Bad 401K or Taxable or Mortgage or Car Loan?

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Topic Author
CantPassAgain
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Joined: Fri Mar 15, 2013 8:49 pm

Bad 401K or Taxable or Mortgage or Car Loan?

Post by CantPassAgain » Sat Jan 24, 2015 12:46 pm

Hello all

I’m having a difficult time deciding to add funds to:

1) A very poor 401K
2) Invest in taxable
3) Pay down mortgage
4) Pay down car loan

Here’s my situation:

Emergency fund with 6-8 months of “continuing lifestyle” i.e. a little more than bare minimum expenses.
Married
Both aged 39
Both employed
One child
15% tax bracket
15 year mortgage at 4.38%, 10 ½ years to go.
Car loan $12.5K at 3.9%. Paying $300 monthly.
No other debt.

My employer’s 401K is “ok” with a very minimal match.
Spouse’s 401K is bad with no match. I won’t list all of the funds and expense ratios because they are all bad and I know it. Instead I’ll just say that the “least bad” choices are:

1) Mutual of America Equity Index Fund ER 1.39%
2) Mutual of America Mid-Cap Equity Index Fund ER 1.39%
3) Mutual of America Mid-Term Bond Fund ER 1.71%
4) Mutual of America Bond Fund ER 1.71%

We are currently maxing out my 401K at $18,000 a year and maxing out two Roth IRA’s at vanguard $5,500 each. That leaves us with $3,000 - $5,000 additional funds each year that we can save. I know that bad 401K’s have the potential of becoming great rollover IRAs, but spouse has been in the job for 15 years and is not likely to ever voluntarily leave.

We do not expect to have a higher tax bracket in retirement but since our plan is to retire around 55 or so it won’t be significantly lower for the first several years (due to bridging the SS/Medicare gap).

I never gave much thought about how to fund early retirement because there are a couple ways to get around the 59 ½ age requirement (withdrawals of Roth contributions, 401K withdrawals at 55 if separated from service if your plan allows it).

I know we are only talking about $3K to $5K extra a year but I’d really like to maximize the situation as best I can. I hate locking that money away in a bad 401K but if that’s the best use of the funds that’s what we’ll do.

I know there are no perfect answers but I’m interested in other Boglehead opinions and would be very grateful to hear your thoughts.

investor1
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Re: Bad 401K or Taxable or Mortgage or Car Loan?

Post by investor1 » Sat Jan 24, 2015 12:50 pm

Is the money intended for retirement? Is part of your retirement plan to sell the house?

Also, you might want to look into refinancing. A 10 or 15 mortgage is going for just over 3% according to bankrate.com.

investor1
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Re: Bad 401K or Taxable or Mortgage or Car Loan?

Post by investor1 » Sat Jan 24, 2015 12:57 pm

And another option is a Mega Backdoor Roth and possibly HSAs.

Userdc
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Re: Bad 401K or Taxable or Mortgage or Car Loan?

Post by Userdc » Sat Jan 24, 2015 1:00 pm

I think paying off the car loan probably makes the most sense, but a couple questions:

Do you have a Roth 401k option? Do you itemize or take standard deduction?

rayson
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Re: Bad 401K or Taxable or Mortgage or Car Loan?

Post by rayson » Sat Jan 24, 2015 1:13 pm

1. If you are receiving employer match in 401k, you should continue to max out 401k as you are currently doing.
2. Consider contributing to HSA or Dependent Care account (5000 max per year)
3. Pay off car loan
4. 529 for child if your can take state tax deduction
5. Mega backdoor Roth if 401k plans allow it
6. Taxable

Topic Author
CantPassAgain
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Re: Bad 401K or Taxable or Mortgage or Car Loan?

Post by CantPassAgain » Sat Jan 24, 2015 1:17 pm

investor1 wrote:Is the money intended for retirement? Is part of your retirement plan to sell the house?

