Hi,
There are several posters on this board who know lots more about this than I do, but here's my 2cents. I would put them both in level 1, but not together. If your 3rd grader has had good phonetic instruction, then he will fly through level 1(like in a month), go pretty fast through level 2(a month or two), then slow down a bit at level 3. Your 1st grader would probably be a good fit for level 1. So, in your situation I would order all 3 levels. You can find them used here on the boards, but I just ordered my level 3 from RR (and of course you can order them directly through AAS website). I am no expert on this, but have been given LOTS of advice on this board. We love AAS. My dd8 always ask to do it.