Arrived at milestone - what should be my next step?

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
Bearcat
Posts: 33
Joined: Wed Feb 17, 2016 8:57 pm

Arrived at milestone - what should be my next step?

Post by Bearcat »

My spouse and I will be arriving at a significant milestone on Friday and l want to seek out guidance on our next steps. 9 months ago we both came to realization that spouse’s student loans had been lingering for too long and we became acutely focused on eliminating them. During this time we have stopped all savings to eliminate the last of these student loans. In total we have eliminated about $90k since August of last year. As of Friday - its all gone. The only debt remaining is our mortgage.

Now that the debt is gone - I want to figure out the smartest way to proceed. In my view there are 3 priorities - the order and/or volume is where my question arises.

1. Save for retirement in tax advantaged accounts
2. Build a big liquid cash reserve - both for emergency and potential bridge to early retirement
3. Pay off mortgage


The numbers:
His Age = 40
Her Age = 37
Kids = ages 7 and 5
His Annual Income = $125k
Her Annual Income = $170k
Marginal Tax rate in 2016 = 28%
State of residence = MO
Current Balance in retirement accounts (401k’s, IRA, RIRA’s, HSA) = $792k
Mortgage Bal = $300k owed on $420k house. Mortgage rate at 3.875% on 30 year loan.
Cash on Hand = $15k
529’s = $20k and $10k respectively
All investments in low cost indexes

Available retirement options:
His 401k = $12k (HCE limited)
His 401k mega back door = $38k
His backdoor Roth = $5500
HSA = $6750
Her Solo 401k EE = $18k
Her Solo 401k ER = $35k
Her backdoor Roth = $5500
Total available space for tax advantaged accts = $120,750

My natural inclination is to put as much as possible into tax advantaged accounts. My spouse’s inclination is to continue the debt payoff momentum and pay off the house (spouse is a big Dave Ramsey fan in terms of debt payoff) I am also keenly aware that we need to have much more cash on hand (emergency fund). We pulled from the cash reserve to help eliminate the debt. I also despise paying taxes and want to shelter as much as possible.

The past 9 months have been transformative for us. We become much more focused on our discretionary spending, readjusted our overall priorities in life, and become better mentors for our children in terms of what we assign value to in our family. With this renewed approach - I want to make that our priorities are correct at a technical level.

1. Should emergency cash be the #1 priority? Build until it reaches a respectable level aka - 3 to 6 months of living expenses?
2. I know the general rule is to fill tax advantaged accounts before doing any taxable investing. Can I assume this holds true despite us having what I consider a relatively large amount of tax advantaged space?
3. The mortgage - I know this is a frequently discussed topic and I’ve read many pro/not so pro threads on paying off the mortgage versus accumulating cash. Should we split the difference and pay an extra $600/mo for example to cut years off? Refi to 15 year? Anything in our specific scenario that should be considered?


Thanks
User avatar
David Jay
Posts: 14569
Joined: Mon Mar 30, 2015 5:54 am
Location: Michigan

Re: Arrived at milestone - what should be my next step?

Post by David Jay »

Your priorities are really the end result of what each spouse values and how you arrive at a happy medium. It is hard to argue against any of the 3 goals: growing your emergency fund, taking advantage of tax-deferred savings and paying down the mortgage.

But never let it be said that I don't have an opinion:
1. Do not ignore tax-advantaged accounts, even if you are focusing primarily on growing your emergency fund over the next year or two. Tax advantaged space not used in a given year is lost forever. Perhaps split your contributions evenly between tax-advantaged and emergency fund over the next year or two so that both goals are met.
2. I would not focus on paying off the mortgage, but shortening the remaining years by making principle payments. Just getting $20,000 - $30,000 ahead on your amortization schedule will knock perhaps a decade off of your payoff date. I intend to take early retirement within the next 18 months and completing the payoff on the mortgage is a key factor in controlling our expenses between then end of employment and the start of SS benefits.
It's not an engineering problem - Hersh Shefrin | To get the "risk premium", you really do have to take the risk - nisiprius
User avatar
flamesabers
Posts: 1848
Joined: Fri Mar 03, 2017 11:05 am
Location: Rochester, MN

Re: Arrived at milestone - what should be my next step?

