Help a Reader: Where to Save

Here's an email I recently received from a reader:

I read one of your older 2008 posts about what order to invest in (meet company matching in your 401k before opening a Roth IRA), and I wondered if you have cash left after that, do you then open another Roth IRA if you’re married?  Or do you go back to increasing your 401k?  In case it depends on some stuff, here’s our quick financial summary...

My husband and I are 26 and live in Houston, TX.  He is a middle school teacher ($43000) and I am an office worker ($35000).  We live on about $40,000 a year (a little less).  As of now, we do not have any plans to have kids…being a middle school teacher or a wife of one makes you a true believer of birth control. :-)

We bought our $130,000 1750 sq. ft. home as a foreclosure for $114,000 2 1/2 years ago and put 20% down on a 15 year loan at 5.375%.  Since I overpay the mortgage, we have $78,000 and 8 years left.

We have one car loan on his 2007 used Prius at a 4.1% rate and have about $12,000 left ($330 a month).  My Chevy Aveo is paid off and is only 4 years old with 37,000 miles.  I will drive it until it won’t drive anymore and then get a used Prius as well (ours really does get 46-52 MPG for my hubby and I hate stopping all the time to fill up in my tiny car…10 gallon tanks stink).

We have no other debt.  We do use credit cards for almost everything (I love my Discover), but we use them for the rewards and to budget.  They get paid off every month.

We have $15,000 in ING Direct in case one of us loses our job (emergency fund)…that should be able to supplement us for a full year if only one of us was unemployed or 4-6 months if we both lose our jobs at the same time.  For retirement, we put 6% to my 401k which is matched at 6% (12% total to a Vanguard Target Fund).  We also contribute to his state pension, I’ve been contributing the maximum $5,000 to my Roth IRA for the last two years (Fidelity Target Fund), and my husband invests about $2,500 a year in the stock market (we really like Johnson & Johnson right now, but our money is spread out over 9-11 stocks).

And my husband is currently getting a masters, which we have been paying for 100%...but he graduates Dec 2010.

So, when we have some extra money starting when my husband graduates ($625 a month), do we get another Roth IRA, increase my 401k, put more in stocks, pay off the car, or put it towards the house?  Or do that in some combination?  Also, are we on track to retire in our mid-fifties as planned?  His pension could start at age 52 since that would be 30 years of working in a school disctrict.

What advice do you have for her?

Comments

[Apex]

My advice is get some more life insurance with those death traps you are driving. :)

Ok, that was a little hyperbole but only a little.

[Help_Us_Decide_Where_To_Save]

Apex, I expected better from you. :)

Given that we are keeping our cars and have adequate life and disability insurance, what would you do?

Also, between the time I emailed this in and now, we will be completely debt free in less than 7 years instead of 8-9...what would you all do with an extra $2000 a month?

[beverly]

i'd pay off the car first and then work on the house. and y'all are doing so awesome at such a young age make sure you have a little fun mixed in there too, YOU really do deserve it.

[Help_Us_Decide_Where_To_Save]

*HUGE GRIN*

Oh, and Apex, according to crash test ratings, only my Aveo is a death trap...the Prius scores pretty well!

LOL...I didn't look at safety stuff when I was 22...oops...

[Help_Us_Decide_Where_To_Save]

Thanks Beverly!

Don't worry, we take at least one big vacation a year and a few weekend mini-vacations in between...we do budget for fun. We actually just took a Western Caribbean cruise that was soooo much fun! I found out that I love snorkeling!

I credit our friends with how little we have to spend for entertainment month-to-month. We get together for board gaming parties and potluck gatherings at least once a month, which are a blast! Our other weekends are usually spent catching up on our favorite shows on DVR since we are TV addicts, reading, or catching a movie or two at the $1.50 theater near our house. :)

Beverly, what would you do once the house and car were paid off? If I work it right, that could be by January 2015...

[Jclimber]

I would do these things:

- max out your 401k's
- increase your emergency fund to 1 year of expenses
- max out your and your husband's Roth IRA's (max $5000/yr right now per person)

Actually if your income can qualify for a tax deduction then a regular IRA should be considered.

[Jim]

I think that putting the money in a 401k, a Roth IRA or paying down the house would all be good. Theres no one right answer here.

They are in a fairly low tax bracket now so thats a good reason to go with the Roth IRA. Right now they would probably be in the 15% tax bracket which is pretty low. If they expect to have relatively high income at retirement then its likely they'll face a higher tax rate later. So pay the taxes now and go with a Roth.

Personally I might pay down the home. I don't think its the best return on your money but it has the added benefit of the security of owning your home outright.

