Help a Reader: What to Do with Savings

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

I am 29 with a husband and a newborn. We have never had extra money and generally live paycheck to paycheck. We have worked hard on living frugally in anticipation for me going from full time to part time work after my son was born.

We exceeded our goals and finally have a $20,000 savings and I am nervous as to what to do with it: start retirement account (husband is a pastor, I am a teacher, both with no retirement benefits), pay down mortgage debt (85,000, 5%) or student loans (20,000, 3%), invest, or put money in 529 college savings for our son? I am really just lost. Any book recommendations or advice is appreciated.

What is your advice for her?

Comments

[Matt]

My first two thoughts are the 529 and retirement. Check out your state and see if a 529 is available. In Michigan they have a well run 529 plan that you can start with as little as $50 and you can put any amount in at any time. Some years I put in alot and some years I did not.Over the 18 years I was able to put away $30k for each kid. It will not pay for it all but it is less debt the kid will have.
Second is the retirement savings. Vanguard is a good mutual fund company to start with in that you can get a target date fund for as little as $1000. If you are 29 and want yo retire in around 35 years that target date fund you are looking for is 2045 to 2050 or around the years you will retire.

You can also check out the websites for additional education information to help.

[so]

Kill the student loans, start a 529 with excess savings.

[My Financial Independence Journey]

I'm not really clear about whether the $20K represents all of your savings or savings on top of an emergency fund.

If it represents all of your savings you should probably keep six months worth of expenses back as an emergency fund. This is particularly important since you stated that you generally live paycheck to paycheck.

I would probably focus on paying off your debts first, starting with the highest interest rate debt and moving down. You should also consider refinancing your home mortgage since 5% is a lot higher than the current rates.

[The question asker]

Yes 20,000 represents our total savings including emergency. As for the mortgage, we are waiting to refinance until we can get rid the PMI in 1.5 years. We might also be moving out of our two bedroom within 4 years if we have more kids.
Vanguard sounds interesting. Do you know how much we would have to put away each year for a decent retirement? I am really clueless since both of our jobs dont have retirement options.

[Jane Savers @ The Money Puzzle]

You need to keep the $20,000 someplace safe but still earning interest as your emergeency fund.

Now that you have that you can start focusing on your debt and other savings. You probably won't like this but you can't start saving for you child's education when you still have your own student debt and have not funded your retirement. Why don't you put any cash gifts that the baby receives in to a post-secondary savings plan? That will be a start.

[Marcus]

My suggestion would be to make sure you have enough for an emergency fund (typically 3-6 months, I like 3). Then start saving for retirement, open an IRA. Good luck and congrats on the success saving.

[Special_Ed]

The internet is a great place to get ideas and learn many things. It is generally a bad idea to base your financial future on internet ramblings. With that amount of money, you would probably be better served by finding a fee based financial planner to get you started on a plan. Be careful not to get tied up with a salesman that will put his future ahead of yours. Find a CPS or certified financial planner that gets generally good recommendations. Then keep reading and educating yourself by reading financial blogs and news outlets. Always keep in mind that NO ONE will look out for you, your family and your money like you will. Education is the key.

[Young Limey]

The interest rates your paying for student loans is not that bad. My first priority if I were you would be for both of you to open Roth IRAs and fund them w $5000 each,for 2012 tax year until April 15th. It's time you won't get back, with how young you are, and the time you have the money to grow tax free. Ticker symbol VOO is a good ETF to put your mOney in over time, the expenses are only .05 percent each year, which is dirt cheap. Good luck. I think contributing fully to the Roth each year should be top priority.

[jmr]

With a newborn and you switching to part time, I would keep the entire $20,000 as a solid emergency fund (meaning a savings account, money market, somewhere liquid...) and start attacking your debt/saving for retirement from there. The key is to continue living frugally so that your inflow exceeds your outflow.

That said, I would advise against a 529 until you have your own affairs taken care of. In this case, I would define that as zero debt outside of your mortgage, PMI eliminated and mortgage refinanced, and retirement contributions established (at minimum). 529s are great tools, but your current and future financial health are far more important.

I would suggest you look into starting IRAs for you and your husband. Do a little research online concerning Roth vs. Traditional IRA benefits, and go from there. I'm a fan of Roth vehicles myself, but you may be able to contribute more early on using a tax-deferred IRA. Vanguard is a solid option (low fees), as are Fidelity (large selection of funds) and T. Rowe Price (low minimums). Saving 10-15% of your income is a good starting place, but the more you contribute, the better off you will be in the long run.

