Matt lives in a suburb of Boston with his wife Laura, their three kids, and their yellow lab Waffles. Matt and Laura both work as engineers and share a love of outdoor recreation–skiing, hiking, kayaking and camping. Their oldest child is a freshman in college and his siblings–ages 16 and 14–will each be headed off to college in a few short years. Matt is concerned about their ability to afford college, plan for retirement and pay off their mortgage. While he and Laura earn superb salaries as highly qualified engineers, these competing financial priorities have Matt concerned. Let’s help him sort through it all together!
What’s a Reader Case Study?
Case Studies address financial and life dilemmas that readers of Frugalwoods send to me requesting advice. Then, we (that’d be me and YOU, dear reader) read through their situation and provide advice, encouragement, insight, and feedback in the comments section.
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Reader Case Studies are intended to highlight a diverse range of financial situations, ages, ethnicities, geography, goals, careers, incomes, family composition, and more!
The Case Study series started in 2016 and, to date, there’ve been 56 Case Studies. I’ve featured folks with annual incomes ranging from $17,160 to $192,720 and net worths ranging from -$317,596 to $1.5M.
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I probably don’t need to say the following because you folks are the kindest, most polite commenters on the internet, but please note that Frugalwoods is a judgement-free zone where we endeavor to help one another, not condemn. There’s no room for rudeness here–the goal is to create a supportive environment where we all acknowledge that we’re human, we’re flawed, but we choose to be here together, workshopping our money and our lives with positive, proactive suggestions and ideas.
A disclaimer that I am not a trained financial professional and I encourage people not to make serious financial decisions based solely on what one person on the internet advises. I encourage everyone to do their own research to determine the best course of action for their finances. I am not a financial advisor and I am not your financial advisor.
With that I’ll let Matt, today’s Case Study subject, take it from here!
Hi Frugalwoods! I’m Matt, I’m 50, my wife Laura is 48 and we have an 18-year old son, a 16-year old daughter, a 14-year old son and a yellow lab named Waffles. We live in a suburb outside of Boston where we both work as engineers. Our oldest son is in his freshman year of college in Boston studying computer science. Our daughter is a sophomore in high school and our youngest son is in his final year of middle school.
I have a degree in chemical engineering and an MBA. I worked in engineering firms for the first 15 years of my career, but I always wanted to own my own business. As my experience and job responsibilities grew, I was spending more and more of my time overseas. At the time, my three children were all very young so I began looking for opportunities where I could do something closer to home.
I ended up buying a small water analysis company where the owner was retiring. This was in December of 2007 – little did I know the Great Recession of 2008 was right around the corner. It was an incredibly challenging time, but it taught me some valuable life and business lessons that I’m eternally grateful for. The business grew slow and steady over the next eight years, but I was working really long hours and making about 60% of my previous corporate salary as I was putting most of the profit back into the company. With my kids entering their teenage years, I knew I needed to make more money if we were going to be able to fund their college tuitions and retire one day. I sold the business in 2018 and began the transition back to the corporate world.
Fortunately, it didn’t take long to land a great job at a large chemicals company, even though it was quite the change from the small business I’d run for a decade. Things I took for granted in the corporate world before, like getting a paycheck every week and having a 401K, I was so grateful to have again.
Laura has a degree in electrical engineering and works in robotics. She’s been with the same company for the past 10 years. She’s really bright, loves her work, and is very good at it. Because of that, she doesn’t have the same desire as I do to sacrifice now in order to retire early.
We both love outdoor adventure in New England. We love to ski the mountains of Vermont, hike the high peaks of New Hampshire, sea kayak along the Maine coast, and camp on the beaches of the Cape and Islands. We also love to travel.
We also have hobbies that we enjoy on our own. Laura enjoys cooking, reading, yoga, and running. My solo hobbies include cycling, motorcycling, technical investing, and home remodeling.
Our Version of Frugality
Laura and I have always been frugal. We’ve always tried to make choices as if we only had one salary. We bought a modest home in a nice neighborhood when we could have afforded something twice as expensive. Over the 17 years we’ve lived here, we’ve slowly renovated every room in the house doing much of the work ourselves.