[Allison]

I'm in nearly the same boat (except an East Coast city so cost of living and salary are inflated). We don't own a house yet but are working on the downpayment (would like to do 25-30%). We prioritize like this:

401k to match
Roth IRAs
Downpayment Savings (for you, I'd say debt payments--pay on the mortgage, then the car)
Maxing 401ks

I think sometimes about once we've actually made the house purchase, do we work on maxing the 401ks out or paying down the debt? FMF says he always maxed the 401k, but at the same time I think(?) only he works--once we are maxing out 401ks for two people, we're talking about a really high threshold to have much left over for extra mortgage payments (15,500*2+5,000*2(iras)=41,000--we save, but not that much!)

Anyhow, all to say, in your situation, I would definitely pursue the Roth IRAs. That's tax advantage you won't get to recoup after you've paid off your mortgage and are swimming in extra cash.

[Old Limey]

Hi Crystal!
If you could possibly swing it financially how about buying another foreclosure as a rental.
The stockmarket and unemployment rate doesn't look very promising to me from here on out but you can probably still find a home or condo near where you live and at a very attractive price. A rental home is a real nice tax saver using Schedule E since you can depreciate it, and also write off every single expense associated with it against your rental income leaving you with a nice tax loss to offset some of your income. The condo, a block from the ocean, that I have had for a very long time has saved me a great deal in taxes over the years. Talk it over with the person that does your taxes, they know all the angles.

[Rick Francis]

First it sounds like you are doing a great job handling your finances! You have lots of saving, a good sized emergency fund, and even a pension.

I wouldn’t be surprised if you can retire in your 50es, but you didn’t give quite enough information to calculate.

- I would max out the Roth IRAs after you’ve got your full 401K match- because you can take out the contributions without any penalties at any time. Useful if you retire early or have a dire emergency.
- I would also switch from individual stocks to ETFs. It simplifies your investing and greatly reduces risks, and is likely to increase the returns.
- You should to calculate how much investing you want to do OUTSIDE retirement accounts. If you retire very early you don’t want to deal with penalties, or be stuck without money until you are 59.5 years old.
- I would not rush paying off the mortgage any sooner, since 5.375% is a pretty low rate you should be able to beat that even with a fairly conservative investment.
- When investing outside tax sheltered accounts you need to be aware of tax efficiency- check out http://www.obliviousinvestor.com/introductory-guide-to-asset-location/ for an introduction about asset location.

-Rick Francis

[laura]

We live in Houston and my husband is also a middle school teacher. He works at Hamilton in HISD. If you don't mind sharing, what part of town/neighborhood were you able to find such a great deal at? we've been looking and can't find a foreclosure for the amount you paid in any neighborhood we feel comfortable with except Humble. And seeing as how I work in Sugarland, that is out of the question. I refuse to make that drive!

And I would pay off the cars, then have a huge emergency fund, then max out the other ROTH. Then i would save to pay cash for the next cars. then i would save even more in the 401ks. In that order.

[Crystal]

I knew Old Limey would know it was me! I emailed this in a little more than a month ago and told my husband that by the time it was posted, Old Limey would know it was us...

And yes, my husband really likes the idea of buying a rental property. I'm worried about having two mortgages at the same time, but I'll be much more comfortable with the idea once he gets his masters and a permanent school librarian position next year.

@laura
We found our home around 249 and Louetta. I did a quick search for you on www.har.com and saw some houses I'd check out that are all under $115,000, more than 1750 square feet, and built after 2000. Like MLS#75460039. I didn't know where you would actually be interested in living, but if you'd like some extra help looking, feel free to email me at velvetblue7 (at) yahoo (dot) com. I love tracking down good deals!

To everybody, thank you so much for your suggestions! We should have at least an extra $1000 a month starting next July (probably $2000 since a masters supposedly raises my husband's salary by at least $1000). I'm also making plans to have our house paid off by 2015 instead of 2017 by increasing our payment another $300.

I'm leaning towards opening a 2nd Roth IRA for my husband. My husband wants to start looking at rental properties. I'm an optimist...I think we can do both :)

If the rental property actually makes enough in rent to pay for itself, we'll definitely max out my 401k. If it doesn't, well at least we'll own two houses that should be worth something. :)

[Apex]

Crystal.

Thats funny about the Aveo. And the thing that spurred my comment is that I am travelling to florida this weekend and rented a car and the standard compact they wanted to put me in was an Aveo. So I went and looked it up on the internet. I told my wife there is no way I am driving that death trap. So we paid to upgrade twice to a slightly larger death trap. :)

As far as real advice I would combine a few comments made on here.

