What to do? General advice

[BuckyBadger]

My first post, but I've been pouring over the forums for a few weeks now...

My question is sort of a long general advice-seeking thing.

My husband and I are in a very fortunate position. We both went to graduate school and came out with well paying jobs and no debt so although we are 30, we are really just starting to learn how to save and invest. However, we make quite a bit of money so we are a little overwhelmed.

The specifics:

Assets: Together we make approximately 215k gross, plus a 12k annual gift from a rich relative. We both max out our company 401k's, and both of those 401k's have a small match. We currently have approximately 66k, combined, in our 401k accounts. We have 30k, combined, in Roth IRAs but can no longer contribute due to income limits. (The Roths are in indexed funds with a target retirement date of 2040.) Our combined take home pay is about 130k yearly, or about 10k every two weeks.

Debt: We owe just under 200k on our house (worth 260k) that we recently refinanced at 4.5% for 15 years. We owe 22k on a HELOC at 4% (house renovations and paying off used car loans). No student debt. No car loans. No other debt, although we do partially support a relative with about $300/month.

Contributing factors: With our after tax money we pay $400 every two weeks on the HELOC. Due to the location of my job we pay another $600/month on travel and expenses to get me to and from my work, we put 1k every two weeks into a savings account that has about 10k in it. We used to use the lump sum to fund our Roth IRAs, but now we can't, so I don't know what to do with that -- actually, we'll be getting the 10k back that we weren't supposed to put in for 2010. I suppose these are our only "liquid" savings.

The additional sticky wicket: We will be receiving a 75k lump sum in a few months.

We have (admittedly) expensive hobbies (think essentially burning money, but it makes us happy) that cost about 20k a year, but in all other aspects we are reasonable spenders. Our mortgage payment is $1500, although we don't escrow and have to pay about 5k in taxes every January. Our cars are used but reliable.

What on earth should we be doing with our money? I was devastated about the Roth thing. I didn't know there was an income limit so we actually had to take out $10k in contributions. Also, since 2010 was the first full year we were both in well paying full time jobs, we owe another 5k in taxes. We have adjusted our withholdings to account for this next year.

We want to retire well and early and since we are young we know that now is the time to let compounding interest work in our favor.

So what should we do with the 75k? What should we be doing with the 1k/two weeks? Are we doing enough? My husband is worried because he feels like we are way behind because we didn't get out of Grad school until we were 28/29, but I tell him that we're okay because we make more money now than we would have if we hadn't gotten our post graduate degrees...

My dad recommends that we see a fee-based planner when we get the lump sum in June.

I know this was a TON of information, but if I learned one thing from reading these boards it's that it's better to have too much info than too little!

So please tell me what you all think we should do to make the most of our money

[AshleyB]

Congrats! You guys are doing great... what a fun problem to solve!

You didn't mention a savings account... or I missed it... so make sure you have 6 months of expenses in savings built up. I personally would get the HELOC paid off and then start working on the primary mortgage. Then you could really start investing. Maybe some real estate?

I second your dad's opinion on a fee only financial planner.

I'm curious to see what everyone else says...

[BuckyBadger]

We have about 10k in savings. Which is definitely not enough. We did get a *touch* ahead of ourselves when we both got employed, so we didn't start saving (outside of fixed retirement contributions) when we should have. It was just so bizzare going from about 36k/year between the both of us (grad school stipends) to having all this money... We never spent more than we had, but we definitely didn't start saving right away.

[dczech09]

Conventional wisdom tells us to have 3 to 6 months in savings just for emergencies. That $10,000 is probably not enough, especially with a $1500 mortgage payment. So figure out what it would cost to support your lives in the event you were both unemployed for 6 months. Put this into liquid savings and leave it alone.

Since you are maxing you 401k's, you two are in a great position to kick retirement into the stratosphere! Seriously, that alone will make you millionaires at retirement; whatever you do, keep that up. With that, you are already contributing about 15% of your gross for retirement.

