How can I optimize on my post-graduate financial situation?
I just recently graduated from a nurse anesthesia program in Los Angeles. I was hoping to get some guidance on how to optimize my financial situation. Here's the background:
Student Loan Debt: $120,000 that's been refinanced/consolidated to ~3%
Monthly Student Loan Payment: $1800/month
Date I will be free of this debt: ~October 2022
Gross Salary: $182,000
403b/457b Contributions ($18,000 each): $36,000
Pension Contributions: $14,000
Net Income: $132,000
I live in the beach community as it is very close to the hospital that I work. I am trying to figure out whether or not it makes sense for me to buy a condo. Considering that the local real estate market is booming and rent is increasing by ~6-8%/year, it seems as though it would behoove me to move into a 1 bed/1 bath condo. I've used the NYTimes Rent vs. Buy calculator and have come up with a variety of scenarios that seem to point in the direction of buying property since rent is so high and continues to rise in this area.
However, in order to buy a condo, I'd have to liquidate a significant portion of my 403(b) along with my savings in order to make a down payment of 15-20%. My question is whether this is a wise choice as it's my understanding if we look at the 30-year return rate from the market, it's ~10% while real estate (as a whole) doesn't generate as great a return. My biggest concern is becoming "house-poor" if I have to buy a condo, but at the same time, I'm also concerned that if I wait, I may end up being priced out of where I live because of the rising rents in the area.
Any tips/advice would be greatly appreciated.
Thank you for providing detailed information on your situation. It helps me to provide a more detailed response.
Your situation seems complex, so I will give you some things to think about. But ultimately, you should meet with a financial planner and your CPA to get specific information for your situation—so you can know the tradeoffs you’re making and the tax ramifications of your investment decisions. From the information you provided, I think your intuition that your “biggest concern is becoming house poor” is correct for your situation. I would consider taking the steps below to save for the down payment. As difficult as it may sound, I would recommend not using your 403(b) account for the down payment, and waiting until you save enough money for it instead.
- Determine what your price range is for the 1-bedroom condo
- Create a savings goal for your down payment
- Potentially change your savings plan to decrease the amount you are saving in your 457 to save more for your down payment in a savings account
- Keep the down payment funds in cash/money market accounts so that you are not affected by the stock market.
- Review your current monthly spending to determine how much you spend in the big categories (housing, retirement savings, car, student loans, vacation, eating out, insurance, etc.). Then you can create a projected budget if you were to purchase a home.
I don’t recommend using your 403(b) as a down payment vehicle because you would be taxed on the distribution and decrease your long-term retirement savings. If you were to take funds from your 403(b) plan as a hardship distribution, the distribution would be added to your earned income and be fully taxable to you by Federal and State taxes, which I estimate to be close to 35% of the distribution. For example, if you took a $100,000 distribution, you would need to come up with $35,000 in cash for your tax bill next April to pay these taxes on the distribution.
In addition, you would most likely not be able to contribute to your 403(b) for a 6-month period (best to check with you plan administrator). You potentially could take a loan on your 403(b) plan, but then you would increase your total loan amounts, which is why I think a loan on your 403b or 457 is counter-productive. Taking funds from your 403(b) will significantly decrease your long-term retirement balance because you’re not allowing the invested funds to compound over the next 30 years.
As an example, I searched the price ranges for a 1-bedroom condo in the Marina del Rey area, which is a fairly large range of $450,000 - $750,000. Let’s take the example of the 1-bedroom condo for $750,000. A 15% down payment would be $112,000. A 30-year mortgage at a 4% interest rate will cost $3,039 a month. Property tax and insurance will cost approximately another $1,000 a month. HOA fees might cost $500-$1,000 a month. This creates a total expense of $54,000 -$60,000 a year in total payments for the condo.
What is your current savings account balance set aside for a home purchase? Remember to set aside funds for moving, appliances and potential furniture. How much have you been saving outside of your retirement account for the down payment? You could potentially decrease your 457 contribution to increase the amount you can save for the down payment. Check to see if the 457 plan matches your contribution. Don’t go below the match percentage. Decrease your 403(b) plan contribution next.
Rent vs. Buy Calculator
I’ve used this calculator also and it’s pretty thorough. The one big downside to this calculator for your situation is that it assumes you have the down payment in cash. If you would need to cash out a significant amount of your 403(b) plan, this would increase the cost of the capital and would potentially change the recommendation to buy or rent.
