Intermediate Savings???

[Sock_It_Away]

OK...

Annual contributions are maxed out into the 401K and Roth IRAs...  Now what?  Taxable Vehicles?

What do people do for an intermediate savings account?  I am looking to contribute money into an account that is used for large purchases (Cars, vacations, school, kids, etc)  I want a little bang for my buck and feel as if I can afford a little risk.  All this while stepping towards my goal, ER.

I am 28 with 40 K in my 401K and just started the Roth IRA.  I have extra cash flow and am wondering if it is best served in building equity into the house or investing it elsewhere.

hmmmm.    

 

[cute fuzzy bunny]

Options:

ING direct offers 2% on their money market accounts

Vanguards Short Term Corporate Bond fund is paying nearly 3% with not a lot more risk than a MM

Paying down your mortgage gives you a guaranteed return of whatever your mortgage costs

Apply for a home equity line of credit at a credit union or ING to use for surprise big purchases. The interest is usually deductible and my current HELOC rate is 4%

Sock the extra money away in a taxable account at a cheap investment house like vanguard in a broad index, a lifestrategy or target retirement account


I think the standard well accepted order of things is:

- Pay down high interest debt
- Max out pre tax options at work
- Do the Roth
- Consider paying down other low interest debt
- Maintain a "safe" cash buffer in a MM or the short term corp acct
- Alternative to maintaining a large cash buffer for emergencies is a HELOC
- Invest the rest in a taxable account

 

[Bob_Smith]

We have the same situation. We max out retirement plans and the rest goes into taxable accounts. After 13 years of investing, we have enough in taxable accounts to meet our needs for 10 years. We view both taxable and retirement accounts as one portfolio in terms of asset allocation. We keep most of the taxable money in a joint account at Vanguard, but I just bought two CDs at Penfed (4.5% for four years and 5.25% for five years), and I have some cash for immediate needs at ING earning 2%.

 

[BigMoneyJim]

What do people do for an intermediate savings account?

I'm planning on a Vanguard MM fund for my emergency fund and short term savings. (I'm in the final months of eliminating debt right now.) Once I'm happy with cash reserves I plan on replicating my pretax investment mix in my aftertax accounts, although I'm recently noticing I may be missing an in between investment option.

Of course I am also listening to other ideas as they come up here.

Oh boy! You asked the magic mortgage question. That and the rent vs. buy topic are periodic topics on early retirement boards. The most recent "pay off the mortgage?" discussion is in this thread. I'm presuming "pay down the mortgage" and "pay off the mortgage" are interrelated if not interchangeable.

 

[unclemick]

? short to five yrs - MM or CDs.

? five to ten yrs - vg. short term corporate or GNMA.

? at ten yrs - maybe vg tax managed growth and income.

Just some thoughts.

 

[Sock_It_Away]

Thanks for the tips... As always, I have more homework to do.

BTW, Firecalc yielded me about 2800 annually if I was to ER now... a wee bit too early I am afraid.

SiA

 

[cute fuzzy bunny]

Not if you can snag a spouse that still enjoys their work

 

[John Galt]

A workin' wife is more valuable than a pumpin' oil well!

John Galt

 

[Skylark]

TH wrote:

I think the standard well accepted order of things is:

- Pay down high interest debt
- Max out pre tax options at work
- Do the Roth
- Consider paying down other low interest debt
- Maintain a "safe" cash buffer in a MM or the short term corp acct
- Alternative to maintaining a large cash buffer for emergencies is a HELOC
- Invest the rest in a taxable account

This is a good list (although I don't know what HELOC is). I'm trying to do all of these at the same time (except HELOC), but focusing my resources on the top items first.

Remember that someone at age 28 may have a different viewpoint on 401k and Roth plans due to pre-retirement age withdrawal penalties. I would still try to max out the 401k but recognize that there may be a point when you should shift from the 401k to taxable investments.

You may want to calculate the future value of your 401k at the time when you become eligible for no-penalty withdrawal. Is it enough to live on for the 30 years or so (or however many years you estimate) that you might expect to live after you become eligible to withdraw? If so, stop contributing to the 401k and shift to other investments.

