Mortgage or Taxable Account?

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AJC408
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Mortgage or Taxable Account?

Post by AJC408 » Sun Jun 05, 2016 10:27 pm

Hi Bogleheads,

I am 27 years old and next month I pay my FINAL student loan payment (Woo-hoo!) and wanted to gain some insight on the extra money we will have and where to funnel it. Currently, we each individually contribute the max to our 401k’s and I have maxed out a Rollover IRA. We also have about $50k in emergency savings and I’d like to build this up to around $100k gradually over time. So here is my question:

Should I pay extra monthly payments towards my mortgage to pay it off quicker or would it be better to contribute to a taxable account?

If you think I should contribute to a taxable account, do you have any recommendations on asset allocation or specific funds at Schwab?

Here’s some background:

Salary & Commission: $150ish
Wife - Salary & Commission: $210ish
Mortgage Balance: $555,299.58
Mortgage Interest Rate: 4.250%
Emergency Fund: $50K
Credit Cards: Fully paid each month
Tax Filing Status: Jointly
State of Residence: CA
Age: 27
Desired Asset Allocation: 75% stocks, 25% (open for discussion though)
Car Loan Balance: $13,640.16
Car Loan Interest Rate: 0%

Thanks in advance!!
Last edited by AJC408 on Tue Jun 07, 2016 4:20 pm, edited 1 time in total.

DSInvestor
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Re: Mortgage or Taxable Account?

Post by DSInvestor » Sun Jun 05, 2016 10:49 pm

I would suggest:
a) pay off the car
b) invest in taxable
c) make some extra mortgage principal payments every month
d) Max out both IRA contributions. Note that your coverage by employer plan and high income will not allow Traditional IRA tax deduction. Make sure your tax returns include form 8606 to track your and your spouse's non-deductible Traditional IRA contributions. Assuming no other Traditional IRA, Rollover IRA, SEP-IRA and SIMPLE-IRA assets, you should look into converting Traditional IRA assets to Roth IRA. Traditional IRA basis (non-deductible contributions) can be converted tax free to Roth IRA.

If starting to invest in taxable, I'd look into holding only a Total Stock Market Index fund first and relying on other space available in 401ks and IRAs to hold US, INTL and bonds to fill your asset allocation. If the 401ks have good options for these three asset class, you can keep the entire portfolio in balance by taking action only in the 401ks. This would be simple and tax efficient.
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Texas Radio
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Re: Mortgage or Taxable Account?

Post by Texas Radio » Sun Jun 05, 2016 11:42 pm

I would split the difference. With extra funds I would put 60% in taxable account with a strong equity allocation due to your age and 40% toward mortgage. Maybe 50/50...
A portfolio is like a bar of soap. The more you handle it the smaller it gets.

theDON2050
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Re: Mortgage or Taxable Account?

Post by theDON2050 » Sun Jun 05, 2016 11:51 pm

DSInvestor wrote:I would suggest:
a) pay off the car
b) invest in taxable
c) make some extra mortgage principal payments every month
d) Max out both IRA contributions. Note that your coverage by employer plan and high i
Why pay off the car loan first when they are borrowing at 0% interest? I understand that some of us have an aversion to debt but it seems like OP could allocate resources better imo. Just asking...

DSInvestor
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Re: Mortgage or Taxable Account?

Post by DSInvestor » Mon Jun 06, 2016 10:06 am

theDON2050 wrote: Why pay off the car loan first when they are borrowing at 0% interest? I understand that some of us have an aversion to debt but it seems like OP could allocate resources better imo. Just asking...
OP has annual salary/commission of 360K. I don't see much reason to have car debt even at 0%. I'm for simplification and fewer bills, so why not just pay it off?
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theDON2050
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Re: Mortgage or Taxable Account?

Post by theDON2050 » Mon Jun 06, 2016 10:35 am

[/quote]OP has annual salary/commission of 360K. I don't see much reason to have car debt even at 0%. I'm for simplification and fewer bills, so why not just pay it off?[/quote]

That's fair :moneybag :sharebeer

BW1985
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Re: Mortgage or Taxable Account?

