I went over understanding your spending and also free budgeting tools. Once you start managing your money better, you should be spending less than you earn. Or maybe you have come across a lump sum of money somehow. Now what do you do with the money? Although everyone’s situation is different, I think that a good discussion can evolve from this.
Here’s a list of possibilities:
- Invest in your 401(k), if you have one, up until the match.
- Pay down your high-interest credit card debt.
- Create an emergency fund with at least 2 months.
- Fully fund your Roth IRA.
- Make sure you have adequate insurance (health, disability and life insurance if you have dependents).
- Pay down any other installment loans at higher interest rates than you could get at the bank (car loans, educational loans, etc.)
- Save towards a house down payment.
- Continue to fund your 401(k) to the max.
- Pay down your mortgage.
- Invest money in taxable accounts.
- Save for your children’s education.
I put it in a rough order of what I think is a good order of things. I know many people are split over paying down credit card debt vs. creating an emergency fund. Although I’m not a debt reduction expert, I think that you should just pay down your credit card debt, as you save more money that way. In addition, as you pay your debt down your credit score will improve. If an emergency happens, just go back on the cards.
Of course, some people think funding a Roth is more important than either one. That tax-free growth is very precious, you know. See? It’s hard. What do you think?
If you want to make it short, you could express your opinion like this – “My order would be 1,4,2,3,7,5.”, adding in supporting information as you see fit.
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4,1,2. Roth all the way! I love Roth. Uncle Sam letting you compound in peace? Priceless! My dream would be for the limited to be raised to like $20,000 per year or something. Of course the goal would be to be able to do all those things at once. 🙂
Any way you save is good… The key is to start now.
Your Roth IRA is more important than an emergency fund. You can only contribute a X amount of dollars each year, once you miss that year you missed out. You can have a savings account in a Roth IRA and you can pull out the contributions anytime, thus a Roth IRA should be higher than an emergency account, since it can virtually be used for both.
I personally see all loans as the same car loan and credit card loans. I can’t say one is better than the other, as people even borrow at 0% from a credit card to buy a car. If it’s not an asset (has to appreciate) then it’s the same to me. Student loan and mortgage are really the only two exceptions.
I would agree with maxing out the Roth IRA, but maxing out the 401k might not be the best advice for everybody. With a tax efficient fund in a taxable account after a year you would only pay 15% versus income in a retirement account, plus in a taxable account you’ll have more flexibility. Therefore after maxing out a Roth IRA and putting 10% in a 401k I’d most likely recommend putting more money in a taxable account if the options are tax efficient.
There are those who think that Roth IRA will eventually be taxed, but there are also those that think the 401k will start to be taxed as well. The case is a person who lives in a state with high state taxes and then moves to a state when they retire that has no state taxes, therefore their 401k was not tax deferred, because they never ended up paying the taxes. My personal opinion is who knows, have money in a Roth, in a 401k and in a taxable account.
Probably somewhere in between 6 and 9 on that list, I’d throw in a “Pay for a nice vacation, in cash.”
A lot of people who get caught up in all this money stashing forget one important thing. Saving to live is only important if you’re actually going to live.
I always hear about how you should fund a Roth IRA, but not much past that. From what I understand, the IRA is just a container, but what can you put in it? Can I put a HSBC savings account in it?
Since the only bills I have are my mortgage and living expenses, it’s all #10 (that is, the stock market). Unless my mortgage interest isn’t benefiting me anymore in regards to tax deductions, I wouldn’t try and pay it down. The tax deductions really help out during tax time. My 401K is maxed out, and I don’t have a Roth IRA (don’t see the point yet). Yeah, I know, it’s supposed to be tax free when I retire. But, that’s what the government said about the regular IRA years ago. The government can change the rules at any time.
4, 1, 2. I totally agree with Wanda.
4,1,8…if you are like me, set out some side money to do someee ..business.
I’ve tried Wikis before, but I don’t know if we have the critical mass of people to successfully create and moderate content here.