Do not go to a financial advisor/planner. There is essentially nothing that they can do that you could not do yourselves. Investing is really just common sense fueld by some basic learning. You will get the same information by reading articles, books, etc. If you want to see a planner to affirm what you two are doing, then go for it, however IMO that is a waste of money.

Do you have kids? Do you plan on having kids? Answering the question will determine whether or not you need to look into college planning in the future.

For now, I would look into paying off that HELOC. $22,000 should be fairly easy to pay off on your income. Get rid of the HELOC while paying the standard payment on your mortgage. I used to sell HELOCs; they cause more problems than they are worth. I would use that $75,000 sum of money to wipe out the HELOC if it is still around when the money comes in. If the HELOC is gone by that time, pay down the mortgage.

Once the HELOC is paid off, use the freed-up cash flow to quickly pay off the mortgage. If you focus on it, you should be able to pay that off within a few short years.

Some will argue that you should invest the money in mutual funds because the nominal return will exceed your cost of debt. I do not recommend this; pay off the mortgage and free up your cash flow.

Imagine what things would be like without the mortgage payment. Thats $1500 per month to do whatever you want with!

As for additional investment opportunities, look into a low cost variable annuity. Shop online for them; do not go through an agent as the commissions are generally VERY high.

On a final note, be careful with what you are spending your money on. Make sure your "expensive habits" do not inhibit your saving and investing. Oh, and tell your husband not to worry; you two are in a very envious position financially.

[MonkeyMama]

Agreed with dczech09. (Well, except for the annuity part).

Priorities = cash savings/emergency fund, then HELOC

I believe you should probably pay off the mortgage, because you are overwhelmed by your income. The other reason is because you can do it rapidly. If you feel confident in investing, keep the mortgage. But, this is my advice seeing you overwhelmed and not sure where to start.

Some other tax shelters to consider:

**401k maxing is the best thing you can do - keep doing that

**HSAs - If you have a HDHP health plan, you can put away about $7k per year into HSAs, tax-deductible. You can save this for retirement (sometimes called a medical IRA). It just depends if you have the right kind of health plan - is a good tax shelter for higher incomes. (If you have better health benefits - keep those - they are worth more. Just to be clear).

**Non-Deductible IRAs - You can still put $5k per year, each, into regular IRAs. You wouldn't get a current tax deduction because of your income. The way it works is that they grow tax-deferred and you then pay taxes on the earnings when you withdraw the money in retirement.

It's not a great tax shelter - but the benefit is that you can buy and sell investments within the IRA without worrying about tax consequences. You also bet on lower taxes in retirement. At your age, the earnings will be substantial, and ideally taxed at a lower rate in retirement.

Also, consider charitable contributions to reduce your taxes, but only if that is something important to you. For the higher income, you get charity and retirement tax breaks, but that's about it.

Other than that, start investing in low cost mutual funds. I like the book "The Only Investment Guide You Will Ever Need," by Andrew Tobias. Maybe pay off the mortgage while you educate yourself about investing and start with smaller amounts. Ideally, you would have more investing confidence after that point - and will have a considerable amount more to invest.

[Little House]

I'd sure like to have your problem. There are definitely some things to invest in:

1. Pay off the HELOC...then....
2. Invest in mutual funds or ETF's - a great addition to your 401(k)
3. Set up a traditional IRA since you are no longer qualify for the ROTH
4. Perhaps invest in rental property? If you are up for the task, or hire a management company to help manage it.
5. I'd even start paying off the mortgage if you have quite a bit of money left over. It would be the last debt you have and then you'd be truly debt free.
6. Find a charity you love and donate some moola.

Of course, you can pick and choose your options for make the best of whatever works for you. You are in a fortuitous situation. Be thrilled!

[BuckyBadger]

Clarifications and more questions, of course!

We do not know if we will be having kids. I'm assuming that any sort of college education fund would lose its advantages if it didn't end up being used for that purpose?