Real Estate vs. Stock Market Return
The growth rates of real estate and the stock markets are going to fluctuate. I agree with you that rents and home prices in Marina del Rey and the surrounding area have been pretty dramatic. I lived in Santa Monica for two years and now live in Long Beach, so I’ve definitely seen the housing market get fairly crazy in the area. It may seem like a race to buy something, but the growth rates will slow down and even decrease at some point once we go through our next recession. I would recommend that you change your savings plan to build up the cash savings for the down payment and be patient. Don’t let the race to “get in” force you to buy something when you are not quite ready, especially while you have a large student loan payment.
The best advice I can give you is to meet with a financial planner and CPA. They can provide you with an outside prospective, and help you to understand your options better and create a savings plan to meet your goals.
Congratulations on the education and the job. You are asking the right questions for certain, but I would add one caveat. I spent 7 years teaching financial planning to seniors at Purdue who were for the most part encouraged by parents to purchase a home as soon as possible. It took a lot of convincing, but I usually got them to understand that’s not always the best answer.
First rule is that if you don’t think you will live there longer than seven years then I would consider being part of the renting community. Yes rent goes up, but so do taxes and upkeep. Between the commission to buy and the challenges and expenses with liquidation, seven years seems to be the magic in how long you should anticipate living in an area before buying.
There was no mention of a spouse and many times you will meet someone who already has property or who doesn’t want to live in a place you bought on your own. Not always the case, but certainly a consideration. Kids would have a hard time fitting into the 1 bedroom place as well.
If you are single, your top marginal tax bracket is over 25%. Any money you take from your 403b will be met with a 10% penalty followed by taxation (and this is only on the federal level) of 25% or more and could be as much as 39.6%. It would be said to pull out a dollar to get $.50! That would pay a lot of increased rent over the years.
First off...You are to be commended for maximizing your contributions to your retirement plans. That will pay off significantly for you.
Regarding your home purchase...It's rare that I see a situation where renting makes more sense than buying. If you are not in a profession that requires you to relocate frequently, it typically is a wise financial choice. You are in a high tax bracket, and the tax benefits alone would seem to tip the scales in favor of a purchase, especially if the cost of renting is growing at a 6 - 8% clip.
Disregard the comparison of your retirement plan returns vs. real estate returns. That is a flawed approach in your case.
The primary question appears to be...how to fund the down payment. I am not a fan of taking distributions from tax deferred retirement savings to purchase a home. Since your contributions are $18,000 and not $24,000, I have to assume you are not age 59.5. Thus your 403(b) distribution would be subject to a 10% early withdrawal penalty, and both the 403(b) and 457(b) distributions would be subject to federal income taxes. That's a hefty price to pay to gain access to your money. Not to mention the effect it will have on your future retirement.
My suggestion would be to do the following in this order:
1. Make sure you have a "portable" Long Term Disability policy in place to protect your most important asset...your ability to generate income.
2. Set aside an emergency fund of (4 - 6) months of fixed recurring monthly expenses. You are in a high demand profession, so the (8 - 10 months) you see in the media is not necessary.
3. Begin saving for your down payment (not including your emergency fund) in a taxable savings account or brokerage account.
It makes sense to purchase...but the time is not right now. Still some work to be done. Rent is rising now, but everything runs in cycles. The wait may benefit you.
You've already shown that you are disciplined and responsible with your retirement savings. Stay on that same track with the home purchase.
Right now...The buffer is more important.
The decision on whether to buy or rent involves consideration of variables such as whether your current employment is secure? Are you likely to relocate making the sale of a tangible asset such as real estate a more complex consideration? Can you obtain financing that is favorable? Is the housing market there over bought and are prices high relative to historical valuations?
It seems as though you feel the timing may be appropriate to purchase versus buy and that rents are rising. You are also wise to not think of residential real estate as an investment. One can be lucky with residential real estate but, in most instances, it is best to think of this as a quality of life decision with some possible and increasingly less significant tax advantages. You could borrow from the 403b (check with your plan administrator for options) for the down payment and also liquidate low yielding savings. It is best to try to build up liquid reserves for the down payment, of course. Consider the condo fees and any potential assessments that may be down the road. Housing is expensive when you factor in utilities, furnishings, maintenance, taxes and the house payment. Be smart about staying within a budget you can easily afford given your income.
Charlotte Dougherty is a registered representative of Lincoln Financial Advisors a broker/dealer (Member SIPC) and a registered investment advisor. CRN-1519506-060716