I tend to fall on 1,2,3,4 lines as well. I totally agree however with jbo’s sentiment to remember that you can pull principle out of a Roth. That was a really important factor for me when starting.
Adequate (minimal at least) insurance probably deserves to be higher. Admittedly credit card debt is so disabling that it almost certainly has to come first, but there’s a lot to be said for a 1,2,5 order. Of course without an emergency fund, you may miss premiums just when you need your insurance.
I guess that leaves “responsible me” leaning toward 1,2,3,5,4.
There can be some tax advantages to saving for your kids education that probably push 10 before 11, too.
The 401k up to the match is potentially an instant 100% return on your money. I don’t think even the Roth IRA can stand up to that. If you assume that the same tax bracket for now and in retirement, the tax benefit of Roths and 401k are the same.
After that, I can see the argument to fund your Roth before higher interest debt. But if you’re paying over 15%, I’d rather pay down the credit card debt. I mean, a tax-deferred average of 10% or so is nice, but getting a guarenteed 15% on your money is better in my opinion.
As for “fun” money, I treat that as a separate category in your budget. I’m talking about money set aside for the future.
How can anyone rate 4 above 1? That’s ludicrous! Matched contributions are free money!
Roth IRA’s are great so long as the market is good and you’re invested properly. Tax-free interest means tax-free gains but it also means tax-free losses (can’t write off any losses in your Roth IRA as capital losses on your taxes).
How is a Roth more benefecial then fully funding my 401k? I currently do not get a match with my 401k but I was planning on fully funding my 401k with the 15k before I did the Roth???
How is paying into a ROTH IRA better than paying off debt that is accruing interest? I have a Roth that is earning squat interest. I need to pull that money out and do something useful with it.
What if you’re lucky enough (high household income) that you can’t contribute to a Roth IRA?
And what if you’re lucky enough that you have no debt, credit card or mortgage or any?
And what if you’re unlucky enough that your employer doesn’t give any matching funds for the 401(k)?
Is a standard investment account better?
Or put the unmatched funds into the 401(k) anyway?
Dave, thinking of retirement savings here not that bike vacation to Italy
Jonathan, I did a very similar break down myself but with more on the “retirement” focus (didn’t mention emergency fund or insurance). I basically went “1 2 4 8 10” and agree with your order for those items. I tried to talk about why that order is so good (Roth over a traditional IRA and/or 401K due to the flexibility of pulling it out). Its hard to do a “general guide” because everyone’s situation is slightly different and some people are more risk adverse than others. But anyway, here’s my post… I think you’ll agree with most the reasons:
http://www.mypocketchange.com/2006/08/23/outline-to-retirement/
The only really unique idea I had was using a 529 account for retirement (!!!) savings. I actually emailed you about that months and months ago… Basically, there is a breaking point where the penalty for using a 529 for non-education is less than the taxes you’d normally pay in a non-529 account. I should write it up in a post. =)
I don’t like some of your categories which I’ve *’d and will comment on at the end.
My order: 1, 4, 8, 3*, 2, 5, 6*, 9*, 7, 10, 11
Issues:
3. Emergency fund should be for 3-6 months in my opinion
6. Pay down short term (5 years or less) installment loans with interest rates higher then bank rates (adjusted for taxes). Don’t pay down longer term loans if the rate is less than your long term investment rate.
9. Never pay down your mortgage unless your rate (adjusted for tax writeoff) is higher than your long term investment rate.
Comments:
1,4,8 – this money is available for emergencies, downpayment, etc so it should be funded first. A debt problem shouldn’t be used as an excuse to underfund retirement – debt reduction should be a bucket that some of your money goes into but it should not take away from your other buckets – you can’t “catch up” your retirement savings later – you either get the funding in on time or forever give up that year’s contribution.
7 should be one of the last things you worry about. You don’t NEED to own a home especially if you are in a market where its cheaper to rent then own. If you want real estate exposure buy a REIT. That being said, if you can afford to buy a house after funding everything else that you NEED (retirement) – there are nice advantages to owning the place you live.
4,1 cuz my company doesn’t match.
My winning numbers are 5,2,3,7,8,10,4,9, and 11….