We’ve never felt the need to buy new cars, always opting for older quality vehicles that are known to last. Almost everything we own, we bought used on Craigslist – our cars, bicycles, kayaks, skis, Honda snowblower, Honda Generator, etc. However, as our kids have grown, so has our spending and our frugal discipline has slipped some. Doing this case study has made me realize it’s a good time for a reset.
The Pressing Issue: College Costs
When researching colleges with our oldest son, we learned that most of the private schools we looked at cost $70,000+ per year and we were not going to qualify for any financial aid. While we’ve been investing in 529 plans since the kids were little, there was little chance we’d be able to save $280,000 for each child. Our goal now is to have $140,000 for each child’s education. If they choose a state school, that amount will cover it. If they choose a private school, they’ll have to take loans out for the difference. We did save $140,000 for our oldest, have almost $130,000 for our second child, but only have about $70,000 saved for our youngest. We’re concerned we won’t be able to save enough by the time our youngest goes to college in four years.
Based on Fidelity’s rule of thumb, we should have 6x our gross salary saved for retirement by now (age 50). Based on my current salary, I’m quite a bit behind because, for the past decade, my salary was much lower while I was self-employed. I’m currently investing about 20% of my gross income into retirement, maxing out my 401K contributions including the catch-up provision. Given our shortfall in retirement and our shortfall in the 2nd and 3rd children’s 529 plans, where should we invest more?
For some time now, we’ve wanted to buy an investment property to add diversification to our stock portfolio. I would love to build a side business over the next 10 years with a real estate portfolio, but I don’t know where to begin. We would prefer to buy a property–or properties–that we would enjoy using and also renting out on AirBnB, such as a small beach house and/or ski condo. We don’t want to be landlords of multi-family units even though we recognize that might be the most lucrative path. I have a lot of tools and experience with home remodeling so I’m not opposed to buying properties that need work.
The Best Thing Right Now?
Working from home during Covid is the best part of my current lifestyle. Not having to commute 40 minutes each way allows me to work out or cycle at lunch time and is saving a lot of gas to boot. Life has become much simpler without all of the after school activities/sports where my wife and I felt like we were Uber drivers.
…And The Worst?
I’ve come to realize that we’re not working from home, but rather living at work. The days and hours are long and blend together. It feels like groundhog day every day. The other downside to my current situation is a lack of job security. When I owned my own business, making payroll and employee issues kept me up at night, but I never had to worry about someone firing me. In the corporate world, there’s constant “restructuring” of the work force and I notice the older population getting pushed out. Even though I’ve been working for more than 25 years, I’ve only been with my current company for 2 years, so if a restructure comes along based on company tenure, I’d be one of the first to go. As I age into my 50’s, the ability to quickly find jobs with comparable income may be a significant challenge.
Where Matt Wants To Be in Ten Years:
- Have our primary residence paid off
- Be done paying for all 3 kids’ college tuitions and have no other debt
- Have an established real estate portfolio to diversify our stock market investments
- Have retirement savings large enough to have the option to retire and live off the 4% rule
- Still married!
- Have time to enjoy hobbies: skiing, hiking, sea kayaking, cycling, motorcycling
- Have the time and means to travel in the US and Europe
- Be involved in our kids’ lives as they start their careers and families
- Have the option to continue working full-time or retire
- Be actively managing our retirement portfolio
- Be actively managing a real estate portfolio
Matt and Laura’s Finances
|Matt’s net income||$7,580||Net salary, minus health, dental, vision insurance, 401k contributions and taxes|
