Desire to Semi-Retire in 10 years - Do we Pay Off Mortgage or Increase Savings?

[RatRaceBeGone]

We are a dual income household in NYC. No children. I bring in approx. 70% of our total income. I am 40 and DH is 46. I would like to semi-retire in 10 years at age 50--perhaps bring in some cash by going on a reduced schedule working 20 hours a week--but DH is happy continuing the daily grind so he may continue working full-time for another 20 years (unless he gets jealous.

Here’s our financial situation: While hefty, our only debts are a HELOC and a 30 year fixed mortgage. We have an emergency fund in an online savings account that covers 12 months of basic living expenses. (Some may argue with keeping so much cash in a savings account earning a measly 1%, and I have debated this issue in my head as well, but I’ll save that one for another time.) We will contribute the maximum allowable by law ($17k in 2012) to our respective employer 401(k) plans ($34k in total for 2012). By the end of 2012 we expect to pay off our variable rate HELOC (currently at 3.25%) of $130k. But doing so will leave little, if any, room to put any other savings aside (other than the 401(k)s). By the end of 2012 our only debt will be the 30 year mortgage and we will owe approx. $400k on it (at 4.625%). So, that leaves us with 9 years to get us semi-retirement ready. If we have no house payment, and DH continues to earn the salary he earns now (adjusted for inflation) we could live on his salary alone, but frugally. I’d love to hear everyone’s thoughts on how to go about accomplishing my dream of getting out of this rat race using the assumption that we plan to live in the house indefinitely. (We have discussed selling the house and downsizing, but we haven't made that decision yet.)

So here are my thought on possible approaches:

(1) Do we aggressively pay down the house for the next 9 years, while continuing to max out our 401ks? As an aside, considering my desire to retire 10 years before I hit age 59 1/2 (which is when I can start taking penalty-free withdrawals from my 401k), am I contributing too much on a pre-tax basis to my 401k? Note that I get no matching contribution. Would that money be better invested in a Roth 401k (my employer has this option) or a taxable account where I can access the money penalty free between the ages of 50 and 60? Only the principal in the Roth 401k would be available penalty free; earnings can’t be withdrawn without penalty before 59 1/2.

(2) Do we stop contributing to our 401ks and use the $34k (reduced by taxes) to pay off the house even faster? Possibly as fast as 6 years assuming we continue to make our same salaries (adjusted for inflation).

(3) Do I split all extra money between paying down the house “somewhat” aggressively and stash the rest into a taxable brokerage account to get our savings going? If we choose this option, do we continue contributing to our 401ks?

(4) Do we do some combination of all of the above, or do we do something completely different that I haven’t considered?

All thoughtful comments are greatly appreciated.

Thanks,
RatRaceBeGone

[bjl584]

What is the total value of your assets? That number compared with your estimated annual expenses will give you a better idea if you can retire or not.

[RatRaceBeGone]

Our annual expenses will be reduced dramatically by 40k if we pay off our HELOC and house. Which is why I am so focused on whether and how quickly such pay off should happen. 2011 was not the year of frugality. We spent 100k (40k of which went to the HELOC and mortgage)

According to Mint.com, our assets are 930k and our liabilities are 535k, leaving us with a net worth of 395k.

I don't want to sidetrack the conversation, but even if I did not intend to or could not retire in 10 years, would you recommend that I pay down my HELOC and mortgage aggresively before socking away money in a taxable brokerage account?

Thanks.

[bjl584]

Our annual expenses will be reduced dramatically by 40k if we pay off our HELOC and house. Which is why I am so focused on whether and how quickly such pay off should happen. 2011 was not the year of frugality. We spent 100k (40k of which went to the HELOC and mortgage)

According to Mint.com, our assets are 930k and our liabilities are 535k, leaving us with a net worth of 395k.

I don't want to sidetrack the conversation, but even if I did not intend to or could not retire in 10 years, would you recommend that I pay down my HELOC and mortgage aggresively before socking away money in a taxable brokerage account?