I’d go with 2, 3, 6, 4, 9, 11
Since I’m self employed, I am still trying to figure out what would work best for me in terms of retirement accounts. I’m pretty new to this so I am still trying to get my head around things like 401(k)’s, IRA’s, etc.
JT: “9. Never pay down your mortgage unless your rate (adjusted for tax writeoff) is higher than your long term investment rate.”
How can we calculate the mortgage rate adjusted for tax writeoff? In my situation, I have a 5.95% mortgage and am trying to decide if I should throw lots of money at that or put it elsewhere. That is my only significant debt.
Jonathan, previously you mentioned the following:
“If you assume that the same tax bracket for now and in retirement, the tax benefit of Roths and 401k are the same.”
I don’t agree. With Roth IRAs, the earnings are never taxed. With 401k’s, earnings are completely taxable. In my mind this completely differentiates the two accounts. The tax advantage of Roth IRAs over 401k’s only gets better as the investor starts younger become younger investors will have more earnings to tax come retirement time. I agree, however, that eventually the tax advantage of the Roth IRA over the 401k will become negligible, so I guess I sort of agree with you. I should do the math to figure out when that point is…
Well in your case you don’t need to calculate it, your long term investment rate should be well above 6%.
But to calculate the adjusted rate, figure out how much of your mortgage payment is going towards interest (really simple for an interest-only loan), then figure out how much you get to deduct on your taxes (your tax rate * interest), then re-calcuate your adjusted interest rate by adding up (12 months) principle payment + interest – interest deduction / total loan amount.
As long as you have the discipline to acutally invest the money as opposed to spending it – it makes more sense to invest it than it does to pay down your mortgage.
?If you assume that the same tax bracket for now and in retirement, the tax benefit of Roths and 401k are the same.?
Brian – It’s really just math. Say you have $10,000 pre-tax income and 25% income tax rate both now and in retirement. 8% annual return. 30 year horizon.
401k (pay tax later):
(10,000 x 1.08^30) [compounding] x 75% [tax later] = $75,469
Roth (pay tax now):
(10,000 x 75%) [tax now] x (1.08^30) [compounding] = $75,469
The only argument is that you can “fit more money” into a Roth because of the identical limit whether it’s post or pre-tax. Most Roth vs. Traditional articles online should show this.
Jonathan, thanks for enlightening me. I hadn’t done the math before. I guess that leaves only two advantages to investing in a Roth IRA: More flexibility because you aren’t limited to your employer’s plan. Also, if you are planning on retiring at a significantly higher tax bracket than you are now, it would benefit you to pay taxes on the money now. Thanks for setting me straight.
No problem, I should have provided a link or better explanation before. As with all things that involve the IRS, I’m still simplifying it. Nobody knows the future tax structure. All I know is that it will be different than now (look 30 years back).
Also, Roth contributions you can take out anytime for whatever. In addition, you never have to take money out of a Roth (no required minimum distributions). This can make a Roth a great boon to your future kids 🙂
JT, thanks for your response. I guess I’m wondering what these 6%+ investments are. I’m not willing to take on a whole ton of risk and don’t have time for significant market research. My IRA is doing very well but that is limited of course. I don’t see any CDs at bankrate.com over 6%. Any suggestions are welcome.
Mathematically, if you have long term horizon, it is definitely best to get the highest interest. 6% is a very low rate historically, and I personally wouldn’t go rushing to pay it down.
However, I would not fault anyone for paying down their mortgage principal. You are getting a guaranteed return on your money (whatever you figure it out to be), that’s probably still above most cash-equivalents after taxes. If you have a goal that you want to retire by a certain date, starting living off your retirement accounts, and have no mortgage to worry about, that’s fine by me. I believe you are buying piece of mind. Some of us hard-core analyticals can’t fathom that, though 🙂
I have to say that paying off high-interest credit card debt would be my top priority. If I owe a four- or a five- or (God help me) a six-figure amount in credit card debt, then I?m just hemorrhaging money every month in interest payments in I don?t pay that off.
