Looking for advice on cash flow, considering going to one income

[laurence]

Hey everyone, long time member, mostly lurk now. Quick summary, I'm about to turn 41, my wife is 39, and over the last five years our income has ramped up, now we combine for about $300k. We have been plowing the legal max into our 401(k) plans for some time, but just have the basic six months living in after tax/cash accounts. We live in San Diego and have a primary residence and a rental property, and our only debt is against them.

Recently my DW and I have talked about working towards one of us staying home - me since I make less - as it would remove a lot of stress. We think the earliest we could make it happen is five years from now. We have three young daughters and even though five years is a ways from now we'd have someone home for late elementary, junior high, and high school years for the two younger ones (our oldest has special needs, different path). We think in five years the amount in retirement accounts will be sufficient that just her maxing the 401k alone from then on will still give us a sufficient nest egg for her to retire at 55, so this isn't a request for investment help. It's a matter of lowering risk and cash flow issues:

We owe $240k @ 4.5% on the rental - the renters cover the mortgage plus a couple hundred positive cash flow on top. We owe $380k @ 3.5% on the primary house first mortgage and $90k @ 4% on the second (used to put down payment on the rental).

My thought is on top of continuing to max our 401k plans, we work to pay off the rental, which I think we can do in five years. Then the rental income will cover the primary mortgage and impound account. Then we'll just pay off the second slowly when we are down to one income. It seems like a good plan, but anything I'm missing? We toyed with selling the condo as it's worth much more and rising, but the tax implications made that less attractive. Thoughts? Thanks, everyone.

 

[REWahoo]

Hey Laurence! Nice to see you posting here again.

So the question is, which mortgage do I pay off early?

I like your current plan.

 

[laurence]

Hey Laurence! Nice to see you posting here again.

So the question is, which mortgage do I pay off early?

I like your current plan.

I was NOT trying to start that debate again! I do feel like housing prices have to stop going up, but what do I know? Recently they started building condos down the street from me, nice neighborhood but not glamorous by any stretch. $500k. For 1500-2000 square foot attached three story row house (1st floor is the garage). And just about every unit has a "Sorry, I'm sold!" sign in the window. The average household income in my area is something like $70k

 

[pb4uski]

If it were me I would plow money into the taxable accounts rather than pay down 3.5-4.5% mortgages, but whatever makes you more comfortable. Five years is a long time and your plans may change... if your plans don[t change and you decide to quit work and you want to reduce your risk then you can always then use the taxable account balances to pay down/off the mortgages.

 

[Animorph]

Don't limit yourself to saving only in a 401k account. I would target a savings amount first and then figure out where to put it. Nothing wrong with putting retirement funds into a normal taxable brokerage account. It is also then available as part of your emergency funds, as long as the emergency isn't a portfolio crash. Paying off the mortgages is OK if you are targeting a 4% long-term return for a substantial portion of your portfolio.

 

[laurence]

Sure, but is everyone 100% equities at this point? Holding any part of a portfolio in assets that perform worse than the mortgage costs (like bonds) doesn't make sense, and part of my problem I'm trying to solve is cash flow. We increase our risk going single income. It's a lot easier to go possum living due to unexpected expenses or a lay off with no mortgage check.


EDIT: I see the angle, build up an after tax portfolio and if we really want to, pay off the condo when portfolio>mortgage balance. That's an interesting thought.

 

[heeyy_joe]

Many in your situation and State sell both places and go live in Texas.

 

[Golden sunsets]

I have a hard time understanding why you would quit working at such a young age when you are not FI yet? Or did I miss something?

 

[samclem]

Sure, but is everyone 100% equities at this point? Holding any part of a portfolio in assets that perform worse than the mortgage costs (like bonds) doesn't make sense. . .

The bonds/cash in the overall AA dampen the ups and downs and make owning equities practical from a "sleep at night" perspective for many people. So, if the portfolio >as a whole< is expected to return more (real, after tax) than the mortgage costs (real, after tax), it makes sense to keep the mortgage.
Also, if having a mortgage means a family can have a higher amount of liquid savings on hand, that could be a very handy thing if the paychecks stop unexpectedly. Once the paychecks stop, it is more difficult to get a mortgage.
For your consideration . . .

 

[Cobra9777]

My recommendation would be: Do it all. Continue maxing out both 401Ks, pay down one or more mortgages, plus start building a taxable account. For your income level, just maxing out the two 401Ks seems like a fairly light savings rate. You indicated that paying off the rental in 5 years was doable. That's $48K/yr on top of $36K per year for the 401Ks. That implies your spend (w/ tax) is $216K/yr, which strikes me as high-ish, even for a family of 5 in San Diego. I realize taxes are pretty high at that income, but if it was me, I'd target something like $175K max spend, and start aggressively plowing the additional money into a taxable account and maybe even one or both of the other mortgages. Re-examine the lay of the land in 5 years and there should be significantly less cashflow risk associated with one of you staying at home. Or perhaps it won't take 5 years.

