Deferred Comp, College Savings, or Pay off the House

**dczech09** · 02-02-2011, 06:06 PM

Deferred comp is simply compensation that is put off until the future. Thus, it does not provide too much benefit as the payout will hardly cover inflation and taxes. You have a state pension which can be good, but will likely be a small portion of your overall retirement. Have you considered a Roth IRA? Based on your joint income, you and your wife still qualify for $5,000 per year.

Since you have no debt, except the house, and a nice savings that can more than cover you in case of emergencies, I would say your next focus is retirement. The rule of thumb is to save 15% of your income. Is this gross or net? I say net since that is all you have for buying power in the first place. Is that $120,000 your take home? If so, then 15% is $18,000.

Put $10,000 into a Roth IRA ($5,000 per person)
The other $8,000 could go into deferred comp or another retirement program. Does your wife have a 401k furnished at work? This would be a great option.

After you allocate your 15% of your income to retirement, put some money into college savings. Here is a good link:

Coverdell Education Savings Accounts

Take a look and determine what makes the most sense for you: Coverdell or 529 Plan.

Once you have contributed 15% to retirement and start putting some money into college savings (I recommend roughly $2,000 per child per year tops), you can use any extra money to pay down the mortgage.

Personally, I would consider using some of that savings for paying down your debt. Think of it this way: saving nets you not even 2% in interest. Paying off debt will guarantee you savings of your interest rates X the amount paid off. Use some of that savings to put a dent in your mortgage. However, make sure you keep at least 3 to 6 months worth of expenses in savings for emergencies. Perhaps keep a little extra in savings if you are planning a vacation or some other big purchase anytime soon. Hope this helps!

**dczech09** · 02-02-2011, 06:11 PM

Side note: you always want to save for retirement with some tax benefit. Deferred comp will not do this as well as the other options. You need to focus on the other retirement options many more times that deferred comp. Same things goes with college savings: go for the Coverdell or 529 Plan as they offer tax benefits.

**zetta** · 02-02-2011, 06:11 PM

Does your wife have a 401k plan at work? Is there a match? (I'm not sure what you mean by deffered comp.) Any money she puts toward it reduces your taxable income.

I would suggest saving for college before paying off the mortgage, but others here will disagree with me. Basically, if you can get anything over 5% return on your other investments, you'll end up with more money in the end by funding them first instead of paying off the mortgage.

I would instead aim to have the mortgage paid off by retirement.

You need to set some goals:
1. Lump sum needed to retire. (Rule of thumb is 20 X income, or 2.4 million in your case)
2. Goal for amount you wish to pay toward college
3. Goal for mortgage payoff date

Then use some financial calculators to figure out how much to put toward retirement, college, and extra mortgage payments each year.

I suggest this saving order:
1. Get the 401k match
2. Set up and contribute to ROTH IRAs (up to 10k)
3. If you haven't met your yearly retirement goal, add more to the 401k
4. Money to college savings
5. Money to mortgage payoff

**hard2figure** · 02-02-2011, 07:02 PM

I agree with the zetta's saving order of 401k minimum (to get match), ROTH IRAs, and if addition desire add more to 401k. If your wife gets a match you really are missing out on the extra help it provides. This "free money" concept is strange to some but those that take advantage of it don't understand why others don't take the money too. Additionally, as a government worker you too may have the ability to contribute to a 457 investment account. I don't know your state and even if they too may offer a match similar to the 401k match many companies offer ... but it is worth asking about.

Unlike zetta, I like the no mortgage idea more than college savings. As I understand it, the parents home equity is not included into college loan equations. Your income, your savings, and your child(ren)s savings are. An advantage to ROTH IRAs is that you can also access the money you put into the accounts after 5 years without any taxes or penalties (assuming you didn't buy investments that have a back end fee). This money could also be used for your kids’ college (such you feel obligated to do so). I'm not saying this is the best vehicle to use for investing for college ... I'm just giving you the information. And also know that the rules could change in the next 18 years, when it is time for your kids’ college.

That being said the 5% on your home mortgage is pretty good and you could likely beat it in the market as the market continues to recover. You have a nice savings balance and I hope you and your wife feel comfortable having enough. You two are in a good position to save for your future retirement ... the earlier you start the easier it will be.

**dczech09** · 02-02-2011, 07:35 PM

hard2figure, I just want to point out that the 457 Plan you mentioned is deferred comp.

**hard2figure** · 02-02-2011, 07:49 PM

dczech09, Is there any matching with that?

**dczech09** · 02-02-2011, 08:41 PM

No matching. The IRS does not even consider it a qualified plan. Basically all it does is allows you to forgo compensations until a future date. For instance, you could put $100 in on your next paycheck and then pull out that same $100 a year from now or 30 years from now.

All contributions are pre-tax so it reduces your taxable income now, however it gets reported as taxable income when you pull it out (thus you have to pay taxes when you pull it out).

It works pretty much the same way as a 401k plan except that there is no matching and there are no penalties for early withdrawl. There contribution limits and the money cannot be transferred into an IRA or anything. It is a stand-alone system that kinda sucks in my opinion. Investment options are generally more limited than 401k or 403b.

**hard2figure** · 02-02-2011, 08:59 PM

Interesting to know ... thank you kindly dczech09! I don't have it as an option for me so I never really looked into it much, I just knew that it was an option to government employees. I guess it could be used to reduce income, an option to invest in stocks or funds cheaper (but I'm again assuming no fees like in a 401k), and I'm assuming deferred tax on earnings. So maybe an interesting way to save up for the bigger ticket purchases like a car or boat. But I agree, Strange thing! Could be useful to some but you'd have to work a plan around it instead of it working into a normal plan.

**MrPolarZero** · 02-03-2011, 08:25 PM

I would suggest that you pay off the house first, as it would be the biggest amount that you need to consider. As for the educational plan, you can slowly build up on that one, since your kids are still away from schooling.

Deferred Comp, College Savings, or Pay off the House