I am doing rentals myself and so if you are comfortable with the extra work and debt I believe thats a good long term investment. If you still have enough money after that I would definately make sure to put every penny possible into fully funding a Roth IRA for both you and your husband. As someone mentioned on here given your current incomes and the fact that you are being so responsible about money, your current taxes are probably lower now than they will be in retirement and thus I would not be in any hurry to overly fund the 401k. Definitely still fund it for the company match and you can still fund it more but I would max out the Roth before the 401k given your current tax bracket and likely future situation. In addition I believe the current government fiscal situation means that taxes will likely be higher in the future, thus the Roth over the 401-k.

If you do a rental and decide that is working for you and want to think about a second or third then be careful not to lock up too much money and not to pay down extra on your house. The interest rate that you have on your primary residence is better than anything you are going to get on any rentals and those are likely to go higher throughout time. So decide if you truly want to start a small little real estate portfolio. If you decide you might want to then stop paying extra on the house right now. Save that money for downpayments on a couple rental properties. It will be the cheapest way to finance those properties.

And put something away to get rid of that Aveo. :)

Good luck.

[Old Limey]

Crystal:
Right now it pays to be very careful about the stockmarket. The bond market is pretty stable since the Fed has sent a very clear signal that interest rates will stay low for quite a long time. The stockmarket however is very risky with oil trading around $80/barrel and a P/E ratio of 137 times earnings for the S&P500, a rising unemployment rate and a budget deficit that is out of sight. Many experts are expecting a second leg down thereby forming an extended W shaped bottom. You have done remarkably well for your age, I would hate to see you take a big hit on your IRAs.

The real estate market however is recovering slowly and rentals are a great alternative to stocks. I know of several people that based their retirement on the acquisition of rentals and they did very well. If the two of you are hard workers and pretty handy you can bypass having to use a property management service and save a lot that way. The main thing is to check out future renters very thoroughly and be somewhat picky about who you rent to.

[Crystal]

Apex, you should have gone with a Smart car...so much safer... :-)

Yep, it looks like our order will be something like:

1) Open and fully fund a Roth IRA for my hubby.
2) Look into rental properties in our area.
3) Put more into 401k if there's anything left...

If property just doesn't look that enticing next year, it seems like we have a bunch of other options too. I guess we'll see (I'll see if FMF would post a follow up if anything interesting happens from all this).

PS I like my cheap-a$$ Aveo...but when it breaks down, I'll move on. :P

[Sarah]

I'd pay off the car, just because then it will go away! I find car payments extra-annoying because the car is depreciating while you're paying for it :)

I'd suggest another Roth for retirement investment -- you're fairly unlikely to end up in a lower tax bracket than you're in now, so paying tax while you know your financial situation is good seems like a clever plan -- and continuing to overpay on the mortgage. You'll probably get more gain on money put in the stock market than you're losing in interest on the mortgage, but it's close, and so splitting probably makes sense.

[JG]

Personally, I wouldn't hold out much hope for that pension being there when you need it.

[Crystal]

@Sarah
I completely agree that car payments are extra-annoying. Our used Prius is the only car we've ever owned that actually appreciated temporarily when we first bought it. According to Kelley Blue Book and Edmunds, it was worth around $21,000 when we first bought it and went up to $22,500 a few months later and held for about 6 months. Then Toyota caught up with demand and it returned to being a normal situation of depreciation.

Thanks to all these suggestions, we are thinking that if we do have an extra $2000 a month, we'll open and fully fund a Roth IRA for hubby for about $400 a month. We'll also probably increase the car payment by at least $100 a month. The rest will either be set aside for a downpayment on a rental property or be divided into paying down our mortgage and increasing my 401k contributions.

I've been so excited to see everybody's opinions for the last month, that I seem to have been extra cheap...our expenses were actually down $400 this month and we only have $75,800 left on the house. I am truly looking forward to next July and seeing if all our plans work out.

@JG
I think we have a better shot at getting something from the pension than we do of getting much from social security, but we do also have the Roth IRA and the 401k, so hopefully something will come through for us in 25 years.

[meakman]

FYI - Car crush/saftey tests are done on cars in a similar class. i.e. A large SUV that has an average saftey rating is MUCH SAFER than a small car that has an excellent rating. Another example, the smart car has a good rating if it get's hit by another smart car, not so much if it gets hit by a c500 series.

* Pay off the car and home ASAP.
* Get a HELOC as a saftey fund and use your savings to pay off your car/home quicker since you probably getting less than 2% on it.
* Get the match first as you are, then max Roths, then max 401k's

[Crystal]

@meakman
I was totally kidding that Apex should have driven a Smart Car...I didn't even look up the ratings. I just expected it would be crushed easier than an Aveo.

We should have the car paid off in the next 2 years and the house in the next 7 years. I totally agree about the order of importance after that too...we'll set up a Roth IRA for my husband next year and see what money we have left after that. Thanks!

[Jim]

Meakman, Crash tests do not test small cars against only small cars and big against big. The crash tests are the same regardless of the size of the cars.