|Matt’s annual bonus||$833||Net bonus, minus taxes. This varies year to year, but this is what it was last year|
|Laura’s net income||$7,338||Net salary, minus health, dental, vision insurance, 401k contributions and taxes|
|Laura’s annual bonus||$1,167||Net bonus, minus taxes. This varies year to year, but this is the average over the last 2 years|
|Item||Amount||Notes||Interest/type of securities held||Bank/brokerage|
|Primary Residence||$750,000||Based on similar homes sold in last 6 months||NA||NA|
|Matt’s Traditional IRA||$377,140||Rollover IRA||19 Individual Stocks||Varied|
|Laura’s Traditional IRA||$366,451||Rollover IRA||Mutual Funds||Fidelity, Columbia, Blackrock|
|Laura’s 401K||$346,235||From Laura’s current employer|
|Rainy Day Fund||$232,000||Savings account to fund potential real estate purchase(s)||Earns <1% interest||Bank of America|
|Savings Account||$164,315||This is our emergency fund||Earns <1% interest||Bank of America|
|529 Plan Child 1||$129,354||College Savings Account||Age Based Fund||U Fund Fidelity|
|529 Plan Child 2||$128,784||College Savings Account||Age Based Fund||U Fund Fidelity|
|Joint Investment Account||$115,679||Taxable investment account||Index Funds||Vanguard VOO|
|Matt’s 401K||$92,000||From my current employer||Age Based Fund||Fidelity|
|529 Plan Child 3||$69,534||College Savings Account||Age Based Fund||U Fund Fidelity|
|Matt’s SEP IRA||$55,027||Self-employed IRA||Index Funds||Vaneck SMH|
|Matt’s Roth IRA||$49,993||Rollover Roth IRA||Index Funds||Vanguard VOO, Biotech ETF XBI|
|Laura’s Roth IRA||$20,827||Rollover Roth IRA|
|Checking Account||$4,280||This is the account we pay bills from||0% interest||Bank of America|
*Matt’s total retirement savings: $574,160
*Laura’s total retirement savings: $733,513
|Item||Outstanding loan balance||Interest Rate||Loan Period and Terms||Amount paid off||Purchase price and year||Current Market Value||Equity|
|Mortgage on primary residence||$132,740.00||3.375%||30-year fixed-rate mortgage; prepaying at 15 yr rate so will be paid off in 2028||$222,260||$355k, purchased in 2003, refinanced in 2012||$750,000||$617,260|
|Vehicle make, model, year||Valued at||Mileage||Paid off?|
|2013 Honda Odyssey||$11,000||105,000||Yes|
|2003 Toyota Landcruiser||$10,000||185,000||Yes|
|2008 Honda Accord||$6,800||75,000||Yes|
|Mortgage||$1,494.72||Includes extra $500 monthly payment to pay down mortgage in 15 yrs. Mortgage will be paid off in 2028|
|529 Plan Investment||$1,300.00||Monthly investment into 529 Plans|
|Groceries||$1,095.20||Yikes – teens eat a lot!|
|Property Tax + Insurance||$838.12||Includes property tax + home owners insurance|
|Restaurants||$575.74||We only get takeout ~1x week, but it’s easy to hit $100 for family of 5|
|Costco||$507.72||Meat & fish, coffee, paper goods, cleaning supplies, wine, dog food, and Lord knows what else|
|Shed materials||$471.91||We built a large shed during Covid|
|Kids Clothing||$252.05||Kohl’s, TJ Maxx, Marshalls|
|Auto Insurance||$224.50||Geico – Went from $800/yr to $2,700/yr when our son was added to policy|
|Verizon Wireless||$209.80||5 lines, unlimited talk, text, data $40 per line – we all have older iPhone 6, 7, and 8’s. Looking for suggestions here to lower this on an unlimited plan|
|Shed Labor||$175.00||One-time expense|
|Gas||$163.16||This is typically >$250/mo pre Covid|
|Home Improvement||$161.35||More shed supplies|
|Utilities: electric||$148.00||Would solar make sense at this monthly electric cost?|
|Sporting Goods||$147.41||Hockey, Lacrosse, and Field Hockey equipment for the kids’ sports|
|Verizon Fios||$138.00||WiFi and Basic Cable|
|Auto Service||$132.35||We DIY most auto work, but use a local mechanic for jobs I can’t do|
|Utilities: natural gas||$125.00|
|Lodging||$118.06||We took a family vacation to Florida last year|
|Hockey||$112.99||Ice time and league fees|
|Skiing||$111.30||Skiing is expensive – usually >$400/day if all 5 of us go – we only got out about 4 days last year|
|Auto Parts||$99.45||Parts for DIY work|
|Entertainment||$96.55||For our Florida vacation|
|Life Insurance||$76.25||$1M 20 yr term policy for Matt w SBLI|
|Furniture||$74.83||Bought two new mattresses for kids|
|Walgreens/CVS||$59.29||Prescription meds, other medical supplies|
|Travel||$58.76||This is typically >$250/mo pre Covid|
|Life Insurance||$55.00||$750k 20 yr term policy for Laura w SBLI|
|College books and fees not covered by the 529||$50.00|
