I recently met with potential clients who are not on track for retirement. In addition to funding their retirement, they would like to help fund their children’s college education and purchase a new home. They were planning to save everything they can for a new home they would like to purchase in 2 years. After that has been accomplished, they will worry about everything else. This does not appear to be the best use of their money.
They currently have enough equity in their current home to put 20% down on the new property, but they want to save more so that they will have a lower monthly payment. I told them that it is more important to maximize their 401k over these next two years instead of focusing on lowering their future mortgage payments.
The first reason is that they are way behind on their retirement funding and need to start saving as much as possible toward retirement or face the reality of living on Social Security or not retiring at all. Having additional equity in their home will not help them generate the income they need in retirement.
Second, the additional down payment will not significantly lower their monthly payment on the new mortgage. If they contribute $18,500 per year for the next two years, that will be $37,000 contributed. If they put $37,000 down on their new home at 4.75% interest for 30 years, their payment will be lowered by $193.01. In contrast, at the 22% tax bracket the 401k savings will lower their federal taxes by $339.16 per month.
Finally, the client told me that they spend everything that comes into their bank account. Since the 401k savings will have been taken out before they get paid, this seems like it is something they should take advantage of. Based on pending their entire pay check, it is unlikely that they will save the same amount for their new home as they would have put away in the 401k.
In an ideal scenario, I would like for them to save money in a Roth IRA as well since this can create tax free income in the future. However, since I am just getting to know them, I don’t want to risk the potential savings being spent. Especially since they are behind in their retirement savings.