There?s a tremendous freedom that comes when you wipe out a debt: it frees up what you were paying in monthly interest to go and do something else with your money, like saving for retirement. To me, putting a windfall in a Roth if you owe credit card debt smacks of putting the cart before the horse.
Well, considering that I don’t believe in paying credit card interest, I’d have all of my credit card debt transferred to a 0% APR for 12-15 months card. Before the 0% offer is up I can just transfer the debt to another 0% card. Little pain. Easy rinse and repeat. This could go on forever with how many 0% offers are out there.
If I ran into a sudden windfall, I’d continue making the minimum monthly payment on my credit cards and would put the overwhelming majority of it into my Roth. The amount that I’d earn in interest would most likely exceed the amount I’d pay on any fees for transferring balances to the 0% cards (but I’d first try to get the ones with balance transfer no fees).
The Roth could also serve as my emergency fund, as I can take out the money at any time (minus any interest earned while it was in the Roth; that stays in it).
When I started working for the first time out of college, the order will change to first 401(k), then Roth, then credit cards.
I always remember the age-old maxim “Pay yourself first”. You want to give your debtors as little as possible for as long as possible at the very lowest interest rate possible. For example, If you owe $50,000 on a 1.5% fixed-rate loan, why should you pay it down if you had a sudden windfall of $50,000 when you could earn 5.5-6.% annual interest on it in an online savings account while making the minimum payment on it? It makes sense to take advantage of this differntial and pocket some extra cash.
Here’s an obscure situation, but it might apply to some. My wife is disabled, so she has disability income, but no W2 income. I was weighing the options of:
8. Continue to fund your 401(k) to the max.
9. Pay down your mortgage.
Some people would be inclined to reverse those, since paying the mortgage down is a guaranteed return. More than that, you are removing an expense early, and removing an expense is like a comparably larger increase in income (because of the taxes–and no, I don’t want to get into the interest deduction).
In my case, however, it occurred to me that if I get hit by a bus, my wife would be sitting with my relatively large life insurance policy which would need to be invested to last a lifetime. But she has no W2 income, so IRAs and 401(k)s and 403(b)s are not available to her. She has no tax deferred or tax free options at her disposal.
She can always pay down the mortgage with insurance. But only I can get money into things like a Roth IRA for us/her. That definitely tips things towards maxing out the tax-advantaged accounts for us.
Good list.
My list order is titled: Defense Wins Championships
1. Create an emergency fund with at least 2 months.
2. Make sure you have adequate insurance (health, disability and life insurance if you have dependents).
3. Pay down your high-interest credit card debt.
4. Invest in your 401(k), if you have one, up until the match.
5. Pay down any other installment loans at higher interest rates than you could get at the bank (car loans, educational loans, etc.)
6. Finish the emergency fund and save towards a house down payment.
7. Fully fund your Roth IRA.
8. Save for your children?s education.
9. Pay down your mortgage.
10. Invest money in taxable accounts.
11. Continue to fund your 401(k) to the max.
I approach these decisions a little differently. I try to leverage current assets as security. I have only 50% equity in my home so paying down that debt and setting cash aside for emergencies is less pressing (I can always leverage a equity line of credit).
Secondly I tend to want to eliminate non-reoccurring costs quickly such as braces for the kids or emergency home repair such as new AC or major appliance purchase. And I leverage the Credit Card teaser rates to handle such emergencies.
My list would look more like this (from ted’s list):
4,3,11,10,8
I would be reluctant to pay down a mortage. I think that money would out earn the interest on a mortgage if invested elsewhere
having trouble posting from firefox…..
I like Ted’s bulleted list. Here’s my version:
(by the way, it’s nice to find a place with people who have a clue about finances, i was starting to think I was the only one…well, my girlfriend and i)
1. Have money stashed in a general savings/emergency fund. Currently about 3-4 months net pay worth. I would only ever tap that for something major, like a house (a new house, to keep the new mortgage down).