You may want to review the early-withdrawal penalties of a 401k and compare the results to a taxable investment. Be aware that laws and regulations change. The 401k is a great deal but you are gambling on future government policies. At age 28, there is time for a lot of water to pass under the bridge before you are going to want to cash in, and no one knows what type of government the people will vote in by the time you are ready to start cashing in your hard earned 401k.

Capital gains will be an important consideration in selecting a taxable investment. I believe the index funds limit your capital gains due to fund churning (not sure about this).

We are talking Early Retirement strategies here, trying to buy some years of freedom before the normal retirement age. And marrying a working wife is not real Early Retirement! A good conservative plan is to save your old used dryer sheets. I have found that when rolled tightly, I can fit almost 500 in a mason jar, and they should last indefinitely buried in the back yard. In the future they may be used as the new currency, and you will have a great feeling of satisfaction knowing that you can always go make a withdrawal from your backyard savings account!

 

[Sock_It_Away]

Fortunately for me, we have enough cash flow monthly to max the 401K and IRAs while pouring some into taxable accounts. The only debt we have is in our mortgage.

I guess a possible goal is to maintain the maxing out of the IRAs and 401K while building enough in taxable accounts to ER and not have to pay early withdrawl penalties on the tax-deferred stuff.

I am leaning towards a cash reserve in a MM and accepting some risk with an Index fund or two.

Good information everyone... thanks!

SiA

PS: TH, what is a HELOC?

 

[wzd]

HELOC is a home equity line of credit. And I agree that it is a good alternative to keeping lots of cash on hand when building investments, although that is not the conventional wisdom. Especially for two earner households.

I think the paydown of mortgage may make sense for those in the withdrawal phase, but would question it for those in the accumulation phase. Especially with todays low rates.

My savings goal was 25% of my pay - I tried to keep it coming out before I saw it and acted as if I really made what was left. I didn't have a real retirement plan till the company came out with a buyout/early retirement offer, but the LBYM strategy of 25% savings had positioned me to take it. It sounds like your savings are in the same ballpark. It took me to age 48 (25 years with the same company). I could have probably done it sooner without the buyout bonus had a divorce, and later remarriage thrown a little delay in. So, I would say that with your savings goal you should be well postioned when the time comes to retire.

Wayne

 

[BigMoneyJim]

Remember that someone at age 28 may have a different viewpoint on 401k and Roth plans due to pre-retirement age withdrawal penalties. I would still try to max out the 401k but recognize that there may be a point when you should shift from the 401k to taxable investments.

Good point; that's something I was wondering about myself. I've been holding off on asking about it until I run some numbers and come up with specific scenarios.

I also wondered about TH's list putting emergency cash priority after maxing out pre-tax accounts and a Roth. On a balance sheet it comes out better, but if you have an emergency and take the 10% penalty plus raise your taxable income . . .

Okay, I'm stopping myself there. Now that I am preparing to transition from debt elimination to wealth accumulation I find myself worrying about all the possible ways I could screw it up and all the bad things that could happen to the savings. In fact I'm worrying a lot more now than when I had $20k of CC debt and had $20k less in my pretax accounts. I'm up $40k and worrying more?

I should start thinking of wealth like insurance: It doesn't stop bad things from hurting you; it stops bad financial things from wiping you out.

 

[unclemick]

Maxed out 401k and IRA (no roth is those days) - that was 'never' money - never to be seen or touched.

Paycheck to paycheck on the rest, including taxable investments, any reserve savings, AND some CC lapses/payoffs over the years.

ER'd at 49, lived off taxable/rental/savings/pension at 55 and now at 60 thinking about tapping 401k/IRA rollover.

Hindsight - the earliest $ were the best, time in the market, not market timing (this includes a slightly lower growth period 1966-1982).

 

[cute fuzzy bunny]

I also wondered about TH's list putting emergency cash priority after maxing out pre-tax accounts and a Roth. On a balance sheet it comes out better, but if you have an emergency and take the 10% penalty plus raise your taxable income . . .

Thats because the emergency cash buffer (I think) is mostly a tool to buffer out a large investment portfolio to prevent yourself from having to sell when you dont want to sell to service an emergency or to continue to pay the bills.

Even in that instance I think its more of a psychological benefit than a real one. I keep about 8k between me and the portfolio, and I have about 5% of the port in the short term corp account that I keep draining to keep that 8k in place. The short term corp account is fed all the dividends and capital gains from the rest of my taxable investments.

