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What’s The Next Step To Financial Independence?

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A reader writes:

Hi Nords,
I have a few questions I’m hoping you can help me with. I trust your expertise in these matters. I am currently an E-8 with seven years to go until retirement. I am hoping I make it to 20 years active and can retire an E-9. I’ll be 48 years old at that point and don’t really want to work a “job-job” after that. My spouse is 10 years younger and cutting back the work hours to stay home with our two young kids. Here are my particulars:

I just boosted my TSP contribution to the max. (I was only putting in about $5K/year.) My account balance is around $55K.
We have an emergency fund. We have a $14K vehicle loan, which is our only consumer debt. We have an additional $30K in savings that we could use to pay off the loan or for a home down payment.
We have a mortgage on our primary residence of $268K with about $40K in equity.
I am upside down on a rental condo (owe $96K but only worth $90K). I’m an accidental landlord and it was not bought to be a rental property. Tenants cover the mortgage. With tax breaks and depreciation we come out slightly ahead. We have 24 years left on that mortgage.

The issue: my spouse and I want to move closer to town for a better school district. (Moving won’t improve our commute.) Our spending is reasonable yet could be better. I’m reading a lot of early retirement blogs and I can see ways we can cut back without impacting our lifestyle dramatically. However the town we want to go to is pretty expensive and our property tax will rise by $2500/year.

Our questions:
1. Is moving worth it? We will probably end up with a house in the $250-$300K range and hopefully put about $50K down. That would leave a mortgage of $200-$250K. In a perfect world I’d like to pay that off before I retire. Then again, I don’t know that we’d stay there for much longer than the kids are in school so would it even make sense to try and pay it off early or try to do a 15 year mortgage? Would it make sense to reduce my TSP contributions and put that money towards the mortgage regardless of whether we move or stay put?

2. Am I better off investing in an after-tax account considering I might have to start taking withdrawals before age 59.5, or should I stick with TSP?

I think we can live on my retirement income if the house was paid off (or close to it).

Just by asking these questions (and doing the analysis) you’ll be on track. When you retire, your pension will probably cover most of your expenses and you’ll withdraw about 4% of your portfolio each year to cover the rest.

The “worst case” is that in seven years you’ll be handling the childcare if your spouse wants to boost their work hours. As the kids grow older, you’ll have more hours to devote to your own part-time work or even (if you’re interested) a bridge career. You have the knowledge & experience to turn your skills & interests into employment income (if you want to) or to keep your spending in line with your assets. The key is having the time (and energy) to make it happen.

Maximize your retirement contributions

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For the next 6-7 years, keep maximizing your Roth TSP contributions. Much of your military compensation is untaxed, so right now you’re in what may be the lowest tax bracket of your life. (Especially if you retire to a military pension and you two boost your employment income with part-time jobs or bridge careers.) The next seven years are your last chance to contribute to the Roth TSP for the world’s biggest passive index funds with the world’s lowest expense ratios. After the six-year point you can decide whether to boost your savings for a transition fund or whether to keep contributing to the Roth TSP.

The next priority would be your two Roth IRAs— and again you’d try to maximize your contributions.

While you’re earning a military paycheck you can take a 10-year view of the stock market. I’d stick to the C, S, & I funds or just put it all in the L2050 fund. Your Roth IRAs and your after-tax account could be invested in similar funds or just the financial company’s total stock market fund.

If the interest rate on your vehicle loan is below 3% then I wouldn’t be in a rush to pay it off. You’d want to drive the vehicle into the ground, of course, but you already have an emergency fund and (if needed) a replacement vehicle fund. That $30K should handle any repair surprises on the rental condo or a tenant vacancy, too.

If the interest rate on your home mortgage is below 5%, and if you guys can sleep comfortably at night, then I’d keep it. If you’re thinking of moving then there’s no reason to put money against a loan that might be paid off during the sale.

If you’re a happy landlord then keep the rental for as long as you’re motivated. If you screen for good tenants (and occasionally raise the rent) then property values may eventually float you back above the mortgage balance. Keep in mind when you sell a rental property that, along with all the other sale and closing costs, you’ll owe a depreciation recapture tax at 25% of the amount you’ve depreciated. The IRS assumes you’ve been depreciating it anyway, so that’s just the payback for the tax break.

Rental property tends to appreciate at about the rate of inflation, so the only way to boost your cash flow is to reduce the expenses or raise the rent. Sell the rental property as soon as you’ve had enough.

Answers to your questions:

1. If moving to a better neighborhood (school district) makes you happier then you should move, but there will be a financial cost to your happiness. Research shows that moving to a neighborhood with better friends for your kids can generally improve their school performance and life skills. However the downside is that you’ll end up working longer to pay for it.