2. Insurance thru work is excellent. No need to supplement at this time.
3. Zero credit card debt. I pay in full each month, and only charge things I would buy anyway (gas, groceries, and normal entertainment items like ski tickets, movies, etc). Everything gets charged, so I can maximize rewards. Meanwhile, the cash is in the bank, earning just a little more interest before I have to pay the bill.
4. Currently maxing out my 100% match, plus some (trying to get Roth 401k added to our plan)
5. Only loans are car and home. Both at close to or less (tax adjusted) than my savings/investment rates (ING for most)
6. Already have a house with >100K equity. That’ll go a long way toward a down payment for the next one (out of townhome, into single family). Saving supplementary cash to increase downpayment and keep monthly mortgage payment as low as possible.
7. Working on Roth. Evidently our 401k administrator has the option to include Roth 401K contributions right in our plan. That would be sweet. We have something like 60 funds to choose from.
8. No plans to pollute the gene pool with my offspring, so no need to save for kids education.
9. Paying down my mortgage would be counter productive since my savings rate and my mortgage rate are exactly the same, and after tax consideration, my mortgage rate is lower.
10. Several taxable accounts are in play. One that already allowed me to buy my home (I left enough in to keep it alive).
11. I split the difference on my 401K, I’m 5% above the match limit, but 5% below the ceiling (im at 10%).
After savings and investments, I currently live on about 60% of my income. And every once in a while, when I have a surplus in my checking, I send it to my savings. My savings consists of several earmarked accounts with ING (general/new house, vacation, new car, toys, taxes, etc)
Not really sure how to make this plan any more sensible. Short of buying a “guaranteed” lottery ticket or something.
Any advice/insight would be welcome!
oK, SUPPOSE YOU are under 50 and make less than $15,500 more than the income limit for ROTH IRA account.
2007 Roth income rules:
You are able to contribute the full $4,000 per year to a Roth only if your adjusted gross income is less than $99,000 if single or $156,000 if married filing jointly (you can contribute up to $5,000 if you are 50 or older). You’ll be able to contribute part of that amount if you’re single and earning less than $114,000, or $166,000 if married filing jointly, and the amount phases out entirely above that level.
So suppose as a single person under 50 and you earn $114,499. You can put $15,500 into a pretax 401K at work, thereby lowering your AGI to 98,999, making you eligible for a full $4000 in a ROTH IRA account.
If offered by your employer, you could instead do the $15,500 into a post-tax Roth 401K at work, but then your AGI would be over the limit for the ROTH IRA.
So here’s the question, which is best…. 1) having the entire yearly contribution amount ($15,500) plus all growth on it through retirement in a Roth 401K be tax free at retirement better or 2) having the $15,500 plus growth taxable at retirement plus $4,000 plus its growth in a Roth IRA , which is tax free.
instinctively I think that having the extra $4,000 invested is best but there’s so many variables here that it gives me a headache trying to determine which is best. Anyone figured this out?
I have a question as well… Say you have consolidated Private school loans, with an interest rate around 8 to 9%. Where would paying these loans off fall on your list of where to put your money? I want to pay them off as quickly as I can, but I’m afraid that neglecting other investments will hurt me in the long run. Any one have any tips on what I should do?
In my humble opinion, the Roth IRA is particularly important, more than the 401K and the high-interest credit card debt, if you think you will be losing eligibility soon. That said, the limits are set to expire, if you believe the president/congress will actually let that happen in a few years.
Bill states that, under certain conditions, one can max the employer 401k at $15.5k *and* contribute $4k to the Roth IRA.
True? I have been looking for a definitive answer on that very questions…
I have a couple thoughts based on previous comments:
Bill – putting the 15,500K into a non-Roth 401k and $4000 into a Roth IRA is the better choice. The non-Roth 401k exactly matches the Roth 401k if you fully invest the tax deduction, but you would in fact invest MORE than the tax deduction amount. The non-Roth 401k is better.
—-
JT says “A debt problem shouldn?t be used as an excuse to underfund retirement. … You can?t ‘catch up’ your retirement savings later.”