Check out Dave Ramsey's "Total Money Makeover." While some here might disagree with a few nuances (his extreme debt aversion, investing strategies, optimistic return expections, etc), his approach to getting out of debt and planning for the future is rock solid.

Congrats on your newborn and hard work saving up! Best of luck!

[Troy]

I would take the amount necessary to apply to your loan to eliminate pmi now, and refinance the home loan with a new 30 fixed at 3.5% with little to no closing costs. take advantage of the 4 years of lower payments and reduced balance. If you move, you owe less. If you stay, you have a cheap payment. (PS - I wouldn't move until the SL is paid off and you are debt fee excluding mortgage)

Take the monthly refi savings, by my guess $100-$150 (no pmi and reduced rate) and apply to student loans monthly.

Save the rest in a savings or MM account at FDIC bank.

At some point, consider a RothIRA, but not now. I would apply all additional income to the SL to pay it off quick first

Then do Roth IRA.

I don't care for 529 plans, so I wouldn't contribute regardless.

[Mike B.]

Pay down mortgage to get rid of PMI immediately and the rest goes in an emergency fund. It's smart not to refi if you think you may move soon, but don't move until you have the 20% to avoid PMI in the future.

That's the easy part. Now, obviously you must be having some positive cash flow to have accumulated 20K. You need to start saving for retirement and college on a monthly basis. (Note on 529s: if your state doesn't give you any benefits for investing in their 529, you can invest in any state's 529: choose the state with the lowest expense ratio). Their are plenty of calculators for both retirement and college savings online. Just play with them to see how much you might need. If you or your husband have any experience with a spreadsheet program ( like Microsoft Excel), it is really easy to type in some basic formulas and see your future money expanding over time, it is the tool I use most often.

Someone mentioned getting a financial planner: I generally would suggest not to, but if you decide it is right for you, get a fee-based one. Not one who might steer your money into things that help him out more than you.

Finally, you asked about reading. At the risk of sounding like a rear end kisser, you have found your most valuable source of info right here at FMF. Search through the archives, and you'll find lots of good information. Not all will be for you (FMF is a big fan of paying off mortgage, for example, but if your next mortgage is around 4%, I'd guess you'd be better off long term not doing so. Full disclosure: I paid mine off--but it was more an emotional response to debt than a savvy financial move), but still read through it all and soak up the good information.

[Diolated]

Keep $5000 in the bank for an EF, and use the rest to pay down the student loan. Rinse and repeat until the SL is gone. You can then use that freed up cash flow to pay down the mortgage until you get rid of the PMI. At that point, consider retirement, college fund, and other goals in that order. Sounds like you are making great strides -- good luck!

[FMF]

Mike B -

;)

[Old Limey]

The obvious thing to do is to refinance your mortgage with a 30 year 3.5% loan (or even lower) while rates are currently at an all time low.

When that's complete take another look at your financial position and each of you should open an IRA. The beauty of IRAs is that they accumulate wealth that is all tax deferred until you reach 70.5 and have to start moving it out.

I have been a Fidelity Investments customer for a very long time. They have a great reputation and what may be ideal in your case is that they have many service centers spread over the country where you can obtain free advice from experts.

[Luis]

I would strongly suggest for you to create a budget if you have not already done so. You should include in your budget a monthly retirement savings allocation since you nor your husband have a plan through your employer.

The best individual retirement plan is the Roth IRA. Because you were able to save 20k in a relatively short period it tells me that you can probably afford to contribute at or near the maximum of $5000 per person per year ($5500 for 2013). This averages out to about $458 per month.

Because you can withdraw money from a Roth IRA without incurring taxes or penalties, it can double as an emergency fund and therefore I'd recommend taking $10,000 of the 20k and open an account for 2012 Roth IRA contribution. You must do this by April 15th. Just go to a branch near you and ask to open a Roth account. Look for a TD Ameritrade, Fidelity, or something like that (not a bank!).

Once you've done all that come back here and submit a "Reader profile" and then we will have more information available from you to better advise how to tackle your mortgage, student loans, etc.

[Paul]

If you may move, don't pay the closing costs a refi requires. If $20,000 is the entirety of your savings, locking it up in an IRA or 529 would be terrible in the event of an emergency. I wouldn't do a thing with the money, keep it all as your emergency fund, then do as Special_Ed said and get a financial advisory so you can have a plan for developing subsequent savings.