Also, you might want to look into refinancing. A 10 or 15 mortgage is going for just over 3% according to bankrate.com.
Right now, since our emergency fund is fully funded I want to sock away extra money for retirement. Child's college is already partially funded. I do not intend saving more for this as child can fund the difference without too much of a burden IMO.

The plan with the house is to stay in it until it is paid off at age 50. After that, who knows. Depends on the value and our personal financial situation at the time. The balance on the mortgage is sub $100K so refinancing will probably be tough to make work regarding availability/closing costs/hassle vs potential upside.
investor1 wrote:And another option is a Mega Backdoor Roth and possibly HSAs.
Haven't thought of those. Thanks, I'll read up on it.
Userdc wrote:I think paying off the car loan probably makes the most sense, but a couple questions:

Do you have a Roth 401k option? Do you itemize or take standard deduction?
I have the roth option for my 401K. Currently I am contributing pre-tax as it keeps us in the 15% bracket. Not sure about the spouses.

We take the standard deduction.

Twins Fan
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Re: Bad 401K or Taxable or Mortgage or Car Loan?

Post by Twins Fan » Sat Jan 24, 2015 1:26 pm

I would get the auto loan knocked out. A guaranteed 3.9% and freeing up $300/month sounds like a pretty good option to me.

Then evaluate again.

investor1
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Re: Bad 401K or Taxable or Mortgage or Car Loan?

Post by investor1 » Sat Jan 24, 2015 2:12 pm

I'd probably go with the car loan too. The mortgage is at a higher rate, but it is also tax deductable. If you pay off the car, you can either start saving for the next car to avoid future debt or put the $300/month toward the house.

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Whit
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Re: Bad 401K or Taxable or Mortgage or Car Loan?

Post by Whit » Sat Jan 24, 2015 2:13 pm

Does your wife work for an employer that would listen to an employee who is asking for better 401k investment options?
I find it shocking that an index fund with a 1.39% ER and a bond fund with a 1.71% ER are "least bad"

If that is not an option I also would pay down debt.

Topic Author
CantPassAgain
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Re: Bad 401K or Taxable or Mortgage or Car Loan?

Post by CantPassAgain » Sat Jan 24, 2015 2:35 pm

Twins Fan wrote:I would get the auto loan knocked out. A guaranteed 3.9% and freeing up $300/month sounds like a pretty good option to me.

Then evaluate again.
investor1 wrote:I'd probably go with the car loan too. The mortgage is at a higher rate, but it is also tax deductable. If you pay off the car, you can either start saving for the next car to avoid future debt or put the $300/month toward the house.
We don't have enough deductions to itemize anyway but I still like the idea of paying down the car loan vs the mortgage (minimal interest difference, benefits of having liquidity sooner). Get it paid off within two years at a guaranteed 3.9%. Then take the $300 and sock it away for a future car. Decide later what to do with the rest.
Whit wrote:Does your wife work for an employer that would listen to an employee who is asking for better 401k investment options?
I find it shocking that an index fund with a 1.39% ER and a bond fund with a 1.71% ER are "least bad"

If that is not an option I also would pay down debt.
If it were me, then maybe. Spouse is less confident than myself and I don't really want to put her in a position of rocking the boat at a job that she likes. That 401K really is shameful though. The employer used to contribute to the plan regardless of employee contributions, so it was a good deal for a while. They quit doing that in late 2008 and never started back :annoyed

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BL
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Re: Bad 401K or Taxable or Mortgage or Car Loan?

Post by BL » Sat Jan 24, 2015 3:18 pm

Too bad about her 401k. I would also pay off car and also check into refi the mortgage.
Look at PenFed: under 3% for 15-yr and various other alternatives. You can join! I am sure other places have good deals as well and may have better customer service.

PenFed:
For home purchase or refinancing
Loan amounts up to $417,000.
1% origination fee
Free 60-day rate lock**

Please click on any of the rates in the table to the right to see the payment spread.
Rate Points APR
2.750% 0.000 2.978%
2.625% 0.500 2.925%
2.500% 2.125 3.039%

Topic Author
CantPassAgain
Posts: 577
Joined: Fri Mar 15, 2013 8:49 pm

Re: Bad 401K or Taxable or Mortgage or Car Loan?