|Hair Cuts||$46.67||Me and boys haircuts – cut my own hair during Covid and the boys refused to let me cut theirs|
|Beer & Wine||$46.03|
|Autobody Repair||$44.40||Son hit a deer – $500 deductible|
|Veterinary||$43.39||Dog needed some xrays, meds|
|Motorcycle rental||$38.48||Weekend trip with Wife 1x per year|
|School Sports||$32.92||Field Hockey & Lacrosse fees – pre Covid|
|Pet Supplies||$32.22||Dog food, frontline flea & tick, heartworm|
|Contact Lenses||$30.42||Daily Wear for Presbyopia|
|Motorcycle membership||$29.92||Eagle Rider rental credits – this is intended to make our 1x a year motorcycle rental cheaper – with this program the cost to rent per day is $60 vs $200 – I will still likely cancel this after this years trip|
|Dog Grooming||$28.38||Gave up trying to do this myself, it cost $65 per grooming which is about what an oil change costs these days so I opted to do the oil changes myself and pay the groomer|
|IBD membership||$24.97||Investors Business Daily subscription|
|Ski Helmets||$23.88||Two younger kids needed new helmets last year – one thing we don’t buy used|
|Ski Rental||$19.83||2 younger kids get seasonal rentals|
|Kayak Lessons||$15.00||Sea Kayak Instruction – will go away in April|
|Building Permit||$12.50||one time charge for shed|
|Krown||$11.66||Undercarriage spray for Landcruiser|
|Amazon Prime Membership||$9.92|
|Movie Rental||$7.99||Amazon Prime|
|Annual Park Pass||$5.00|
Credit Card Strategy
|Card Name||Rewards Type?||Bank/card company|
|Costco Visa||Cash Back: 4% on gas, 3% restaurants & travel, 2% on Costco, and 1% on everything else||Citicard|
|Double Cash Mastercard||Cash Back: 2% on everything||Citicard|
Matt’s Questions For You:
- We are currently investing $1,300 per month into the 529 plans. If our goal is to have $140,000 for each child’s education, how much additional investment do we need to make each month?
- Should we take a portion of our rainy day fund to fully fund these 529 plans now?
- We currently owe ~$132,000 on our mortgage and are prepaying an additional $500 per month to pay it off in 8 years. Should we continue to prepay or divert these funds elsewhere? Or should we use the rainy day fund to pay off the mortgage now?
- With the real estate market off the charts in our area, it may take quite some time to find the right property at the right price. We’re using this time to do our research. In the meantime, we have a lot of money sitting in cash. Do you have any recommendations for what to do with these funds in the short term?
- In addition to a real estate business, I’m interested in starting a trading business where I use technical analysis to buy and sell stocks and options. Do you have any recommendations on how to get started in this area?
- We are both maxing out our 401K’s. For me, that’s $19,600 + $6,500 per year (catch-up for age 50+) and $19,600 for Laura. Our companies also provide a 4% to 6% match. If we stay gainfully employed for the next 10 years, and continue to max out our 401Ks, how large would our retirement portfolio be given an average rate of return?
- Since we are W2 earners and have little in the way of deductions, we are paying upwards of $120,000 a year in taxes. Do you have any recommendations on how to reduce our tax burden? Are the potential write-offs from a real estate business the best path?
- We need to do a reset on our expenses. We used to live on one salary and save the other. Now it seems the more we make, the more we spend. Please give us your recommendations on where we can cut spending?
Mrs. Frugalwoods’ Recommendations
Matt and Laura are doing a fabulous job! I’m so excited they came to me for a Case Study because they’re at a juncture many parents face: planning for retirement and paying for college.
Matt and Laura have done an excellent job over the years of increasing their salaries and saving a decent percentage of their earnings. While yes, they have high salaries, they’ve also been careful not to live above their means.
I commend Matt and Laura for making these prudent choices over the years and for setting themselves, and their kids, up for success. Let’s dive right into Matt’s questions!
Matt’s Question #1: We’re investing $1,300 per month into the 529 plans. If our goal is to have $140,000 for each child’s education, how much additional investment do we need to make each month?