Post by BW1985 » Mon Jun 06, 2016 10:41 am

Are you both in Pharmaceutical Sales? Just a guess.
"Squirrels figured out how to save eons ago. They buried acorns. Some, they dug up, for food. Others, they let to sprout, in new oak trees. We could learn from squirrels." -john94549

poker27
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Re: Mortgage or Taxable Account?

Post by poker27 » Mon Jun 06, 2016 10:47 am

Whenever you are unsure, I would split it between both goals.

AJC408
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Re: Mortgage or Taxable Account?

Post by AJC408 » Mon Jun 06, 2016 4:29 pm

DSInvestor wrote:I would suggest:
a) pay off the car
b) invest in taxable
c) make some extra mortgage principal payments every month
d) Max out both IRA contributions. Note that your coverage by employer plan and high income will not allow Traditional IRA tax deduction. Make sure your tax returns include form 8606 to track your and your spouse's non-deductible Traditional IRA contributions. Assuming no other Traditional IRA, Rollover IRA, SEP-IRA and SIMPLE-IRA assets, you should look into converting Traditional IRA assets to Roth IRA. Traditional IRA basis (non-deductible contributions) can be converted tax free to Roth IRA.

If starting to invest in taxable, I'd look into holding only a Total Stock Market Index fund first and relying on other space available in 401ks and IRAs to hold US, INTL and bonds to fill your asset allocation. If the 401ks have good options for these three asset class, you can keep the entire portfolio in balance by taking action only in the 401ks. This would be simple and tax efficient.
Thank you for your response, DSInveestor! I was under the impression that for a Roth IRA there were income limits that didn't allow my wife or I to have a Roth IRA?
BW1985 wrote:Are you both in Pharmaceutical Sales? Just a guess.
Hi BW1985, very close, I'm actually in medical device sales. My wife on the other hand is in fashion and sells clothes.

DSInvestor
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Re: Mortgage or Taxable Account?

Post by DSInvestor » Mon Jun 06, 2016 8:15 pm

AJC408 wrote:Thank you for your response, DSInveestor! I was under the impression that for a Roth IRA there were income limits that didn't allow my wife or I to have a Roth IRA?
There are income limits that determine whether one can contribute to a Roth IRA. Assets in Traditional accounts can be converted to Roth IRA without any income limits.

Traditional IRA contributions are allowed no matter how high one's income but if one is covered by an employer plan, then there are income limits that determine whether one can take the deduction. At your level of income and coverage by employer plan, you would be allowed to contribute to TIRA but not take the deduction. In this case, you can consider using the backdoor into Roth IRA which combines two steps 1) contribution to Traditional IRA and 2) conversion to Roth IRA. These two steps combined work around the income limits that disallow direct Roth IRA contribution.

If you cannot deduct the IRA contribution, you may as well convert to Roth IRA immediately after the TIRA contribution. Say you contribute $5000 non-deductible to TIRA and keep it in TIRA. It grows to 50K in the TIRA but your basis is still 5K. When you withdraw the entire TIRA 50K, 5K basis is non-taxable and 45K is taxable. If you instead converted that 5K from TIRA to Roth IRA immediately after the contribution (tax free to consume the 5K basis) and it grows to 50K in the Roth IRA, the entire 50K can be withdrawn tax free (assuming you meet the requirements for tax free withdrawal).

Check your tax returns to make sure they include form 8606 to track your non-deductible TIRA contributions (IRA basis).
Wiki

Rebecca_S
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Re: Mortgage or Taxable Account?

Post by Rebecca_S » Mon Jun 06, 2016 8:38 pm

I would consider paying down the mortgage to the point where you can refinance as a conforming loan. You should be able to refinance at a rate much better than 4.25%.

AJC408
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Re: Mortgage or Taxable Account?

Post by AJC408 » Mon Jun 06, 2016 10:55 pm

DSInvestor wrote:
AJC408 wrote:Thank you for your response, DSInveestor! I was under the impression that for a Roth IRA there were income limits that didn't allow my wife or I to have a Roth IRA?
There are income limits that determine whether one can contribute to a Roth IRA. Assets in Traditional accounts can be converted to Roth IRA without any income limits.

