/403b/457 account than have it all tied up in a paid off house. I am myself debt averse and paid off my mortgage early - but only after funding my 457 account.

[NYBoglehead]

What happened in Rhode Island is quite scary, and is something I'm trying to plan for. My husband and I are both vested in the pension system in Louisiana, but have about 23 years to go before we'd be eligible to retire. Like Ohio, we don't have Social Security. Unlike Rhode Island, there are some contractual protections included in our state constitution. But right now it's something of a waiting game until some of these pension cases make their way to the Supreme Court to see exactly how much we need to be saving. My husband and I were talking about this very issue a few days ago. In some ways, the earlier we find out what kind of a changed system there will be, the better we can plan our own finances. On the other hand, the longer there's a delay, the more benefits we'll accrue (which under our state constitution can't be taken back), but the less time we'll have to invest in our retirement.

Runner9, I agree with Wizze about the benefits of putting in enough money into your 457 to get you down to 15% as that tax savings will outstrip any mortgage interest savings. Dropping your mortgage repayments by $7500 a year will still get your mortgage paid off in less than 2 years ($3k/month for 2 years is $72k, and your mortgage is currently $57k), which would be give you much more economic freedom.

In comparison with most people (including my husband and I, who are around your ages), you're doing remarkably well. Your house is nearly paid for, you have DB pensions lined up, and an excellent start on a separate set of retirement funds. You're doing a very good job; keep it up.

I bet the taxpayers in Rhode Island might disagree about the "scary" part. Is a massively underfunded pension plan not scary?

[runner9]

Thank you everyone for your responses. Again, a lot for us to think about and decide on. Some information that I’ve learned in response to some comments and questions:

I’ve called both STRS Ohio and Ohio 457 today.

STRS will change to 35 years and age 60, but will still be 2.2 X years worked which it is now, but that percentage will be times highest 5 years salary average, instead of current 3 years. So, at 35 years it will be 77% of salary. (currently is 66% at 30 years)

Yes, this is subject to future changes, so that would be more incentive to save using a 457. In fact, this change took 3 years in the state General Assembly to pass, but, according to the STRSOhio website:

“The bill also provides the Retirement Board the authority to make future adjustments to the member contribution rate, retirement age and service requirements, and the COLA as the need or opportunity arises, and depending on the funding progress.”

Concerning being vested, actual vesting isn’t an issue for member contributions. If one leaves employment covered under Ohio STRS there are two options:
-Leave it there and get the same formula above at age 60, or 65 with less than 5 years. So, if one quits/changes jobs after 13 years s/he would get 28.6% average of highest 5 year salary.
-Or, withdraw all the member contributions plus 50% plus interest. (member and employer each put in 10%, going to 14% in the next few years)

The Ohio 457 plan does not offer a Roth option. FYI, I found that a Roth457 was ok’d by the IRS starting in 2011.

I liken the STRS DB to be instead of Social Security and 403b/457 to be instead of 401k. I’ve looked at a few of the other 403b/457 options we have, they are almost all annuity products from insurance companies. Still, his and her 457 would total 35K of very low fee, indexed, tax advantaged space a year.

One additional observation: While my limited experience with a regular company was the 401k was encouraged, etc. learning that 403b/457 options even exist is difficult with both our employers, I highly doubt most of our coworkers even know they are an option. (My wife had a ½ page about them in her insurance enrollment packet, I’ve never heard of them at my employer as far as I can remember.)

[AustenNut]

What happened in Rhode Island is quite scary, and is something I'm trying to plan for. My husband and I are both vested in the pension system in Louisiana, but have about 23 years to go before we'd be eligible to retire. Like Ohio, we don't have Social Security. Unlike Rhode Island, there are some contractual protections included in our state constitution. But right now it's something of a waiting game until some of these pension cases make their way to the Supreme Court to see exactly how much we need to be saving. My husband and I were talking about this very issue a few days ago. In some ways, the earlier we find out what kind of a changed system there will be, the better we can plan our own finances. On the other hand, the longer there's a delay, the more benefits we'll accrue (which under our state constitution can't be taken back), but the less time we'll have to invest in our retirement.

I bet the taxpayers in Rhode Island might disagree about the "scary" part. Is a massively underfunded pension plan not scary?