Post by flamesabers »

1. How much cash are you aiming to accumulated for your emergency fund? How long would it take to fulfill this goal?

2. Having a large amount of tax-advantaged space isn't a bad thing. Unless you're saving for a short-term goal, I would say make full use of your tax-advantaged space, especially since your spouse and you are in the midlife phase. Also, since you're in a relatively high tax bracket, I suggest prioritizing tax-advantaged investing over taxable investing.

3. Generally I think it's best to pay extra on your mortgage after you max out your retirement contributions, not before. If you prioritize retirement savings over the mortgage, the worst case scenario is you might have to sell the house and live in a more modest home when you retire. On the other hand, if you prioritize your mortgage over retirement savings, you and your spouse might have to keep working when you otherwise would prefer to retire.
User avatar
JDCarpenter
Posts: 1800
Joined: Tue Sep 09, 2014 2:42 pm

Re: Arrived at milestone - what should be my next step?

Post by JDCarpenter »

first, GREAT job!

How solid are your jobs; are they economically connected? When we were in your family/age position, we basically didn't have emergency fund because we could live off either income, DW's job (private practice doc) was rock solid, and mine was independent of the medical field.... If you are in a similar position, you likely wouldn't need a giant E.Fund. (Assuming disability insurance, and after-tax investments that can be liquidated in event both of you are in a nasty car wreck or the like ....)

On your marginal rates, don't forget MO's 6% bite. Even if you itemize, that adds up.

Given the MO income tax, I'd not put 100% to mortgage debt reduction. At least fill up the tax deferred accounts. How long will it take you to pay mortgage off if you "only" filled the non-roth accounts and went 50% of remainder to MTG and 50% to liquid accounts? (Disclosure: we have chosen to take a 2.75% mortgage into retirement, the principal of which is a bit more than our planned yearly retirement spending....)
Our personal blog (no ads) of why we saved/invested: https://www.lisajtravels.com/
Topic Author
Bearcat
Posts: 33
Joined: Wed Feb 17, 2016 8:57 pm

Re: Arrived at milestone - what should be my next step?

Post by Bearcat »

flamesabers wrote:1. How much cash are you aiming to accumulated for your emergency fund? How long would it take to fulfill this goal?

I'd like to have 50k which would take about 3 months

2. Having a large amount of tax-advantaged space isn't a bad thing. Unless you're saving for a short-term goal, I would say make full use of your tax-advantaged space, especially since your spouse and you are in the midlife phase. Also, since you're in a relatively high tax bracket, I suggest prioritizing tax-advantaged investing over taxable investing.

3. Generally I think it's best to pay extra on your mortgage after you max out your retirement contributions, not before. If you prioritize retirement savings over the mortgage, the worst case scenario is you might have to sell the house and live in a more modest home when you retire. On the other hand, if you prioritize your mortgage over retirement savings, you and your spouse might have to keep working when you otherwise would prefer to retire.

Great perspective
an_asker
Posts: 4903
Joined: Thu Jun 27, 2013 2:15 pm

Re: Arrived at milestone - what should be my next step?

Post by an_asker »

David Jay wrote:Your priorities are really the end result of what each spouse values and how you arrive at a happy medium. It is hard to argue against any of the 3 goals: growing your emergency fund, taking advantage of tax-deferred savings and paying down the mortgage.

But never let it be said that I don't have an opinion:[...]
I'm so with you on this one :-)

From my standpoint - my understanding is that retirement accounts are kinda untouchable with respect of getting sued, etc. Don't know if all tax advantaged accounts fall in this category or only the 401(k)s and the Roths or ... regardless, I would try to load up the retirement balances as much as possible (one other thing working in its favor is the psychology associated with it - you'd be less inclined to touch it if you tell yourself that it is 'retirement' money).

That said, I would also suggest that you either pay extra toward your mortgage or convert to a 15-year term (or both!).

At your (dual) income (and savings) level, I doubt that it is as big a deal to have an emergency fund as Dave Ramsey says. Worst case scenario, you could always liquidate up to your contributions in your Roth IRAs. Besides, I am sure you are not Dave Ramseyians enough that you don't have a credit card or two that could ward you through an emergency or two until you get your next paycheck(s).