Post by CantPassAgain » Sat Jan 24, 2015 3:37 pm

BL wrote:Too bad about her 401k. I would also pay off car and also check into refi the mortgage.
Look at PenFed: under 3% for 15-yr and various other alternatives. You can join! I am sure other places have good deals as well and may have better customer service.

PenFed:
For home purchase or refinancing
Loan amounts up to $417,000.
1% origination fee
Free 60-day rate lock**

Please click on any of the rates in the table to the right to see the payment spread.
Rate Points APR
2.750% 0.000 2.978%
2.625% 0.500 2.925%
2.500% 2.125 3.039%

Thanks. Do you really think a refi would be worth it though? As I said earlier, my mortgage balance is <$100K. $98,570.14 to be exact. Refi's come with closing costs, including but not limited to (according to penfeds website):

Processing Fee (Often charged by other lenders. Not charged by PenFed)
Underwriting Fee (Often charged by other lenders. Not charged by PenFed)
Application Fee (Often charged by other lenders)
Document Preparation Fee
Appraisal
Flood Certification
Tax Service
Credit Report
Settlement Fee
1% Origination Fee on all Fixed Rate Mortgages.
Title Fee
Government Recording Fee
Insurance Premium
Survey or Pest Inspections

I did a refi almost 5 years ago from a 5.5% 30 year to 4.375% 15 year and I only broke even about a year ago due to the closing costs. That was a substantially higher mortgage balance as well.

I'm definitely glad I did it but refinancing again at $99K and incurring a couple thousand in closing costs and extending the loan out 4 more years....I dunno. I might take a look at 10-year deals though.

Thanks for the suggestion, I definitely need to run the numbers again and think about it more.

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BL
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Re: Bad 401K or Taxable or Mortgage or Car Loan?

Post by BL » Sat Jan 24, 2015 3:54 pm

These are just suggestions for research/decision making ( I had a family member who did the 15-yr recently.):

Here is another PenFed 5/5 ARM, since you have about 10 years left on current mtg.
5/5 Adjustable Rate Mortgage
Adjusts only once every 5 years

Months Rate Points APR Payment*
First 60 2.750% 0 3.170% $1,632.96
Next 300 3.375% 3.170% $1,748.48
*Payments shown do not include taxes or insurance, actual payments may be greater. Rates and offers are in effect as of January 22, 2015, offered for a limited time and subject to change without notice. Example based on $400,000 loan. Other restrictions apply. Rate is variable and can increase by no more than 2 percentage points every 5 years with a lifetime maximum adjustment of 5% (7.750% for this example). Since the index in the future is unknown, the First Adjustment Payments displayed are based on the current index plus margin (fully indexed rate) as of the date above.
Get Started
For home purchases or refinancing up to $417,000
Offers not available on investment properties
NO ORIGINATION FEE!
See below for loan to value and combined loan to value limits for conforming, jumbo, super jumbo mortgages, and condos
Free 90-day rate lock**
New Feature! Rate Reset Protection¹: We've added ease and convenience to your mortgage loan experience with Rate Reset Protection. In just "one click," eligible borrowers now have the option to reset a rate up to five times during the life of their loan. The Rate Reset Protection feature must be selected during the original mortgage application process.
See additional details below

Minty
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Location: NorCal

Re: Bad 401K or Taxable or Mortgage or Car Loan?

Post by Minty » Sat Jan 24, 2015 4:03 pm

I would look for a no closing cost loan. You will pay a higher rate, of course, but even so you might be able to do better than where you are now. Also, if rates drop still further in the future (it seems unlikely, but I would have said the same thing about current mortgage rates), you will be free to refi again; its harder if you've paid closing costs.
Core Four with nominal bonds and TIPS.

Userdc
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Re: Bad 401K or Taxable or Mortgage or Car Loan?