The HELOC (at least now at 4%) is the best "emergency buffer" around, it costs nothing if you dont use it, and doesnt create a scenario where you're holding significant cash doing nothing, making next to nothing on it.

I also remember living hand to mouth, and putting your investments ahead of a fat savings account and maintaining the same lifestyle has a benefit. Low temptation. I can think of a lot of folks that lived hand to mouth, dug themselves out of the hole, put some money away, felt good, and then splurged it on something.

Lastly, I cant think of too many bona fide emergencies that would cause me to have to yank 5-10k out of a bank account in under a day or two that wasnt accompanied by someone willing to lend me the money

 

[John Galt]

I agree that a low interest HELOC is one of the best
"emergency funds" you can have. In my case, I also
have large CC availability which could be tapped.
Of course, there is the issue of those pesky interest
rates.

John Galt

 

[Sock_It_Away]

I too looked at my CC limits as "emergency" dollars. If worse came to worse, you can float balances between CCs and usually get a lengthy intro rate at 0%.

I am still not quite sure I understand the HELOC. Is it essentially dumping money into building equity in your house?

 

[JWR1945]

For many people, an emergency fund is used to cover expenses when there is a job loss. Guess what happens when you try to borrow money but don't have a job? Home equity lines of credit are great for some people but not for others. It depends upon one's personal circumstances.

Have fun.

John R.

 

[BigMoneyJim]

I also remember living hand to mouth, and putting your investments ahead of a fat savings account and maintaining the same lifestyle has a benefit. Low temptation. I can think of a lot of folks that lived hand to mouth, dug themselves out of the hole, put some money away, felt good, and then splurged it on something.

Lastly, I cant think of too many bona fide emergencies that would cause me to have to yank 5-10k out of a bank account in under a day or two that wasnt accompanied by someone willing to lend me the money

Very good points, even the ones I didn't quote are good.

Since I've been living 1000 miles away from my relatives while attacking my debt I've had in mind that an unsued CC would be used for moving expenses if I lost my job, followed by a later assessment of how to deal with the CC bill. (Job? Savings? Relative?) I suppose the same plan works whether I'm $20k in debt with a nest egg versus no debt, no cash and a nest egg. I just hadn't looked at it that way before.

Furthermore, I have a history of raiding after-tax savings accounts. To tell the truth, a few months ago I had $1k cash in my savings account, but now I have about $250 and I'm about to raid it again.

During my tightest times and largest debt I was eyeing the 401(k) as an easy if painful solution, but after doing the tax/penalty calculations combined with the tax-deferred opportunity loss I couldn't bring myself to do it.

So if I have, say, $15k in the bank and see that 52" plasma TV on sale or a shiny 3-year old convertible I may find myself justifying the expense as opposed to if most of that money was in my 401(k).

And again you're right about loans. My relatives have a ring of "my debt is on your credit card" going. My CC debt is actually on my grandfather's special offer card to keep the interest low. Surprisingly we haven't had any financial squabbles you always hear about in families. But the point is why would my relatives be less likely to loan me money when I am debt free with boocoo's of money in the bank than when I have $20k debt already? (Yes, I know it's beaucoup and used wrong, but I'm throwing in some Texan dialect; John Galt needs to learn sooner or later.)

 

[cute fuzzy bunny]

I too looked at my CC limits as "emergency" dollars. If worse came to worse, you can float balances between CCs and usually get a lengthy intro rate at 0%.

I am still not quite sure I understand the HELOC. Is it essentially dumping money into building equity in your house?

I have the same thing. Two $10,000 limit cards that cost me nothing to have sit in my desk drawer.

For me an emergency is something that needs a lot of money suddenly, or a fair bit over a moderate period of time.

Realistically, not a lot of big money, big urgency emergencies happen very often, and the longer term thing would probably only kick in if someone lost their job. Come on now, there is no reason to be unemployed for a long time and my worst unemployment was just a couple of weeks. I did some crap jobs, but those are better than sitting at home moping about.