You actually CAN ‘catch up’ your retirement savings once high-interest debt is paid off and in fact you’ll have a higher net worth in the long run by doing so. All debt with an interest rate above expected retirement returns (say 10%) should be FULLY paid off before saving a dime for retirement.
Caveat – get your full 401k employer match first, THEN pay off debt with the remainder. But no investing besides the match until the debt is gone.
This all came from creating an Excel spreadsheet with the two options and then comparing the net worths at the end. Try it out for yourself if you’re curious.
I’m 25 years old and just woke up to the thought of financial well being. My current status is as follows:
Credit card debt:
1800 at 29.99
2800 at 4.99
1800 at 7.99
Student loans:
19,000 at 8-9 percent
19,000 at 3.25
Savings checking:
200 at 5.05
480 in checking
401K:
3,000
Thus I am about 40k in debt with a decent credit score 730.
I am thinking of this plan of attack and would like your opinions:
1.) Pay 29.99 and 7.99 credit card first.
2.) Pay more than minimum on 4.99 cc
3.) After all the credit cards are paid off start paying more than min on student loan with higher interest.
– Ramp up savings/emergency fund to 3,000.
– start roth ira acct. And increase to limit.
4.) Increase 401k contributions to max.15k.
5.) Keep paying min on 3.25 student loan for the life of it.
6.) After 30K in roth and savings combined purchase apartment with 10-20 percent down.
So I guess my order is credit cards first, then increase savings and contributions simultaneously while paying installment loans at a regular pace.
Thanks for reading.
40kInDebt – If your credit score is 730, I would try to get all that credit card debt lowered by doing a balance transfer to a 0%R APR card. That will save you some interest.
Also, can you lower the student loan debt at 9% with consolidation or something?
Thanks for the advice. I took the plunge and got accepted for the universal 0 percent but only for 4100. I will put my 29.99 and 7.99 cards on that. Would you recommend I close them? I currently have five cards, the three I mentioned and one providian with 0 balance out of 9,000 and one chase with 0 balance out of 600. I also have a store card with 0 balance out of 1000.
As for the student loan.. It’s with sallie mae and I’ve tried negotiating with them but they won’t budge from the 8-9 percent average. Can anyone recommend a good student loan consolidator?
Besides that I am really glad to have found your site. It’s given me guidance and insight to things I once viewed as complex and tried to avoid as much as possible.
Oh I also figured that I now have to save 250 every paycheck until the end of the year due to my withholding not being high enough.. I guess interest account with hsbc will have to double for emergency and taxes.
But thanks once again for all the advice I really do appreciate it.
401K – In Debt.
I have both of my student loans through Nelnet (www.nelnet.net). So far so good, and I was able to lock in 4.5% interest for the whole term. I know the rates have gone up since I locked mine in, but I am sure they can beat 8-9% hands down. Best of Luck.
Thanks for the suggestion Chadz. I called Nelnet up as i currently have my federal loans with them(3.25%). They said for private loan consolidation it will be 8.25% – 13% variable rate. I guess i just have to suck it up and pay my loan as is.
2 things –
1. 40k in debt – don’t cancel your cards unless they have an annual fee – it’s bumping up your credit score showing you have “available debt” – that’s why it’s hard to find a card right out of college – no debt or “debtability” – although I’ve heard you don’t want more than 5 or 6 because it’s showing you take on too much debt –
2. Something people overlook because it has only recently become worthwhile is PERMANENT or WHOLE life insurance should be tossed in there as well somewhere – maybe at 4-8 depending on your age. You can be fully covered in accidental death and ALSO can draw from it like the principal in a ROTH IRA. A portion goes to the coverage, and the other portion to mutual funds similar to ROTH –
401K = free money!! I like it. I have my savings invested in the HSBC high yield savings. Nothing like earning CD interest on completely liquid cash!
This post has completely convinced me to fully fund a Roth IRA (i had no idea you could withdraw up to the amount of your contribution with no penalty!!!),
Can anyone recommend a good Roth IRA (was assuming Vanguard or Fidelity)?