The kinds of tests they run:
They run the car at 40MPH offset into a fixed obstacle
They run the car at 3-6MPH into a fixed obstacle
They crash a large moving object into the side of the test car to simulate a side impact

[Jim]

"I was totally kidding that Apex should have driven a Smart Car...I didn't even look up the ratings. I just expected it would be crushed easier than an Aveo."

Actually the Smart car has good crash test ratings. Its 'good' on 3 tests and 'acceptable' on one. That beats the Aveo easily. The Aveo is marginal or poor on 3 of 4 tests. The Smart car was designed with safety in mind.

[Crystal]

@Jim
Bad assumption obviously...I had just finished looking at email with a Smart Car crushed like a tin can in between two large trucks. That was on my mind when I was joking around. I obviously am not someone who takes a look at safety ratings too often since I had no idea my Aveo was rated so poorly.

It has served its purpose given the fact I only bought it because I needed a cheap car to get me from A to B when my husband was unemployed and I was raking in $26,500 a year.

[Michael in ABQ]

Based on your given scenario, I'd do the following (in order):

1. Pay off Prius ASAP (the money you're saving on gas is what you're giving to the bank).

2. Contribute 15% to retirement (matching 401k up to full match, Roth IRAs for each of you).

3. Put some aside for next car(s). A paid-for car drives better.

4. Pay extra on house. Once house is paid off, max out 401k for each.

[Crystal]

@Michael
You would pay off the 4.1% car loan before working on the 5.375% mortgage? I've seen that mentioned by a couple of other people as well...am I missing something?

I do fully agree with your other suggestions. Based on most of these replies, we will open a fully fund a Roth IRA for my husband ASAP.

I didn't mention it, but we already have a Home and Auto account with ING Direct, which has been receiving my car payment ($200 a month) since I paid it off 2 years ago as well as $350 a month for any house repairs/renovations that might pop up. Looks like great minds think alike. :)

Thanks!

[AdamCO]

Not to be an ass, but if a house cost $114k, it is a $114k house, not a $130k house. Anything else is immaterial until a sale. For example, where I live, you could get a 1100 sf house appraised at $275k, but we have a thirty year supply...

[Jim]

Crystal, I think everyone assumes the Smart car is unsafe. It just plain LOOKs unsafe. Its so small that its hard to see how it could hold up well in a collision. I just happened to read about it being better on the safety tests somewhere in a magazine or online news report recently so thats the only reason I knew it was rated better. I think the Smart cars safety ratings are a testement to modern technology. Some safety innovations are obvious like airbags, electronic stability control, etc, but other innovations are in the engineering of the structural design.

Here's an interesting illustration of how much structural design can matter:
Crash a 2009 Malibu into a 1959 BelAir and compare the results: http://www.iihs.org/50th/default.html

We'd assume that the heavy old cast iron 1950's boat would plow through the newer car. But we'd be wrong. The new car driver compartment remains mostly intact while the old Chevy is smashed.

[Jim]

"You would pay off the 4.1% car loan before working on the 5.375% mortgage? I've seen that mentioned by a couple of other people as well...am I missing something?"

one reason might be taxes: Theres no tax incentives from the car loan. The home loan mortgage interest is tax deductible. So you could potentialy be saving 15-20% of that mortgage interest which would make it effectively 4.2 to 4.5%. BUT you have to itemize your taxes for this to help you.

[Crystal]

@AdamCO
I meant that it could sell for at least $130,000 this week. Our neighbor 3 houses down just sold theirs last month for $155,000. Ours has 300 less square feet, but it is in better condition since it wasn't torn up during the foreclosure and was built the same year (all the houses in this subdivision were built in 2004). I think my $130,000 guess is conservative if anything...

[Crystal]

@Jim
According to our tax lady, the standard deduction for our house is better than itemizing it. We only pay about $4000 a year in mortgage interest. We will definitely take taxes into account when we get our next home. Thanks! :)

[Mike]

Hi Crystal,

You and your husband are certainly on a great path. As a fellow middle school teacher in Texas (like your husband), let me share some of my own personal advice, both financial and otherwise:

- Continue overpaying the mortgage.
- Look into work that pays slightly better for yourself.* Could you teach school, as well? How many additional years of school might it require, if any?
- If you switch to a more stable career* (if to a teacher, different ISD than your husband), perhaps then *stop* increasing the emergency fund.
- Even though you're over-paying the mortgage, *do* focus on adding to your IRA balances. Also have your husband look at his 403(b) options! ***Max out your retirement contributions now if possible, as you may find yourself easily hitting the contribution caps later.***

*Note: I am not implying that your job is low-paying or unstable. I just personally find teaching to be a bit better paying and even more stable.

Keep up the great work!

-mike