[Ivy]

You seem to be getting a lot of diverse opinions here - which may be making you feel even more confused if you are missing some basic financial knowledge. I would recommend a couple of basic books - see below names and links to Amazon. The Boggleheads (named for John Boggle, the founder of Vanguard) also have a very popular forum on the internet, where it's easy to ask questions, but you need some basics, so start with the books

The Boggleheads Guide to Investing

The Boggleheads Guide to Retirement Planning

Personally I would prioritize emergency fund, then mortgage refinancing, then retirement (Roth IRA), student loans and only then 529s. But then a lot depends on your job stability, saving rate and personal priorities.

[NoTrustFund]

I agree you can probably find a lot if the basic info you are looking for here. My favorite basic book for getting yourself on a basic budget is Elizabeth Warren's All Your Worth.

As far as priorities, I would take saving for college off the table until you and your husband feel your are saving for retirement and debt free besides your mortgage.

In the short term start a 3-6 month emergency fund, refinance and then start paying down your debt. Then keep saving. We have all our money, including Roth IRAs at vanguard. And the books ivy recommended above are great for getting started on investing. I'm sure your local library has copies.

Great job getting 20k saved so quickly.

[Strick]

Lots of good advice here on what to do with the $20K, so instead of adding to it I'd rather put the question into perspective.

Whatever you did to get your spending lower than your income to create the $20K in savings quickly is much more important than whatever you do with the $20K. A budget that keeps your spending lower than your income after you go part time is much more important that what you do with the $20K. Those of us getting closer to retirement think by the 4% rule, so we know to equate $20K in assets (which I used to think of as huge) to $800/year, or just $66/month (which I used to think of as minor), which is what it can produce for me.

Kudos to taking care of the $20K in the most efficient manner, because that will lead to important habits and know is the time to gain the knowledge. But never forget that that $66 you may save by not going out to eat that one dinner per month, or bypassing that one trip to Target because you were bored, is much more important.

[jim]

I'd make sure to have a few months of expenses in savings as #1 priority. It won't get much interest but you need it liquid and safe.

Paying down the mortgage to get to 20% equity and refi now to get rid of PMI might be your best investment for the rest of the money. Hard to know exact detail without knowing what the house is worth, but getting rid of PMI now and getting down to 3.5% on the mortgage will save you money.

Past that I'd certainly get a IRA or ROth IRA. As you have no retirement yet I'd put some in traditional IRA. That will save you on some taxes now. As you have no retirement yet theres going to be some tax free income in your retirement due to standard deduction so I'd start with a traditional IRA to save on taxes now.
I'd shoot for saving 10% of your income minimum for retirement. 15% would be good.

Paying down your student loans would be next priority but its not a high urgency as its only 3%.

529 is lower priority than above. You need to ensure your retirment and pay off your student loans before saving for your kids college. This isn't short changing your kids. They can borrow for school, you can't finance your retirement on loans.

[JimL]

Along the lines of some of the advice, I would do the following:

1. Keep $5K in an emergency account.

2. Pay down mortgage enough to refinance

3. Take savings from mortgage as well as all other free cash flow and focus on paying off student debt asap.

4. Once Student loan is paid off, I would build up emergency savings to at least 6 months living expense.

5. After emergency savings is fully funded (with at least 6 months expenses), I would fully fund your retirement accounts.

6. Once you are track with making the maximum contributions to retirement, I would focus on paying off the mortgage.

7. After mortgage is paid off, focus on college funding.

[retirebyforty]

I would keep that $20,000 in a saving account for now until you made the transition to part time. You might have a lot of expenses after having a kid and you need this cushion.
If you are still doing well after 6 months to a year, I would refinance and try to get rid of PMI.

After that I would split between retirement saving and paying student loan off.

Good luck!

[Holly]

House values are on the rise. If your house value has increased enough since you purchased it, you can pay for an appraisal and might be able to get rid of the PMI simply based on the increase of the house's current market value (that's what happened to us... 3 yrs into the mortgage the value increased enough for our bank to drop the PMI).

The bank might also be willing to decrease the amount you pay for PMI if you have excellent credit and call to inquire (that's also what happened to us...our bank told us we have one of the best credit scores that they had seen for being so young (25 and 26 y/o) which helped to get a reduced PMI rate.

[Wisedollar]

If I were making this decision for myself I would carve out enough for an emergency fund and invest the balance in retirement accounts. The 529 is a good option but that will not do anything to help you when you hit retirement age. That may seem like a long ways from today but take my word for it, it creeps up on you a lot faster than you think.

[Jerry]

I agree that the EF is paramount as it leads to some element of insurance against the financial slings-and-arrows, especially with starting a family. Once that is in place, and the amount will vary according to living expenses, the other elements can be folded in monthly. Good luck!