Also assuming one wants to use their Roth IRA as their emergency fund (as i intend to) i should probably invest in less risky (bonds, conservative mutual funds with low expense ratios) correct?
just re-posted so i could click the notify button via email..had forgotten to with my last post….thanks for any advice on a good Roth IRA provider
I like Vanguard the best personally. Fidelity and T. Rowe Price are other options.
Yes, look into money market funds, like the Vanguard Prime Money Market Fund. Good luck!
Can you take out your principal contribution from a Roth 401K for any reason or only for qualifying reasons? (i want to have it double as my emergency fund, thus liquidity or lack there of is a deal breaker)
Also if i put in 4K, then remove 4K, can i put it back in the same tax year just so long as my net principal contribution is less than 4K (or the max for that year?)
Many thanks, all advice is greatly appreciated
Hank,
You must be an insurance agent. The ONLY time whole life insurance is a good deal is when you are selling it.
Why anyone buys these policies is beyond me. Why would you tie up your money in an account that earns very low interest, has very high commissions, and is difficult to liquidate?
You are better off with term insurance and then taking any extra money and buying a no-load mutual fund.
Okay, all you money-minded people, I need advice.
Most of you in this forum have well-paid jobs that you are factoring in to make your financial decisions, which is commendable and I am learning alot from all your wisdom…
The thing is, I am on a totally different financial/career path and I could really use some sound advice.
I quit my big old corporate job six years ago today, to follow my real passions of acting and writing. To make ends meet until my dreams cover the bills, I’ve been substitute teaching and tutoring. Within the month, I am also launching a new ‘green’ business online and have high hopes for it.
But…I’m having trouble figuring out how to save ANYTHING, let alone pay into a Roth IRA or a 401k. I also have about $2500 I owe to collections (which makes me feel like junk, but I’m determined to finally get that paid off). The hard part is that because of my career change and choices, the money I make essentially covers the bills and leaves very little, if any, for anything else.
Does anyone have any sound advice? And please try to refrain from the “get a real job” comments. I have made my choices, and I believe it is still possible to be financially responsible with the little I have.
Greengirl: I am in a similair boat as far as low-paying jobs go (though it will hopefully change soon) and I also have some debt to pay off.
The key here is budgeting. Make sure you are saving at least 10% of your income. Write out a monthly budget of all your fixed expenses: rent, utilities, insurance, food, etc… than subtract that from 90% of your monthly income.. Whatever is left over is what you have to spend on things like entertainment. Put that ammount in cash in an envelope every month and once it is gone, you can’t spend anymore until the next month (kind of like an allowance for kids).
Most people spend too much when they aren’t on a budget. If you can live off less than 90% of your income than that is great.. If not, you might have to adjust some of your fixed expenses (such as a cheaper cell plan, no cable tv, etc.).
I hope my advice can help.
I disagree…fund your emergency fund before you Roth. If you don’t, you will let any minor disaster derail your ultimate plans towards financial independence. 1) Get rid of all debt (except house), 2) Save up the emergency fund, 3) Max retirement funding, 4) Fund the kids college, 5) Payoff the house, 6) Fund other investment vehicles — In that order.
I have similar issues to poster “40k in debt”:
$40,000 in 3% student loans (a 30 year loan)
$20,000 in 8.3% private student loans (8.5 more years left)
I have a money market account, a retirement account (403b), and a mutual fund. While I don’t have lots of money in these accounts, I’m getting into the habit of depositing automatically, which I regret not doing a long time ago!
I’m 33, and I am “finished” taking graduate and post-grad classes finally for my professional development. I’ve just finished paying off my credit card debt, and I’m on my way to building a solid financial plan…
I don’t want to go back to credit card debt (even though I understand that 0% interest might be good for that 8.3% loan). Any other advice?
Has anyone tried paying the principal on individual student loans like David Bach’s technique of paying off a mortgage biweekly?
Also, how do private student loans affect one’s credit score?
Thanks,
Lola
Greengirl:
I’ve been doing the actingfilmmaking thing for about 7 years now. I didn’t care at all about my finances til last year when I got married (to an actress as well). We’re both determined to NOT get a ‘real job’ and keep at our dreams.