Traditional IRA contributions are allowed no matter how high one's income but if one is covered by an employer plan, then there are income limits that determine whether one can take the deduction. At your level of income and coverage by employer plan, you would be allowed to contribute to TIRA but not take the deduction. In this case, you can consider using the backdoor into Roth IRA which combines two steps 1) contribution to Traditional IRA and 2) conversion to Roth IRA. These two steps combined work around the income limits that disallow direct Roth IRA contribution.

If you cannot deduct the IRA contribution, you may as well convert to Roth IRA immediately after the TIRA contribution. Say you contribute $5000 non-deductible to TIRA and keep it in TIRA. It grows to 50K in the TIRA but your basis is still 5K. When you withdraw the entire TIRA 50K, 5K basis is non-taxable and 45K is taxable. If you instead converted that 5K from TIRA to Roth IRA immediately after the contribution (tax free to consume the 5K basis) and it grows to 50K in the Roth IRA, the entire 50K can be withdrawn tax free (assuming you meet the requirements for tax free withdrawal).

Check your tax returns to make sure they include form 8606 to track your non-deductible TIRA contributions (IRA basis).
Glad I asked the question.. Ill be converting to ROTH. Thanks again for your help! :D

DSInvestor
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Re: Mortgage or Taxable Account?

Post by DSInvestor » Tue Jun 07, 2016 1:00 pm

AJC408 wrote: Glad I asked the question.. Ill be converting to ROTH. Thanks again for your help! :D
If you and your spouse have been contributing to Traditional IRA for several years and those contributions were non-deductible, your tax returns should have form 8606 (one for each of you) to track the basis and the basis builds up over time as you make more non-deductible contributions.

Let's say you contributed $5500 for tax year 2014, $5500 for 2015, $5500 for 2016. Your 2014 8606 would show $5500 which would carry forward to 2015's 8606. Your 2015 8606 line 1 would show $5500 for the new IRA basis and line 2 would show $5500 carried forward from prior years giving you 11K IRA basis which carries forward to your 2016 8606. In this example, your total IRA basis in 2016 would be $17500. If your TIRA is 19K, you'd convert all 19K to Roth resulting in non-taxable amount of 17.5K, taxable amount of 1.5K and leave no basis behind to be carried forward. You'd start 2017 tax year with a clean slate and ZERO IRA basis.

Watch out if you change jobs as if you roll your old 401k into a rollover IRA, that would complicate the IRA basis calculations on roth conversions as partial conversions would trigger proration of the IRA basis.
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blues008
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Re: Mortgage or Taxable Account?

Post by blues008 » Tue Jun 07, 2016 1:25 pm

Rebecca_S wrote:I would consider paying down the mortgage to the point where you can refinance as a conforming loan. You should be able to refinance at a rate much better than 4.25%.
Today's rates you should be able to get a jumbo loan under 3.75%.

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Meg77
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Re: Mortgage or Taxable Account?

Post by Meg77 » Tue Jun 07, 2016 1:34 pm

My husband and I are in a similar situation and started paying extra on the mortgage each month. After about 6 months I realized we were paying even more a month than a 15 year payment would be, so we are biting the bullet and refinancing to a 15 year loan at 2.75% (current rates are closer to 3%). Since our cash flow allows us to comfortably afford the 15 year payment - even assuming our expenses could rise if we have kids - I figured there was no point paying more in interest than we need to.

If you DON'T want to refinance to a 15 year payment - if you think your incomes may drop, or if wife wants the option to stay home with a kid for example - that's fine. In that case I'd split the difference between taxable investments and the mortgage once you have 6 figures in cash.

Although one thing that made me more comfortable plowing $$ to the mortgage is knowing that if we really wanted or needed to at some point, we could borrow cheaply on a home equity line of credit for some other need or want (starting a business, investing in a rental, etc). I didn't want too much more than $70K sitting around in cash for some future, years off "possible" financial need, so I concluded that paying down the mortgage is a decent place to park that money given that we can theoretically access the equity down the road.
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AJC408
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Re: Mortgage or Taxable Account?

Post by AJC408 » Tue Jun 07, 2016 3:41 pm

DSInvestor wrote:
AJC408 wrote: Glad I asked the question.. Ill be converting to ROTH. Thanks again for your help! :D
If you and your spouse have been contributing to Traditional IRA for several years and those contributions were non-deductible, your tax returns should have form 8606 (one for each of you) to track the basis and the basis builds up over time as you make more non-deductible contributions.