Thanks.

Most will advocate some combination of the two. Because, you don't want to retire with a lot of debt, and you also don't want to sacrifice investment potential to pay down debt. Especially debt with a low interest rate and a tax advantage.

[bjl584]

Our annual expenses will be reduced dramatically by 40k if we pay off our HELOC and house. Which is why I am so focused on whether and how quickly such pay off should happen. 2011 was not the year of frugality. We spent 100k (40k of which went to the HELOC and mortgage)

According to Mint.com, our assets are 930k and our liabilities are 535k, leaving us with a net worth of 395k.

I don't want to sidetrack the conversation, but even if I did not intend to or could not retire in 10 years, would you recommend that I pay down my HELOC and mortgage aggresively before socking away money in a taxable brokerage account?

Thanks.

By the way, a quick dirty answer is the 20 or 25 rule. When assets equal 20 to 25 times your annual expenses, you can retire comfortably. It's more of a guideline than a rule, but it's a decent ballpark figure. So, if you think that you will spend 50K a year in retirement, then you will need 50000 * 25 or 1.25million.

[RatRaceBeGone]

Using the 20 to 25 guidance, assuming we spend 50k a year and DH nets such amount annually, that seems to support the route of paying off the house ASAP. More to think about...especially if DH changes his mind and decides he doesn't want to work for the next 20 years. Of course, once he retires we will have to start relying on our savings which are no where near the 1.25m needed if no income is comiing in.

[bjl584]

Using the 20 to 25 guidance, assuming we spend 50k a year and DH nets such amount annually, that seems to support the route of paying off the house ASAP. More to think about...especially if DH changes his mind and decides he doesn't want to work for the next 20 years. Of course, once he retires we will have to start relying on our savings which are no where near the 1.25m needed if no income is comiing in.

There are lots of variables to consider. You and DH will need to figure out exactly what will happen with his work situaton. The income that your nestegg generates will also have to be looked at. Most of it will be invested conservatively, but a portion of it can be placed in dividend yielding funds and stocks which will provide additional annual income for you.

[MonkeyMama]

For really good advice, will need to know your income and expenses, as well. (Okay, I see $50k).

My thoughts:

#1 - Maxing out the 401k is probably going to be key at this point. I am assuming you are in a huge tax bracket and probably make too much money to contribute to a ROTH, anyway. If you stopped contributing say $17k to 401k, annually, your taxes could easily go up $7k or so. Then you are only saving $10k per year by giving up $17k.

#2 - You *may* get a lot of advice not to pay off mortgage. My perspective is different being from a high cost area (San Francisco) and having a spouse who *retired* at 25. Getting a reasonable mortgage is key. Your income may support a higher mortgage balance, but not everyone wants to be shouldered with that forever or in case of layoff, disability, etc. Likewise, if you could maybe knock off the "excess" and finance a reasonable amount from age 25 - 65 is one thing, but you don't have three decades to wait for long-term stock market returns. So I think age becomes a big factor.

What interest rate is your mortgage at? - would be another good question. You might be much better off refinancing to a 10 or 15 year loan at a much lower interest rate, or even a lower 30-year rate if you haven't refinanced lately. Or if you have had your mortgage for a while and are paying more principal than interest, I might advise otherwise. If you are mostly paying principal anyway, aggressive pre-payments won't buy you much economic advantage. But you may be really surprised to run the numbers on a refinance.

[MonkeyMama]

P.S. Practice makes perfect. Put your income to savings, 401k, mortgage pay down, etc., these next 10 years. You will really have a solid idea if you can live on just dh's salary when the time comes. The sooner you start that mindset (yes, today), the easier the transition will be. Plus, if you are continually digging into your paycheck for this or that (a new car? Forgot about the property taxes? Whatever it be...) you will be better prepared for a more realistic view of what it will be like to live on one income. OF course, if you are miserable and it is not working, your goal may be overly aggressive, but that just might mean tweaking your goal and being more realistic.