Post by Userdc » Sat Jan 24, 2015 4:22 pm

I'm definitely glad I did it but refinancing again at $99K and incurring a couple thousand in closing costs and extending the loan out 4 more years....I dunno. I might take a look at 10-year deals though.
You aren't really extending the loan, you are giving yourself the option to extend the loan. If you continue to make the same monthly payments you make now on a new 15 year loan with a lower rate, you will pay off the mortgage SOONER.

10 year fixed rate loans aren't that common, but I would look in to 10/1s, 7/1s and 5/5s as well.

To your original question, I would also try to use every penny of the 15% bracket (if you aren't already) by switching some of your pre-tax 401k contributions to Roth.

Topic Author
CantPassAgain
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Re: Bad 401K or Taxable or Mortgage or Car Loan?

Post by CantPassAgain » Sat Jan 24, 2015 4:27 pm

Minty wrote:I would look for a no closing cost loan.
I keep hearing about these but have yet to come across a true, honest to goodness "no closing cost loan." I remember looking high and low for something like this the last time I refinanced but never found it. The best options I found were to roll the closing costs into the loan and I took the one with the lowest.

Penfed looks like they have a good 10 year fixed option at 2.75%. I just threw together some amortization schedules and if I rolled $2.5K closing costs (estimate) into a new balance I could break even in 20 months and pay off the mortgage 7 months early by paying the same amount I am paying now. Sounds OK. If I weren't so lazy I probably would have done this a year ago or so.

Thanks for the suggestions everyone. I love this forum :happy

Topic Author
CantPassAgain
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Re: Bad 401K or Taxable or Mortgage or Car Loan?

Post by CantPassAgain » Sat Jan 24, 2015 4:37 pm

Userdc wrote:
I'm definitely glad I did it but refinancing again at $99K and incurring a couple thousand in closing costs and extending the loan out 4 more years....I dunno. I might take a look at 10-year deals though.
You aren't really extending the loan, you are giving yourself the option to extend the loan. If you continue to make the same monthly payments you make now on a new 15 year loan with a lower rate, you will pay off the mortgage SOONER.

10 year fixed rate loans aren't that common, but I would look in to 10/1s, 7/1s and 5/5s as well.

To your original question, I would also try to use every penny of the 15% bracket (if you aren't already) by switching some of your pre-tax 401k contributions to Roth.
Right, that was a dumb comment on my part.

As far as using Roth 401K, that might be a good idea. My initial thoughts by using traditional all the way was that I did not think we would extend all the way to the top of the 15% bracket in retirement, therefore avoiding some 15% tax now would probably work out better in the long run. Considering our lifestyle and expectations right now it seems pretty hard to imagine withdrawing all the way up to the top of the 15% bracket in retirement. Right now that is $73,800 after standard deduction and exemptions of about $20K. $93K would be a lot for us to spend in a year, to say the least :happy

bdpb
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Re: Bad 401K or Taxable or Mortgage or Car Loan?

Post by bdpb » Sat Jan 24, 2015 11:40 pm

CantPassAgain wrote: 15% tax bracket
15 year mortgage at 4.38%, 10 ½ years to go.
Car loan $12.5K at 3.9%. Paying $300 monthly.

We are currently maxing out my 401K at $18,000 a year and maxing out two Roth IRA’s at vanguard $5,500 each. That leaves us with $3,000 - $5,000 additional funds each year that we can save. I know that bad 401K’s have the potential of becoming great rollover IRAs, but spouse has been in the job for 15 years and is not likely to ever voluntarily leave.

I know we are only talking about $3K to $5K extra a year but I’d really like to maximize the situation as best I can. I hate locking that money away in a bad 401K but if that’s the best use of the funds that’s what we’ll do.
Paying off debt is effectively the same as investing in bonds. Right now, bonds are yielding maybe 2%. The rate on your debts is much higher. Use this extra savings to pay down your debt.

Pay off the car loan first. It is a slightly lower rate, but has a significantly lower term than the mortgage which based on yield curves makes it more expensive than the mortgage. When the car loan is paid off, use the car payment plus this 3k-5k towards mortgage. It also enhances your liquidity level because the car payment would be gone in a couple of years. Your mortgage payment would still be there for another 7 or 8 years if you paid it instead.