Since the 529s are invested in the market, part of this answer depends on the rate of return the market delivers between now and when Matt’s second and third kids go to college. Since no one knows what the market will do in the future, we’ll ignore this fact and do the math assuming a 0% rate of return.
Kid #2 is a sophomore in high school and will presumably go to college in circa three years, aka 36 months. Kid #2’s 529 account balance stands at $128,784. If the goal is $140k by the time she enters college, that equals a deficit of $11,216. Spread out over 36 months, Matt and Laura should add $311.55 to this 529 every month ($311.55 x 36 = $11,216). Again, this assumes a 0% rate of return from the market, which makes it a very safe, conservative estimate. We can always be excited when it ends up being more!
Kid #3 is in 8th grade and will presumably go to college in circa five years, aka 60 months. Kid #3’s 529 account balance stands at $69,534. If the goal is $140k by the time he enters college, that equals a deficit of $70,466. Spread out over 60 months, Matt and Laura should add $1,174.43 to this 529 every month ($1,174.45 x 60 = $70,466). Again, this assumes a 0% rate of return from the market, which makes it a very safe, conservative estimate.
Matt and Laura are currently putting $1,300 into these two accounts, which is just a bit shy of the targets I outlined above ($311.55 for kid #2 + $1,174.45 for kid #3 = $1,486). Bumping the total up to $1,486–distributed between the two accounts as noted above–would put them on a safe trajectory for achieving $140k by each child’s freshman year. When kid #2 goes to college, they’ll cease contributing to her 529 and their monthly outlay will drop down to just $1,174.45 for their third child.
A Few Caveats About 529 Plans
The real benefit of using a 529 is when the appreciation on the money you put in is not taxed. Given that, the closer you get to spending the money (as in, the older your kids are), the less of a tax benefit you’ll see. The money in a 529 grows tax-free and isn’t subject to federal income taxes when it’s withdrawn for educational expenses. This is what makes a 529 a better college savings vehicle than, say, a regular taxable brokerage account. The major tax advantage of using a 529 is if you start one when your kid is a baby because then you have 18 years of tax-free appreciation.
What if a kid doesn’t go to college? The simplest way to think about a 529 is that it’s an investment account that has potential downsides if your kid doesn’t go to college. That’s because the money in a 529 can only be utilized for specific, higher-education-related expenses. However, you can transfer money between children. In Matt and Laura’s case, since they have three kids, they have the flexibility to transfer funds between accounts. For example, if kid #2 doesn’t go to college, they can divide up that 529 between kids 1 and 3. 529s can also be used for graduate school, so in the event that there’s money leftover in one of their children’s 529 plans after undergrad, it can be transferred to a child attending a graduate program.
Read more here: How We Use 529 Plans To Save For College
Matt’s Question #2: Should we take a portion of our rainy day fund to fully fund these 529 plans now?
In short: no. There’s no tax-advantaged reason to do so and it’s highly likely this money can be better deployed elsewhere, as we’ll address in a moment. Since kids #2 and #3 aren’t going to college tomorrow, there’s no reason to park this money in 529s right now, especially given the restrictions inherent to 529s. Plus, as outlined above, Matt and Laura only need to contribute a teensy bit more every month in order to fully fund the 529s for kids #2 and #3.
Matt’s Question #3: We currently owe ~$132,000 on our mortgage and are prepaying an additional $500 per month to pay it off in 8 years. Should we continue to prepay or divert these funds elsewhere? Or should we use the rainy day fund to pay off the mortgage now?
This is a really good question. Matt’s correct that it doesn’t make sense to have a mortgage AND this much money in cash. Both a paid-off house and a savings account represent low-risk, non-aggressive, low-return places for your money to sit. Matt and Laura have a total of $396,315 sitting in cash at present (that’s their $232,000 rainy day fund + their $164,315 emergency fund). This is an impressive stash of cash and I heartily commend them for saving up so much!
However. There’s actually such a thing as having TOO much money in cash (bet you never thought you’d hear me say that!). Why? Because that much cash represents a major lost opportunity to invest and earn a return on this money. Money sitting in cash isn’t doing anything for you; conversely, money invested in the stock market or in a paid-off house IS doing something for you.