We do contribute to a few of our favorite local charities (prefer to donate on the local level to these organizations).

Sadly no HSA -- just a use-it-or-lose-it flex spending account.

I have a question about the HELOC. What is the incentive to pay it off early, as it is at a low rate and the interest is tax deductible. I understand the impetus from a overall debt-reduction viewpoint, but are there any reasons that having it worse than having just the mortgage alone?

Does the advice to pay extra to the mortgage change if we are only planning on being there for a few more years?

Thanks for explaining traditional IRAs for me! I couldn't seem to grasp it! Just to make sure I understand: Roth IRA is paid for with after tax money and you pay no tax when you use it, traditional IRA is paid for with after tax money and you pay tax on the earnings, but not until you take them out, and regular investments mean you pay taxes on the earnings as you earn them year by year?

We will definitely start maxing out a traditional IRA. I've also heard of rolling it over into a Roth. I'm assuming that you pay tax on the earnings up to that point, but that you don't have to pay more when you take money out at retirement? So if that is an option, we should do it, right?

We will start working on the EF ASAP, but I was wondering if the spending potential of an "empty" HELOC counts for anything when considering the size of an EF.

[MonkeyMama]

Does the advice to pay extra to the mortgage change if we are only planning on being there for a few more years?

We will start working on the EF ASAP, but I was wondering if the spending potential of an "empty" HELOC counts for anything when considering the size of an EF.

As far as the mortgage - no. My advice wouldn't change. Either invest if you feel comfortable with that, or pay down the mortgage if you don't. Heck, I'd almost advise paying it down because who knows where interest rates will be in a few more years. (Traditional advice is to not pay down if you plan to move in the near future, but not sure that makes sense in your situation and considering interest rate trends).

Don't rely on a HELOC as an EF. The HELOC shouldn't count for anything but a potential backup plan if things go bad. Unfortunately, when things go bad, HELOCS are often closed off by banks. So it shouldn't be a primary backup plan. Keep it as secondary.

I believe you should pay down the HELOC just as far as building equity in your home. You only have about 15% equity? From an interest rate standpoint, the HELOC is fine.

I don't think you can do wrong by keeping the mortgage or the HELOC. It was just some advice since you seemed overwhelmed. That said, with housing kind of crazy, I would want more equity. So that I could lessen the chance of getting stuck with an upside down home.

I suppose it also just depends how steady and secure your jobs are.

[MonkeyMama]

Thanks for explaining traditional IRAs for me! I couldn't seem to grasp it! Just to make sure I understand: Roth IRA is paid for with after tax money and you pay no tax when you use it, traditional IRA is paid for with after tax money and you pay tax on the earnings, but not until you take them out, and regular investments mean you pay taxes on the earnings as you earn them year by year?

We will definitely start maxing out a traditional IRA. I've also heard of rolling it over into a Roth. I'm assuming that you pay tax on the earnings up to that point, but that you don't have to pay more when you take money out at retirement? So if that is an option, we should do it, right?

Yes, I think you understand.

In reality, a traditional IRA is funded with pre-tax money, and all the money + earnings is taxed when you use it.

The distinction is that if you are not eligible for the tax deduction (due to higher income), you can still fund a traditional IRA. It is called a non-deductible IRA and you need to report it for tax purposes (& keep track of the amounts you put in, forever, so you don't get double taxed on the money later). That is why only the earnings are taxed upon withdrawal. The contributions were already made post tax.

If you can roll a regular IRA into a ROTH, yes you are correct. You would pay tax on the value when you roll it over. That said, if it is a non-deductible IRA, you only pay tax on the earnings to that point, when you roll it over. There was a 2010 one-time tax law allowing high earners to roll money into a ROTH. It is likely that will be available again some time in the future - generates lots of tax revenue for the government.