The HELOC is simple. Its a mortgage on the equity you hold in your house over and above your current mortgage (if any). Say you own a $200,000 house and have a $100,000 mortgage balance. A bank or credit union will write you a HELOC for up to 100k (the equity balance). Usually is a zero closing cost, zero out of pocket cost item. You get a "credit card" or a "check book" with this. If you need it, you use the card or checkbook, or request via phone or web a transfer of money from the HELOC to your checking account. You have money. Off you go. From that month forward, you are charged (currently) 4% annual interest on the open balance, and you'll have a minimum monthly payment. Its exactly like a credit card, only lower interest, secured by your home. Like your mortgage, if you fail to make your payments, eventually you lose your house. Like a mortgage, the interest you pay is usually tax deductible.

Hence, a perfect short to medium term emergency fund.

 

[wzd]

For many people, an emergency fund is used to cover expenses when there is a job loss. Guess what happens when you try to borrow money but don't have a job? Home equity lines of credit are great for some people but not for others. It depends upon one's personal circumstances.

It was left unsaid, but a HELOC must be in place before you need it due to the job loss or other emergency. Mostly $0 cost to set up in todays markets. I have one for $50k, and have used $10k in the past (for emergency building repairs). But it is there, approved, and I can draw on it anytime I want. I set it up before I retired.

Wayne

 

[Sock_It_Away]

The HELOC is simple.  Its a mortgage on the equity you hold in your house over and above your current mortgage (if any).  Say you own a $200,000 house and have a $100,000 mortgage balance.  A bank or credit union will write you a HELOC for up to 100k (the equity balance).  

So its not just the equity from paying down your mortgage and takes into account your house's rising (hopefully) value.  This is good as I am in my first home for just over a year and just refinanced from a 30 yr fixed (6.625) to a 5/1 ARM (4.125).  In that time, I have not contributed much equity wise but the appraisel came back about 50K higher than when we moved in.

Interesting stuff.

BTW, the refi is giving me 500 dollars extra a month in these important early contribution years.  

-SiA

 

[cute fuzzy bunny]

Yep its important to have it in place up front, before the "emergency". I've had 100k on my old house and 100k on this one. I used the 100k on the old house as a partial payment to buy the new one so I didnt have to cash out a lot of investments to pay cash for this place prior to selling the old place. Then when the old place sold a few months later, I paid off the HELOC. My cost was about $375 worth of interest, all tax deductible.

sockit...the only thing you have to mind is if your value has gone up and you DONT have a recent appraisal, the bank may ask for one to do a heloc over the amount of last appraisal.

Also, if you hold a current first mortgage, there may be some extra paperwork if you dont do the HELOC with the same company. Since you deeded the house to the mortgage company in case you default, adding a second bank as a HELOC provider means they have partial interest in the same property. For your primary mortgage holder to seize and sell it, they need to pay off the secondary holder (or vice versa). You are also at the mercy of the stronger of the two companies foreclosure requirements in the event of default.

Since I've only had a primary mortgage for two out of the last 19 years, hasnt been a problem for me.

The structure of the heloc is usually that you have a 15 year "draw period" to use it as a revolving line of credit, then it stops being a withdrawal vehicle and you have an additional 10 years to finish paying it off. So its sort of like a 25 year mortgage. Once you get past the 15 year draw period, you can renegotiate the HELOC for a fresh draw period, sort of a refinancing.

Most HELOC's allow conversion to a fixed mortgage. Mine allows me to "lock a rate" on an amount up to four times during the draw period at a rate of about prime+2 (roughly 6% today). My girlfriends allows a single lock for prime + the current 3 year treasury rate (again about 6% today). This is handy if a few years in you need to pull $25k for some major house renovation project and are concerned that rates may rise during your payback period.

The only other really big things to look at other than rates, terms and locks are caps. I see one HELOC with a 2% maximum annual raise, done once a year, with a cap of 9%, and I see another with a 2% maximum annual raise, done monthly, with a cap of 18%. Same rates and terms. The former is obviously a better buy unless you think rates will go lower still and stay there for the term of your payback. Pretty unlikely.

 

[Sock_It_Away]

sockit...the only thing you have to mind is if your value has gone up and you DONT have a recent appraisal, the bank may ask for one to do a heloc over the amount of last appraisal.

A new appraisal was necessary for the refi...
Thanks for all the good information... especially the tip on the CAPs.

 

[zbwmy]

What about the education (coverdale) account?