Let's say you contributed $5500 for tax year 2014, $5500 for 2015, $5500 for 2016. Your 2014 8606 would show $5500 which would carry forward to 2015's 8606. Your 2015 8606 line 1 would show $5500 for the new IRA basis and line 2 would show $5500 carried forward from prior years giving you 11K IRA basis which carries forward to your 2016 8606. In this example, your total IRA basis in 2016 would be $17500. If your TIRA is 19K, you'd convert all 19K to Roth resulting in non-taxable amount of 17.5K, taxable amount of 1.5K and leave no basis behind to be carried forward. You'd start 2017 tax year with a clean slate and ZERO IRA basis.

Watch out if you change jobs as if you roll your old 401k into a rollover IRA, that would complicate the IRA basis calculations on roth conversions as partial conversions would trigger proration of the IRA basis.
DSInvestor, sorry I wasn't clear in the beginning. This is a rollover 401k from a previous employer that is now a TIRA.. same rules apply?

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avenger
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Re: Mortgage or Taxable Account?

Post by avenger » Tue Jun 07, 2016 3:44 pm

AJC408 wrote:
Hi BW1985, very close, I'm actually in medical device sales. My wife on the other hand is in fashion and sells clothes.
Wow! The medical device salesperson (you), makes more than the surgeon implanting them (me)! Good for you.

At one point I was unsure what to do with regard to paying off debt or invest in a taxable account. I split the difference.
cheers ... -Mark | "Our life is frittered away with detail. Simplify. Simplify." -Henry David Thoreau | [3 fund portfolio: VTI, VXUS, SV fund (yield 3.01%)]

DSInvestor
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Re: Mortgage or Taxable Account?

Post by DSInvestor » Tue Jun 07, 2016 3:57 pm

AJC408 wrote: DSInvestor, sorry I wasn't clear in the beginning. This is a rollover 401k from a previous employer that is now a TIRA.. same rules apply?
Rollover from 401k to TIRA is not a contribution to TIRA. Did you make any contributions to TIRA? If no contributions and you didn't make after-tax non-Roth 401k contributions into the old 401k, your rollover assets are entirely pre-tax which means ZERO IRA basis (i.e. no money that you've already paid taxes on). These assets are eligible for conversion to Roth IRA but because your IRA basis is zero, every dollar converted will be taxable and subject to very high fed and state income tax.

If you wanted to use the backdoor into Roth IRA (i.e. contribute to TIRA and convert to Roth IRA), I would find a way to get the rollover IRA assets back into a 401k at your new employer. The backdoor into Roth IRA does not work well when there are substantial pre-tax assets in the mix as the IRA basis will need to be prorated on partial conversion. Hopefully your new 401k plan has good low cost investment options. Once you get those assets out of the IRA container, you will have isolated your IRA basis which will allow you to convert that basis tax free to Roth IRA.

If you did not contribute to TIRA, you should consider editing your original post to fix the part where you said " I have maxed out a Traditional Schwab IRA".
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Re: Mortgage or Taxable Account?

Post by grabiner » Tue Jun 07, 2016 11:49 pm

AJC408 wrote:Salary & Commission: $150ish
Wife - Salary & Commission: $210ish
State of Residence: CA
That implies a 33% federal and 9.3% CA tax bracket, for an overall income tax rate of 39.2%.
Mortgage Balance: $555,299.58
Mortgage Interest Rate: 4.250%
Presumably, this is a 30-year loan. If you do decide to contribute extra money, you should refinance to a 15-year loan, so that you pay less interest while making larger contributions.

And if you do refinance, should you make the extra payments? If you refinance to a 15-year loan at 3%, the after-tax rate on the loan would be 1.83%. At 2.75%, the rate is 1.68%. Admiral shares of Vanguard CA Long-Term Tax-Exempt yield 1.72%. This makes it a close decision, depending primarily on how fast you can pay off the 15-year with extra payments. If you can only shorten it to 10 years anyway, you should probably refinance to 15 and just pay the minimum then.
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