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On the financial side I’d look at getting a low-interest fixed-rate 30-year mortgage under 5% and making the minimum principal & interest payments. Keep investing in the TSP and your Roth IRAs, preferably in equities for higher returns. Again I wouldn’t accelerate a mortgage payoff if you’re not sure that you’re staying there after your kids finish high school. Your TSP and Roth IRA returns will probably be at least 5% APY, which will grow your wealth faster than you could pay down the mortgage or build equity.

However you could also take a good hard look at “improving” your current neighborhood. For example, does your current school have gifted/talented programs or advanced math/reading tracks? Does the high school offer AP classes for college prep? Could you get a geographic exception to attend school in a different district (for a specific course or extracurricular activity) while living in your current neighborhood? Could you fill in the school’s educational gaps with tutoring services like Kumon or homeschool curriculum or Khan Academy videos? Could you influence your kids’ choices in friends by getting them involved in sports leagues or Scouting or YMCA? Even if you drove to more activities, it might still be cheaper than higher property taxes.

I think involved parents can have a greater impact on student performance (and friend choices) than the school. Although the other school may look better on paper, it’s difficult to tell whether the grass is really greener or if you’ll simply trade one set of problems for another.

The important factor is that you, your spouse, and your kids all support the decision. If your kids (or your spouse) are fighting you on the school choice then the money doesn’t matter.

By the way, if you’re pretty confident that you’ll be spending seven more years on active duty then you should make a decision on transferring your GI Bill benefits to your spouse or your kids. College is their problem, not yours, but if you’re going to stay on active duty anyway then that’s a nice benefit.

2. Keep maximizing your contributions to the Roth TSP, then your Roth IRAs (passive index funds), and then your taxable accounts. Between ages 48-59.5 you’ll be able to withdraw the contributions from your Roth IRAs (if necessary)– no taxes or penalties. After retirement you’ll also be able to roll your Roth TSP into a Roth IRA, and then five years after that rollover you can start withdrawing the amount that you rolled over– free of penalties and taxes.

Everybody worries about this issue before retirement, and they pile up their savings in taxable accounts or even cash instead of the Roth TSP and Roth IRAs. But the reality is that they retire to a pension and/or a bridge career and don’t need the money which could have compounded tax-free. There are plenty of tax-free and penalty-free ways to tap TSP and IRA funds during that 11.5 years after you retire, but it’s not likely that you’ll need to do more than an occasional withdrawal of a Roth IRA contribution.

I’d save the real estate investing until you’re retired and have the landlording time. For the next seven years you could read up on the subject and decide whether you want to pursue it, but you’d hate to acquire a half-dozen rental properties in your local area and then move to a different part of the country.

In the long term (over 10 years) I think it’s better to keep a 30-year mortgage below 5% and keep investing in a high-equity portfolio (which will earn at least 5% APY). The key to this strategy is reliable retirement income (your military pension) which guarantees that you’ll be able to pay the mortgage. Meanwhile your investments will continue to grow through the volatility of both bear & bull markets. (Personally, I’ll be making mortgage payments on our home & rental property until I’m 80 years old.) However it’s also critical that you and your spouse be able to sleep well at night. That type of emotional comfort comes at a financial price.

By the way, your spouse’s gender and age difference can make a compelling financial case to purchase the full amount of Survivor Benefit Plan at retirement. You’ll pay a premium of 6.5%/month of your pension for 30 years but the mortality statistics say that the survivor will receive far more after you’re gone. Between the 55% of your pension and Social Security, you may not want any other insurance on your spouse or your minor kids.

If you’re seeking more resources, I’d recommend Early-Retirement.org and the MrMoneyMustache forums. The latter group is extremely good at challenging wasteful spending and there are quite a few landlords posting to the property threads. You might also want to join the Facebook group “Personal Finance For Military Service Members And Families”. These questions come up all the time there, and at least two of the members are military retirees with fee-only CFP practices.

A few days later I received this note:

I just wanted to say thank you. This was way more in-depth than I expected and was exactly what I was looking for. Everyone’s situation is unique, and I appreciate that you took the time to really read my situation and questions. Dave Ramsey’s advice wasn’t quite ringing true with me :).

I’m happy to help!

Readers: any other suggestions?

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Related articles:
Early Withdrawals From Your TSP and IRA After The Military
Covering A Mortgage In Retirement
Hedging Inflation With A Mortgage
Should I Use A Financial Advisor Or The Thrift Savings Plan?
Don’t Buy A Home On Active Duty

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