An underfunded pension plan is scary, but it's not the employee's fault if the employer was not putting aside their contributions like they were supposed to. I can't speak to Rhode Island's particular case, but in Louisiana the legislature passed a bill that would make payments lighter on the front end and heavier on the back end during a time when they wanted to spend money on other things. It's the state's fault for not saving moderately all along, rather than paying little to nothing in earlier years and then complaining when it has to start paying out bigger chunks in the later years.

[pingo]

I liken the STRS DB to be instead of Social Security and 403b/457 to be instead of 401k.

This is a good way to look at them for personal planning purposes, and I view my pension and 457 in the same way. All I meant was that an employer and individual contribute to SS via payroll taxes, but some employers can opt to provide a 457. Instead of paying SS taxes, the employer pays less in the form of a match. As such, it would seem strange to me if there is no match to the 457... <--There may be errors in those statements.

[AustenNut]

I liken the STRS DB to be instead of Social Security and 403b/457 to be instead of 401k.

This is a good way to look at them for personal planning purposes, and I view my pension and 457 in the same way. All I meant was that an employer and individual contribute to SS via payroll taxes, but some employers can opt to provide a 457. Instead of paying SS taxes, the employer pays less in the form of a match. As such, it would seem strange to me if there is no match to the 457...

I have yet to hear about any of the school districts in my state offering any kind of match for 403/457 plans (they think their contributions to the DB is sufficient). I would also recommend double-checking any fees that these different companies have. My district has a list of providers (only one of which has actually shown up to any schools or district benefit fairs), and most of them offered annuity products as well. Those that didn't still had big administrative fees. The two best providers either took 0.8% off the top, or 0.9% off the top before any expense ratios were considered. In my husband's district it's even worse. They only have one provider. You either get the annuity that guarantees a minimum of 2% return with no fees, or you have 1.55% taken off the top, plus all ERs. The lowest ERs were about .40 if I recall correctly. Hopefully your district(s) will cover the administrative fees of the plans, but I would definitely double-check this.

[Novine]

I would point out that not every 457 plan participant falls into the no Social Security scenario. I've seen that mentioned a couple of times and that must be state or jurisdiction-specific because the wife and I both have 457 plans and we're both still paying into SS.

[pingo]

It appears that the Bogleheads Wiki also corroborates what the rest of you are saying.

And I was so sure of my myself, too!

Strangely enough, I have full and part-time employment that offer 457s with matching contributions and we do not pay into SS. The first does offer a pension, but no other plan beyond the 457; the second only offers a 457. The first is from a county government and the second a school district. Hmmm.

[325e]

Seems like you're doing great so far. I'd agree to get money into tax advantaged first now. Then only if you have anything left, throw it at the mortgage. You've hit the mortgage hard enough that youre mostly paying principle anyways.

One idea....have you checked out the penfed 5 year HEL instead of the ARM? You just refinanced but i like it better then a traditional mortgage for a loan amount this small. It is 1.99 percent and the cost to acquire is 300 at most. We paid nothing. But best of all, when you pay extra, it pushes out your mandatory due date. For instance, our next payment is not due until April next year. It then becomes an extra emergency fund or gives you the ability to reduce emergency fund.

Hedge that with the penfed 3 year cd or the ally cd and you are barely paying any mortgage interest...more reason to get in the tax advantaged. Payments for the 5 year will be higher, but for 50k you are still looking at less than 1k a month.

[William4u]

You are doing great regardless, and anything you decide will probably be just fine. But IMHO I would max out the ORP plan, which is fantastic (between you and your wife, you can essentially add $35k this year to a tax deferred "401k" style plan). You could transfer money from taxable or your mortgage to fund the ORP. At the low Penfed rates, the investment is pretty good. You will save big on your taxes this year if you drop some of the $35k from your highest tax bracket. It would move you entirely into the lower tax brackets.

[runner9]

Thanks everyone for the advice. After talking it over and doing more research we enrolled last night. Currently planning to put $12K in for 2013, all into one fund while selling off that fund's investor shares in a Roth. Will save 0.02 on the expense ratio at institutional over admiral.

Thanks again for the advice on this great forum!

[pingo]

^ Thank you for the follow-up!

All the best!