TLDR: My suggestion (in order of priority) - convert to a 15-year mortgage, max up tax advantaged space, pay extra to mortgage, work on emergency fund! [this assumes you have a month or two at least, if not more, of expenses that you have contributed into your Roths]
User avatar
David Jay
Posts: 14569
Joined: Mon Mar 30, 2015 5:54 am
Location: Michigan

Re: Arrived at milestone - what should be my next step?

Post by David Jay »

With regards to a 15 year mortgage, you should only do that if it makes sense based on lower interest rate that more than covers your closing costs. There is nothing magical about a 15 year mortgage (if you pay the same monthly amount on a 30 year mortgage it becomes a 15 year mortgage if the interest rate is the same) so I would not refi unless there is a significant interest rate reduction.

I am pleased with my "30 year" because I make principle payments as funds are available, but retain the lower monthly minimum for budgeting purposes. The loan was originated in 2009 and will be paid off in 2019.
It's not an engineering problem - Hersh Shefrin | To get the "risk premium", you really do have to take the risk - nisiprius
Topic Author
Bearcat
Posts: 33
Joined: Wed Feb 17, 2016 8:57 pm

Re: Arrived at milestone - what should be my next step?

Post by Bearcat »

JDCarpenter wrote:first, GREAT job!

Thank you. I've always thought we were doing a pretty decent job but its a great feeling to have an educated outsider confirm

How solid are your jobs; are they economically connected? When we were in your family/age position, we basically didn't have emergency fund because we could live off either income, DW's job (private practice doc) was rock solid, and mine was independent of the medical field.... If you are in a similar position, you likely wouldn't need a giant E.Fund. (Assuming disability insurance, and after-tax investments that can be liquidated in event both of you are in a nasty car wreck or the like ....)

We are in a very similar position. Spouse is in medical field and has pretty good stability at current hospital and could jump elsewhere if needed. I am in technology at a megacorp and reductions can happen at any time. Thanks for the reminder that we can now easily live off 1 salary so that does factor into EF decision. We lived so inefficiently for so long that these new viewpoints don't come naturally. :)

On your marginal rates, don't forget MO's 6% bite. Even if you itemize, that adds up.

Given the MO income tax, I'd not put 100% to mortgage debt reduction. At least fill up the tax deferred accounts. How long will it take you to pay mortgage off if you "only" filled the non-roth accounts and went 50% of remainder to MTG and 50% to liquid accounts? (Disclosure: we have chosen to take a 2.75% mortgage into retirement, the principal of which is a bit more than our planned yearly retirement spending....)

Using your formula and some quick math - I estimate the house could be paid off in 6 years. Good idea of a different way to approach this.
bigred77
Posts: 2049
Joined: Sat Jun 11, 2011 4:53 pm

Re: Arrived at milestone - what should be my next step?

Post by bigred77 »

If I were in your shoes, where it appears you have about 10k in free cash flow per month, I would do the following:

- If you feel better with 50k sitting into savings and it would only take you 3 months to get there, then do it.

- I would then prioritize all of your tax advantaged space first, before I prepaid anything on a mortgage that fixed at 3.875%. If you would itemize your taxes even with a paid off mortgage your effective after tax borrowing cost is 2.79%. If you max out all of your tax advantaged you will still have in excess of 1k a month just in tax savings. If you want to use that extra 1k a month to prepay the mortgage then great. If you want to just add to your cash pile that's fine too.

The ability to throw 120k a year into tax advantaged accounts when your only 40/37 is HUGE opportunity that I suggest you take advantage of. You will be able to retire QUITE early (if you want to) and will be able to do Roth conversions for over a decade to optimize your tax bill. Any future increases in income can go to paying down the mortgage, adding to cash, investing in a taxable account, or even increasing your spending.

Congrats
Leemiller
Posts: 1357
Joined: Sat Jun 01, 2013 12:42 pm

Re: Arrived at milestone - what should be my next step?

Post by Leemiller »

If I was answering your phone questions for myself I'd consider my income needs/wants in retirement and whether either spouse wanted to go part-time in the future or explore other career options. I'd also likely beef up my 529s prior to any mega back door contributions.
User avatar
Nate79
Posts: 9354
Joined: Thu Aug 11, 2016 6:24 pm
Location: Delaware

Re: Arrived at milestone - what should be my next step?