[rj.phila]

thumbnail sketch: emergency savings, good idea.

investment vs. debt: this seems pretty simple to me. invest if you are sure you can generate more income than you are losing via interest on the debt. both of these numbers should be easy to deduce. you really need to start comparing hard numbers to hard numbers at some point, IMO.

[BuckyBadger]

Yes, I think you understand.

In reality, a traditional IRA is funded with pre-tax money, and all the money + earnings is taxed when you use it.

Wait, now I'm confused again! I thought a traditional IRA was funded with money that you have already paid taxes on... Otherwise, wouldn't it reduce my tax liability -- and I thought that I wasn't allowed to do that because of my income level.

And MonkeyMama, we ARE overwhelmed! We also, however, like to try and learn about our options and understand this stuff, which makes us kind of annoying with the questioning! THanks for your help and time!

[MonkeyMama]

Wait, now I'm confused again! I thought a traditional IRA was funded with money that you have already paid taxes on... Otherwise, wouldn't it reduce my tax liability -- and I thought that I wasn't allowed to do that because of my income level.

And MonkeyMama, we ARE overwhelmed! We also, however, like to try and learn about our options and understand this stuff, which makes us kind of annoying with the questioning! THanks for your help and time!

In reality, a traditional IRA is funded with pre-tax money, and all the money + earnings is taxed when you use it.

The distinction is that if you are not eligible for the tax deduction (due to income limits), you can still fund a traditional IRA. It is called a non-deductible IRA. Contributions are post-tax, but earnings are taxed when you use it (withdrawals).

Does that clarify the difference?

For tax purposes there are 3 types of IRAs: Traditional, non-deductible, and ROTHs.

[MonkeyMama]

And MonkeyMama, we ARE overwhelmed! We also, however, like to try and learn about our options and understand this stuff, which makes us kind of annoying with the questioning! THanks for your help and time!

I think you are better off throwing your money at debt until you gain more confidence in all your investment choices, etc., etc.

I work with a lot of high wealth individuals - some who come into money really quickly. People who have "more money than they know what to do with." From a math standpoint, keeping a 4% loan sounds nice. But a lot of them just pile money in cash (not paying attention to FDIC limits, earning 0%, etc.), because they have no idea what to do. At which point I tell them to pay off all their debt while they get more comfortably with managing their assets. Just where I am coming from.

That you are actively looking for advice, is great.

P.S. Take free internet advice with a grain of salt. That said, there are a lot of resources out there - blogs, forums, books, etc. I think you can do it yourself, but be careful with some of the advice you will see. I am a tax professional, but I am spouting a few things off the top of my head - not thoroughly reviewing your circumstances. Likewise, I have seen terrible free financial and tax advice in forums like this.

All that said - I don't think you necessarily have a lot to gain by paying for tax or investment advice. Just be discerning and seek out a lot of opinions.

[feh]

I haven't read the other responses; I apologize if I'm duplicating what others have said...

If you've exhausted your tax-advantaged savings options, then open a taxable investment account. And save, save, save, while you are young.

You are obviously in an advantageous position. If you live frugally (ie. don't spend $20K per year on hobbies) and save as much as you can over the next 10 years, you'll be able to retire very early and happily.

That would be my goal.

[snshijuptr]

Kinda summing everything up:

1. Continue maxing your 401k's. This is awesome.
2. Start an e-fund of 3-9 months expenses (Personally I like 6 months of normal expenses) in an FDIC insured savings account
3. Put $5000 for each of you in a non-deductible IRA for both 2010 and 2011
4. Get smart about investing and taxes (HINT: The best bet is usually index funds)
5. Until you are comfortable investing, pay down your HELOC then your mortgage

Some other advice:
- Identify financial life goals like having children, retiring early, moving, buying cars etc so you can set aside money for these things
- You might want to talk to a CPA about investing and taxes. Generally this is the most complex part of investing.
- Some great websites include:
beginnersinvest.about.com
Early Retirement & Financial Independence Community
FIRECalc: A different kind of retirement calculator