If your incomes push you into the 25% bracket, invest in wife's 401k to get you back down to the 15% bracket. The 1.39% ER in her 401k is not great, but it's good enough for a tax break at the 25% rate (especially since she's only 15 years away from rolling it to an IRA).

What's your state and it's tax rate? This may affect the decision on your wife's 401k (and possibly your Roth decision).

You look to have a very good saving rate. Do you plan to pay for some of your kid's college education? Do you get a state tax break on 529 contributions?

If you don't itemize, can you pay two year's real estate taxes in one year and none the next? Would this put your total itemized deductions above the standard in the double payment year? If so, you can earn additional tax break on your RE taxes and mortgage interest.

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grabiner
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Re: Bad 401K or Taxable or Mortgage or Car Loan?

Post by grabiner » Sun Jan 25, 2015 11:35 am

CantPassAgain wrote:Both aged 39
15% tax bracket
Spouse’s 401K is bad with no match. I won’t list all of the funds and expense ratios because they are all bad and I know it. Instead I’ll just say that the “least bad” choices are:

1) Mutual of America Equity Index Fund ER 1.39%
2) Mutual of America Mid-Cap Equity Index Fund ER 1.39%
3) Mutual of America Mid-Term Bond Fund ER 1.71%
4) Mutual of America Bond Fund ER 1.71%

I know that bad 401K’s have the potential of becoming great rollover IRAs, but spouse has been in the job for 15 years and is not likely to ever voluntarily leave.

We do not expect to have a higher tax bracket in retirement but since our plan is to retire around 55 or so it won’t be significantly lower for the first several years (due to bridging the SS/Medicare gap).
So this 401(k) will last 16 years at 1.34% extra expenses (compared to Total Stock Market Index in a taxable account). My rule of thumb is that a taxable account may be better than a bad 401(k) if the product of the extra expenses and years exceeds 30%. You aren't quite there; however, you are in the 15% bracket, and won't pay any taxes on dividends and capital gains as long as you stay in that bracket. Thus, I would prefer investing in Total Stock Market in taxable to investing in the spouse's 401(k).

However, paying off the car loan and mortgage are still better investments. Paying off the car loan is a risk-free 3.9% return. Paying down the mortgage is a risk-free 4.38% return (I assume you don't itemize deductions), or a risk-free 3% return if you refinance to a mortgage at 3%. You can't match that in a risk-free investment elsewhere.

I normally recommend maxing out tax-deferred space before paying down a reasonable-rate mortgage, but the tax-deferred space isn't worth much for your spouse, so paying down the mortgage is a better deal.
Wiki David Grabiner

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Ketawa
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Re: Bad 401K or Taxable or Mortgage or Car Loan?

Post by Ketawa » Sun Jan 25, 2015 12:21 pm

CantPassAgain wrote:
Minty wrote:I would look for a no closing cost loan.
I keep hearing about these but have yet to come across a true, honest to goodness "no closing cost loan." I remember looking high and low for something like this the last time I refinanced but never found it. The best options I found were to roll the closing costs into the loan and I took the one with the lowest.

Penfed looks like they have a good 10 year fixed option at 2.75%. I just threw together some amortization schedules and if I rolled $2.5K closing costs (estimate) into a new balance I could break even in 20 months and pay off the mortgage 7 months early by paying the same amount I am paying now. Sounds OK. If I weren't so lazy I probably would have done this a year ago or so.

Thanks for the suggestions everyone. I love this forum :happy
I am refinancing with Third Federal and they have low cost refinance mortgages. $295 in some states, $595 in some states. It happens to be $0 for me since I'm in the military. You might check to see if they operate in your state.

AmeriSave is another example. They give a table of rates and lender fees/points, and you can click further to view total closing costs. You can calibrate the loan to fit your needs. However, they may not have the best rates. Several other online mortgage providers do something similar.

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