The other disadvantage of having so much cash is inflation. Holding this much cash is not only causing you to lose out on return opportunities, it’s likely to cost you money due to inflation. With inflation, every dollar is worth less because the cost of goods and services rise. Hence, if your cash isn’t keeping up with inflation, you are essentially losing money.
Here are three things they could do with this cash:
1) If Matt & Laura paid off their mortgage tomorrow, they’d get a 3.375% return on their money. That’s because their mortgage interest rate is 3.375% and by paying off their mortgage, they’d essentially accrue that return on their “investment” of paying it off.
2) If Matt & Laura keep their $396,315 in cash, they’ll get a sub 1% return as that’s the interest rate of their savings account.
3) If Matt & Laura funnel this money into a taxable investment account, made up of diversified total-market low-fee index funds, they can project receiving a 7% annual rate of return from the market–provided they keep the money invested for several decades. 7% is the accepted historical rate of return that the market has delivered; of course, past performance does not predict future results, but it’s the number most economists use to determine long-term market gains.
A side note here: One of the hallmarks of our current market is that there’s no good place to put cash conservatively because savings account interest rates are abysmal as are bond return rates. Both are returning less than 1% right now. Savings accounts and bonds represent low-risk, low-return vehicles for storing cash, but right now they’re even more low-return than they were a few years ago. At present, the only way to get a return is to become more aggressive with your cash.
Of these three options, #3: investment in the stock market, is likely to be the mathematically better solution given the projected rate of return. However, since Matt and Laura are chomping at the bit to pay off their mortgage AND they have so much cash on hand, there’s not much of a downside to paying off their mortgage in full tomorrow.
Amount of cash $396,315 – Amount of mortgage $132,740 = $263,575
As we can see, even after paying off the mortgage, they’re still left with a gargantuan amount of cash money! Plus, if they needed to, Matt and Laura could later take out a HELOC or a cash out refinance in order to access the cash that’s tied up in their house. I don’t strictly recommend HELOCs, but, they can make sense and it’s good to remember that they are options.
Next up, it’s–of course–wise to keep a robust emergency fund on hand. Based on their current spending of $10,089.74 per month, they should target an emergency fund of $30,269 (three months’ worth) to $60,538 (six months worth). If we go with the more conservative six month’s worth, Matt and Laura STILL have $203,037 left hanging out in cash. Woohoo!
Bottom line: do not keep this much money in cash because it’s not doing anything for you. As we can see, Matt and Laura could easily pay off their mortgage, invest in the market and retain a robust emergency fund. All of those options would put their money to work in a far more advantageous way than sitting in savings accounts.
Oh but wait, what about their real estate dreams? It’s convenient that the next question is…
Matt’s Question #4: With the real estate market off the charts in our area, it may take quite some time to find the right property at the right price. We’re using this time to do our research. In the meantime, we have a lot of money sitting in cash. Do you have any recommendations for what to do with these funds in the short term?
I kinda scooped myself and answered the question about what to do with the cash in the short-term, so let’s dig into the real estate question.
A question I have for Matt is why they’d need this much cash in order to pursue a real estate portfolio? With two W2 incomes and a low debt-to-income ratio, they’d likely qualify for a mortgage with a good interest rate. I’m a proponent of leveraging a mortgage on an investment property because it’s typically a better rate of return to keep that excess cash invested in the market than in a paid-off property (see again the math in question #3).
I agree that taking the time to do a lot of real estate research makes sense. If they haven’t already, Matt and Laura should create an evaluation spreadsheet and use currently available properties to start punching in the numbers. Getting a sense of what their expected rate of return might be, how much their expenses would be, whether or not they’d hire a property manager, how they’d manage the maintenance fund, how they’d vet tenants and manage the legal aspects of a lease, how they’d respond to middle-of-the-night phone calls from frantic tenants, who they’d contract with for repairs Matt can’t do on his own, etc is all a great exercise in preparing to own a rental.
Once they fully research the financial realities and the anticipated rate of return, they’ll be ready to jump in. Real estate investing is a slow process and typically does not reward people who jump in without research.
Matt’s Question #5: In addition to a real estate business, I’m interested in starting a trading business where I use technical analysis to buy and sell stocks and options. Do you have any recommendations on how to get started in this area?