In our case, it was around your age that we started building the taxable account at a surprising rate. Income was increasing fast as our careers were peaking (stock options, bonuses). At the same time, expenses had flattened or decreased slightly with kids moving out. All that extra money went into the taxable account at a very substantial rate. This was on top of maxing out two 401Ks, paying for college, plus making additional principal payments against a large mortgage. Despite a fair amount of stress (job & family), I stuck it out to age 52. By then, the kids were nearly done with college and the taxable account was big enough to: (1) pay off our remaining mortgage, (2) buy two rental houses for cash, and (3) cover ER spending through age 70 when SS and RMDs begin.

I'd be hesitant to skip too much of that dual-income "sweet spot" in your 40s. For us, that's what made ER possible. If you've made up your mind to skip the second half, then I'd make the first half count, in a big way. Just my perspective.

 

[Nords]

Good to see you here again, Laurence!

Recently my DW and I have talked about working towards one of us staying home - me since I make less - as it would remove a lot of stress. We think the earliest we could make it happen is five years from now. We have three young daughters and even though five years is a ways from now we'd have someone home for late elementary, junior high, and high school years for the two younger ones (our oldest has special needs, different path). We think in five years the amount in retirement accounts will be sufficient that just her maxing the 401k alone from then on will still give us a sufficient nest egg for her to retire at 55, so this isn't a request for investment help. It's a matter of lowering risk and cash flow issues:

We owe $240k @ 4.5% on the rental - the renters cover the mortgage plus a couple hundred positive cash flow on top. We owe $380k @ 3.5% on the primary house first mortgage and $90k @ 4% on the second (used to put down payment on the rental).

My thought is on top of continuing to max our 401k plans, we work to pay off the rental, which I think we can do in five years. Then the rental income will cover the primary mortgage and impound account. Then we'll just pay off the second slowly when we are down to one income. It seems like a good plan, but anything I'm missing? We toyed with selling the condo as it's worth much more and rising, but the tax implications made that less attractive. Thoughts? Thanks, everyone.

Well, if you're going to leave your job then first you should sell your BMW.

Just kidding. Like REWahoo says, your plan looks good.

We increase our risk going single income. It's a lot easier to go possum living due to unexpected expenses or a lay off with no mortgage check.

That's the key. If you're not working and your spouse is still susceptible to layoffs (however slim the possibility) then it's better to play good defense. If the recession hits and the stock market drops 30% and then your spouse gets laid off because of the economy, you'd be pretty annoyed at your aggressive equity portfolio (and your mortgage balance).

Remember when you told me in early 2008 that our portfolio looked way more aggressive than you'd ever be comfortable with? We sold the equities in our daughter's college fund (she was 15 years old then), put it mostly into CDs, and ended up avoiding a 50% loss. By the way, thanks again!

That's the risk you avoid by paying down your mortgage(s). You're giving up some gains but you're insulating yourself from much bigger losses.

Some thoughts that you may already be taking care of:
1. You're not going to be an at-home parent who watches TV all day, does laundry, and bakes cookies. (Almost nobody is.) Your employer (or their competitors) are going to start pestering you to consult 10-20 hours/week on special projects. You'll work less than half your current hours for a little less than half your current pay, and about 1% of your current stress.
2. Are you looking at a special needs trust for your oldest?
3. When you leave your job (after maxing your 401(k) match for the year), that's your chance to roll over your 401(k) from whatever crappy high-expense funds it's in to Vanguard index funds at a fraction of the expense ratio.
4. If your spouse retires at the age of 55 then she's permitted to start tapping her 401(k)... or you could roll it over to a conventional IRA and start converting it to a Roth IRA.
5. You're going to keep raising the rent on that condo along with the rest of the rental market. Your cash flow (or your mortgage payoff rate) may actually rise. If you're paying a property manager on it now, then when you leave your full-time job you may be able to take over managing the condo.

I have a hard time understanding why you would quit working at such a young age when you are not FI yet? Or did I miss something?

Let's see: when he gives up FI for a few more years then the only things he has to gain are less stress, placing a higher priority on family, and having a better quality of life.

He'll still reach FI but at a slightly slower pace and at a much lower price on domestic harmony. And in general over the last decade, those have been his priorities all along.

Are you sure you're asking those questions on the right forum?!?

 

[daylatedollarshort]

Another option to quitting is just downshifting to something where you can work at home / work during school hours. I worked at home, mostly during school hours when our kids were in K - 12th grade.

 

[laurence]

Thanks for all the thoughtful replies, yes, I am strongly considering a related position that would allow me to work 20 hours a week on a flexible schedule (background investigator).


Nords! Yes, I think the rental rates for my condo should go up a bit over the next five years, once it's paid off the net after property taxes and insurance (so much insurance) should be over $2k/month, if I can get a 20 hour a week job that will make the hit a lot less.


Cobra, yes, I won't make excuses, our spend rate is a little high, but we only recently got to this income level, my wife only went back to work full time 3 years ago. Over the last three years we've made the choice to have a full time Nanny which was in excess of $30k/year for those three years (they really get you on taxes with Nanny help). We want to get to about 190k spend, taxes are really high for us, though, we've been phased out of a lot....