[MonkeyMama]

By the end of 2012 we expect to pay off our variable rate HELOC (currently at 3.25%) of $130k. But doing so will leave little, if any, room to put any other savings aside (other than the 401(k)s). By the end of 2012 our only debt will be the 30 year mortgage and we will owe approx. $400k on it (at 4.625%).

Thanks,
RatRaceBeGone

I am assuming rate on HELOC is variable and that is why you are knocking it out? Maybe should revisit a refinance the end of 2012? Rates are 3.25% on a 15-year, right now, if you have equity and good credit. Rates will probably be low a while, so something to keep in mind once HELOC is paid off. I am not one to pass up "rock bottom" but have heard much speculation that rates may fall even further. If HELOC is not a factor in avilable equity and ability to refinance, I would seriously consider a 15-year refinance right now, on the first mortgage. But don't panic if you want to/need to pay HELOC off first - might still be great 15-year refi opportunities in a year or two. I suggest because gives you huge opportunity to pay down mortgage very quickly without tying up significant cash flow. These low rates are just incredible.

[RatRaceBeGone]

I am assuming rate on HELOC is variable and that is why you are knocking it out? Maybe should revisit a refinance the end of 2012?

The HELOC is variable and we refinanced our 30 year in 2009 at 4.625%

I'll have to run the numbers on a 15 year refi to see if the cost associated with the refi is worth it. But, if we are able to pay off the 30 year in 6 years it may not be worth the cost.

My thought was to stop all savings (other than the 401ks) and throw every extra dollar at the heloc and 30 year in the hopes of paying both off in 7 years. That would leave me 3 years to save all we can in a taxable account. At that point, we'll have a sense of whether there's enough saved up for me to retire or scale down to part-time employment.

What scares me most is emptying out our hard earned savings to pay off the house. It's such a comfort having cash stashed away in the event of a major emergency or catastrophe.

[RatRaceBeGone]

In my opinion, you should not retire or semi retire until you are completely debt free.

Since you are currently investing in a taxable 401k with no employer match, I would adjust that to Mutual Funds that you can get to before age 59 1/2. I would reduce the amount that you are investing until the house is paid for. The key to financial freedom is to be debt free.

Without knowing the details of your financial situation, I am guessing that it will be tough for you to semi retire by age 50...55 seems very possible as well as somewhere in between 50-55.

Thanks artwest. I absolutely agree that we must be debt free before I retire. I wouldn't do it any other way.

When you say you would reduce the amount that we are investing until the house is paid for do you mean reduce to $0? Does that include DH's 401k contributions where he does get a match? I've toyed with the idea of stopping our retirement savings alltogether. If we did that we could pay off the house, heloc and all, in 6 to 7 years. It would be tough, but doable. But I fear that will set us back as we would lose those years of compounding. Decisions decisions...

[MonkeyMama]

One thing I forgot to mention is that you can probably live more easily off spouse's income than you realize - since your income taxes will probably decrease VERY significantly with you not working. You can likely significantly decrease his tax withholding (or just take very large tax refunds, if that is what you prefer).

You would be surprised on the refinance numbers. You could easily break even on costs in less than a year, so I wouldn't rule out the short time period you want to pay off mortgage. I just saw 3.125% today. Play with some amortization schedules, and you will see. I bring up because a refi should make the faster payoff a LOT easier. & don't assume anything until you run the numbers. We are in the middle of refinancing from 4.875% to 4% (we last refinanced 2009, too), which at face value I wouldn't bother. But, this will be our best/most profitable refi, ever. These low rates can make a substantial difference to your ability to pay off faster, and I was amazes just looking at a $200k mortgage. The bigger the mortgage is, the more substantial the interest savings will be.

[greenskeeper]

I would think you can retire on a lot less monthly income if you have a paid in full house to live in.

At least that is my thinking, I hope to have my house paid off before I turn 40.