In my opinion, I do not consider this an investment where you’re likely to see a return on your money. Is there a 1 in a billion chance you can beat the markets? Sure! Is this a likely outcome? Nope. If you want to budget money for this, do so, but consider it an expensive hobby. For example, if this is a priority to Matt, he might need to give up motorcycles in order to afford this hobby. Don’t invest your family’s future in this, but if you want to have play money for gambling, go for it.
Matt’s Question #6: We are both maxing out our 401K’s. For me, that’s $19,600 + $6,500 per year (catch-up for age 50+) and $19,600 for Laura. Our companies also provide a 4% to 6% match. If we stay gainfully employed for the next 10 years, and continue to max out our 401Ks, how large would our retirement portfolio be given an average rate of return?
A note of clarification here: the IRS-established contribution limit for 401ks in 2021 is actually $19,500, not $19,600. Matt is correct that the annual allowed catch-up amount for folks over age 50 is $6,500.
Combining all of their retirement accounts–401ks, Roth IRAs, IRAs–Matt and Laura currently have:
- Matt’s total retirement savings: $574,160
- Laura’s total retirement savings: $733,513
- TOTAL: $1,307,673
To project Matt and Laura’s retirement portfolio in ten years, we need to use an investment calculator.
- For ‘starting amount,’ I input their total current retirement amount ($1,307,673).
- For ‘annual contribution,’ I input $52,660.64, which represents the maximum allowable combined contribution for Matt and Laura [($19,500 + $6,500) + $19,500 = $45,500] + their employer matches of 4% ($3,638.40 + $3,522.24 = $7,160.64)
- 4% of [$7,580 x 12 = $90,960] Matt’s annual income is $3,638.40 and 4% of [$7,338 x 12 = $88,056] Laura’s annual income is $3,522.24.
- From Matt’s question, it wasn’t clear to me if their matches are 4% or 6%, so I went with the lower number. They can plug in their actual match percentages if 4% isn’t accurate.
- Additionally, sometimes the match percentage is calculated on net income and sometimes on gross. Since I only have their net incomes, I used those numbers. Matt and Laura can check with their HR departments to determine the actual numbers.
- For ‘rate of return,’ I input 7% as that’s an acceptable historical rate of return for the market.
- And for ‘years to grow,’ I input 10.
Their projected retirement investment value in 2030, according to this calculator and these variables, is $3,299,965.
- The IRS sets the contribution limit for 401ks on an annual basis and, historically, this limit increases over time. Given that, it’s likely Matt and Laura will be able to contribute more than $19,500 per year for the next ten years.
- Once Laura is over 50, she too will be eligible to tack on the catch-up provision, which in 2021 is $6,500.
- The 7% rate of return I used is an estimate based on historical rates of return. It may or may not be born out in the future.
- If they leave/lose their jobs, they’d no longer had access to the employer match they currently enjoy.
Don’t Forget About Social Security!
The other variable we haven’t considered yet is Social Security. Since Matt and Laura have both been working for decades, they should qualify for Social Security. They can calculate their expected monthly Social Security payments by following these instructions on how to retrieve their earnings tables from ssa.gov (the government’s Social Security website).
Then, to determine if they’ll run out of money in retirement, Matt and Laura can input variables into Engaging Data’s Post-Retirement Calculator.
Matt’s Question #7: Since we are W2 earners and have little in the way of deductions, we are paying upwards of $120,000 a year in taxes. Do you have any recommendations on how to reduce our tax burden? Are the potential write-offs from a real estate business the best path?
Matt and Laura are already participating in most of the standard tax-advantaged opportunities: they’re contributing to their retirement accounts and they have 529s for their kids.
Another avenue for tax breaks are Donor Advised Funds, which are charitable giving vehicles. Contributing to a Donor Advised Fund enables you to take the full tax write-off for the money you contribute in a calendar year, whether or not you donate all of that money in that calendar year.
If Matt and Laura envision making charitable donations every year, a DAF can be a great way to be philanthropic and accrue tax advantages. I myself have a DAF and wrote several articles about them:
- How We Donate To Charities Like Billionaires
- How We Make Meaningful And Tax Efficient Charitable Donations
Another thing they could consider is getting solar, IF they plan on being in their house for a long time. There are good federal tax credits for solar and Massachusetts has historically been pretty generous in terms of credits as well. They’d need to calculate the ten-year rate of return on this, as solar is usually pretty expensive up-front, but it could be a good investment. It’s probably worth having a solar consult done to see if they’re well-sited for panels.