Post by Nate79 »

Even if spouse is a big Dave Ramsey fan (me too for certain aspects) my understanding of his steps are:
1) Small emergency fund
2) Pay off all debt except mortgage
3) 6 months emergency fund
4) Retirement funds, college funds, and then start paying off mortgage.

As far as I know he doesn't recommend you pay off the mortgage before putting a certain percentage (15%?) towards retirement unless you can knock the mortgage out in just a couple of years.

So I would not let the whole Dave Ramsey must pay off all debt get misunderstood to mean to wait to put money towards retirement.

Personally I would put as much as possible towards retirement funds while perhaps paying a little extra on the mortgage.
Topic Author
Bearcat
Posts: 33
Joined: Wed Feb 17, 2016 8:57 pm

Re: Arrived at milestone - what should be my next step?

Post by Bearcat »

Nate79 wrote:Even if spouse is a big Dave Ramsey fan (me too for certain aspects) my understanding of his steps are:
1) Small emergency fund
2) Pay off all debt except mortgage
3) 6 months emergency fund
4) Retirement funds, college funds, and then start paying off mortgage.

As far as I know he doesn't recommend you pay off the mortgage before putting a certain percentage (15%?) towards retirement unless you can knock the mortgage out in just a couple of years.

So I would not let the whole Dave Ramsey must pay off all debt get misunderstood to mean to wait to put money towards retirement.

Personally I would put as much as possible towards retirement funds while perhaps paying a little extra on the mortgage.

This is a very good point and I'm kicking myself that I didn't think of it already. I've listened to enough Dave shows over the years that you would think I would remember the steps. I don't dislike Dave - I just think things could be done better than what he recommends from an investment perspective. Our baby step 4 will be just a bit beefier than Dave's 15% savings.

miamivice
Posts: 2973
Joined: Tue Jun 11, 2013 11:46 am

Re: Arrived at milestone - what should be my next step?

Post by miamivice »

My comments are:

Financially, you will do better to hang on to the house debt as long as possible, as a 3.87% rate on a loan (partially tax deductible) is less than the 8% historical average of the stock market. So, I think that taking a long time to pay off your house while putting the savings into retirement / taxable accounts is planning for the best possible future.

However,

Paying off the house debt first is living for today. As soon as you pay it off, you free up a lot of cash flow that you can use for other purposes.

So, I'd consider whether you want to plan for the best possible future or live a little today.
an_asker
Posts: 4903
Joined: Thu Jun 27, 2013 2:15 pm

Re: Arrived at milestone - what should be my next step?

Post by an_asker »

David Jay wrote:With regards to a 15 year mortgage, you should only do that if it makes sense based on lower interest rate that more than covers your closing costs. There is nothing magical about a 15 year mortgage (if you pay the same monthly amount on a 30 year mortgage it becomes a 15 year mortgage if the interest rate is the same) so I would not refi unless there is a significant interest rate reduction.

I am pleased with my "30 year" because I make principle payments as funds are available, but retain the lower monthly minimum for budgeting purposes. The loan was originated in 2009 and will be paid off in 2019.
Agreed!!
retire57
Posts: 735
Joined: Fri Oct 28, 2016 3:03 pm

Re: Arrived at milestone - what should be my next step?

Post by retire57 »

Nate79 wrote:Even if spouse is a big Dave Ramsey fan (me too for certain aspects) my understanding of his steps are:
1) Small emergency fund
2) Pay off all debt except mortgage
3) 6 months emergency fund
4) Retirement funds, college funds, and then start paying off mortgage.

As far as I know he doesn't recommend you pay off the mortgage before putting a certain percentage (15%?) towards retirement unless you can knock the mortgage out in just a couple of years.

So I would not let the whole Dave Ramsey must pay off all debt get misunderstood to mean to wait to put money towards retirement.

Personally I would put as much as possible towards retirement funds while perhaps paying a little extra on the mortgage.

+1. Though I wouldn't follow Ramsey's investment recommendations. Stay with the Bogleheads for that. Btw, Congratulations!
Post Reply