[Adam]

1. Maintain the emergency fund of 6 months expense.
2. Focus on student load debt (yes it is not the higher interest debt, but it will be paid off faster which will increase cash flow.
3. Re-evaluate after that. See where the mortgage is and whether it is low enough to refinance or think about retirement planning. The 529 should be the last item on the list. Why pay for the kids education when you will need their help during retirement?

[Walden]

Congratulations on changing your financial habits, saving a great chunk of money, and (last but not least) on your new baby!

Since this $20k number includes your emergency fund, I would take the e-fund and keep it in a savings account.

After that I would fully fund ROTH IRA's for you and your husband.

Anything left over I would split between paying down the student loan debt and saving for a re-fi or move.

I would not contribute money to a 529, other than monetary gifts that he receives. I would also not consider moving into a bigger house just because of an additional child unless you can really afford it.

[Rick Francis]

First congratulations on going from paycheck to paycheck to 20,000 in savings, that is a major accomplishment. You should be proud of the hard work that made it possible.
> I am really just lost.
That is understandable you’ve never had such a large sum of money to put to work before so it makes sense that you would be worried about making a mistake with it.
All of your initial thoughts for the money could be good options. It’s hard to give the best advice without knowing the specifics of your situation, but I hope these comments will make your choices easier:
#1> You may want to keep some money liquid for emergencies
How much depends on your situation, for example how secure your jobs are and how much flexibility you have in your budget.
There are some rules of thumb- at least $1000, Expenses for a Number of Months, but ultimately how much do you need to sleep well at night?
As a first pass I would look your savings balance while you were saving up that $20,0000- did you need to dip into it from time to time? If so you may want to keep at least that much liquid.
Your savings account is probably earning ~0% interest- to improve things without taking risk read up on a CD Ladder as a way of getting better interest while keeping the money safe and fairly liquid.
#2 > both with no retirement benefits
That sounds like a financial disaster waiting to happen. That really concerns me. If you do nothing you are setting yourselves up for trouble. Even putting all of the $20K into a retirement account won’t fund your entire retirement. The good news is that since you are young you still have many years to save for retirement, and small changes now can make a big difference in the future.
Stating an IRA would be a good initial step but you will need to plan for future contributions as well.
#3 Payoff mortgage.
5% is not an outrageous rate, you can refinance to a lower rate but even if you didn’t it shouldn’t be terrible. Note as soon as you have 20% equity you should be able to get rid of PMI payments even if you don’t refinance. You could potentially refinance now, since you never know when rates will go up and get rid of the PMI payments later.
I’ve heard that you have to request an end to PMI – or the bank will happily keep taking your money and paying for the no longer required insurance. I would contact the bank and find out what the process is and if you have to pay any expenses like a home appraisal.
#4 Pay off Student loans
3% is a pretty low rate- and each time you make a payment you are paying off some of the principle too. Since the rate is so low I wouldn’t rush to pay it down right now.
#5 > put money in 529 college savings for our son?
I would leave that for last because your son has options- grants, scholarships, working part time and loans. Also he may not decide to go to college. You won’t have grants, scholarships, or loans and you may not be able to work in retirement, so I would cover that first.

-Rick Francis

[Meg]

Ok I know you are getting a lot of advice, and all of it is good but you need to figure out what is best for you in light of your current situation and job outlook. There are lots of good books on the subject (just go browse at a bookstore in the personal finance section). However flexibility is key, especially with a growing family and the fact that the breadwinner is in a generally low paying profession.

1) Maintain excellent insurance - car, home, life and medical.

2) Have an emergency fund with 6 months of expenses in cash.

3) Save for retirement. Yes, this comes before college savings and debt repayment, unless you have very high intrest credit cards to pay off. You and your husband need to open up Roth IRAs at Vanguard and start investing, even if you can only do $100 here and there. To have a good chance of retiring comfortably you should be saving 10-15% of your gross income every year if you are starting around the age of 30.

4) If you have money leftover (and most people never get beyond step 3) then you can pay down your mortgage quicker and/or fund college accounts for your kids. But you and your husband aren't likely to earn a lot with your professions, so your kids will likely qualify for student loans when the time comes. You can't take out a loan for retirement though.

If you think you might move in a few years don't bother refinancing now - it will take around 2 years to break even after closing costs so refinancing may be a waste of money and you will give up some liquidity to get rid of PMI. Instead save that money for the next down payment.

Good luck!