To Matt’s second part of the question, be forewarned that real estate is not a magic font of write-offs. If Matt or Laura decides to quit their job and become a full-time real estate professional, maybe then they can explore this in earnest. But the IRS is pretty good at figuring out if you’re not doing this correctly. As a W2 employee, you can’t deduct paper real estate losses against your W2 income.
Matt’s Question #8: We need to do a reset on our expenses. We used to live on one salary and save the other. Now it seems the more we make, the more we spend. Please give us your recommendations on where we can cut spending?
This is really a question of how much they’d like to save every month. Given their salaries, they’re doing really well in this department! Yes, their spending is high, but so are their earnings. Their monthly income is $16,918 and their expenses are $10,089.74, which means they’re saving $6,828.26 per month.
If Matt is feeling the urge to save more (an urge I’d never argue with 🙂 ), there are some obvious targets that would reap rewards. In a case like this, I’m a fan of going after the big tuna expenses–the stuff that’s going to move the needle the most. For Matt and Laura that’d be the following:
- Mortgage $1,494.72: As outlined above, I think it makes sense for them to go ahead and pay off their mortgage
- Groceries ($1,095.20) + Restaurants ($575.74) + Coscto ($507.72) = $2,178.66: Some savings in here will probably make sense. I get that teenagers eat a lot and that this isn’t going to be $0, but there’s likely an opportunity to bring this total down.
- Kids Clothing $252.05: I don’t have teenagers, but this seems like a lot every month? Other folks with teens, please weigh in on your advice for used/second-hand options.
- Cell Phones $209.80: time to investigate the wonderful world of MVNOs! Here’s my post explaining how: My Frugal Cell Phone Service Trick: How I Pay $10.65 A Month
They can keep going down the list, but these are the really big expenses I’d start with. The other question I have is whether or not any of their kids have part-time jobs and thus any responsibility for paying for their own clothes/cell phones/sports equipment? Just throwing it out there. Additionally, might there be an opportunity for some of the sports equipment/ski fees/etc to serve as Christmas or birthday presents? A reader-sourced article on this topic might be helpful food for thought: Reader Suggestions: How To Save Money While Raising Teenagers And Teach Them Financial Lessons In The Process
I do not have teenagers, so I know not of what I speak, but I know many readers do and I look forward to their insights.
I also want to point out that it’s obvious Matt and Laura do a fantastic job of tracking their expenses every month! The fact that they have a bunch of one-time expenses divided out over the year is a dead giveaway that they are expert expense trackers. If you’re not tracking your spending this carefully (or at all–no shame!), I recommend you find a system that works for you. I use and recommend the free expense tracking service from Personal Capital, which I explain here (affiliate link).
Sidenote: Matt and Laura should remember to factor in the increased contribution to the 529 Plans when calculating a new monthly expense rate.
- Increase monthly 529 contributions to $1,486 ($311.55 for kid #2 + $1,174.45 for kid #3). This’ll put them on a safe trajectory for achieving $140k/each by each child’s freshman year. Note: if either kid is going to college at a different point in time, Matt and Laura can adjust the number of months in the formulas I used above.
- Don’t fully fund the 529s now. Instead, spread the contributions out over the number of months until each kid enters college.
- Do something with their $396,315 in cash. If it were me, I would probably do all of the following:
- Pay off the mortgage immediately
- Set aside a six-month emergency fund
- Invest the rest in diversified total-market low-fee index funds
- Proceed with exhaustive real estate research. Consider getting mortgages on rental properties instead of paying cash (see the math in #3 for rationale).
- Retirement: Calculate their anticipated Social Security payments and adjust the variables as needed in the retirement portfolio equations outlined above.
- Tax breaks to research: Donor Advised Funds and solar.
- Expenses: determine how much more they’d like to save every month and begin by focusing on the largest expenses that’ll deliver the highest rate of return.
Ok Frugalwoods nation, what advice would you give to Matt? We’ll both reply to comments, so please feel free to ask any clarifying questions!
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