FICO FICO FICO!
The main thing I learned in this past year was to concentrate on getting my FICO score up to get my debt down. I managed to go from a 630 to a 725 in one year. Now, I have all these 0% credit card offers to which I’m transferring my high interest rates – some as high as 30%.
PASSIVE INCOME IS ONE OF THE SECRETS OF LIFE
Also you gotta keep your eye on the ‘passive income’ like your website (read Rich Dad Poor Dad if you haven’t already).
Last year I worked on over 35 passion projects (indies, student films, etc) which won many awards at festivals, but didn’t pay a dime – actually I lost money if you count the gas involved. This year I was determined to only get paid acting gigs, but didn’t enjoy them as much even though I made about $3.4K in acting – which I thought would’ve been impossible a year ago. FYI: The average SAG actor in LA makes about $6K/yr through acting. So having passive income from another source will let me choose passion over trying to get a gig just because it pays, but which I can’t stand.
I’ve been living on $1200/mo for everything. I’m usually in the hole by a 100 or 200, so I totally understand what you mean about Roth and 401K as not even being an option. So at the end of almost every month, I’m kinda scrambling for background work or something to the like. On paper, I look like crap, but in reality, I’m more stable than some guy who’s been at a job for 30 years is about to get laid off.
SAVING 10%
I got my savings account up to about $2K by just saving 10% of everything I brought in even if it was a $10 gas money from a student film. However, it went away b/c of medical bills (no health insurance previously, but got it now). I fell off the horse, but I’m determined to get back on.
The main reason I read this whole thing to the end was the debate b/w Roth funding or debt payment. I think I’d go towards clearing the debt til I become a financial chess-master like Jonathan. I’d rather write a screenplay than jump my credit cards around – even though I have autopayment now for the credit cards, I still miss something now and then and can lose the low APR. If I get rid of it and don’t accrue more (I only put $150 this year on credit. Everything else was paid in cash (aka debit card).
After 7 years, I’m kinda getting tired of the starving artist thing, but am determined to be financially smarter yet not get a day-job. I’ve been getting into real estate as well (flexible enough to make every audition). The main reason is that my parents are getting older and I want to see them and not have lame excuses like I don’t have enough money to fly out there.
Good luck, or um , break a leg. Keep me posted.
Hi everyone, It seems like there are some really intelligent people on here.
I am having a serious problem with my family. I am 26 y/o dentist (just graduated) and currently is working for a resident salary (40K/yr). I will start in private practice this summer once program is finished.
My family is in a serious financial crisis. I could write a whole book on what exactly happened but needless to say, the bank is very close to foreclosing on my parents house because they haven’t paid a 7,000/month mortgage since November. Their business just filed bankruptcy today actually (THANK GOD). They decided to put a 3 million dollar lean on the home. Due to their severe financial crisis, they currently do not have ANY money to pay this mortgage and the bank is about to foreclose on the home, as I said earlier.
SO, my parents want me to cash out my entire Roth IRA right now. I have taken over my IRA for the past year and want to consider all of my options before I do this. There is only so much that I can do to help out with my parent’s problem in terms of cash.
This is my current cash/debt:
1. 200K in student loans (this is going to be really FUN isn’t it.)
2. 11 K in cash from personal savings/work
3. 11K in Roth IRA (my parents DID set this up for me and technically it is their money, HOWEVER, this is also security for my future. I would prefer to use my personal savings to help them first. They are all extremely upset at me that I won’t cash out my entire IRA for them.)
4. I have a 30K engagement ring from going through a divorce. I can only get 12K for it if I sell it outright at a local jeweler. I want to go to auction with it but I don’t think I have time.
5. Other jewelry is worth about 4K possibly more if I bargain hard.
6. My car which is worth 12K being generous. but i need to get to work somehow.
8. My mother is trying to bargain with me saying that she will give me a diamond bracelet worth about 30K if I cash out my IRA. I don’t understand why she doesn’t just sell the bracelet if she needs money!!!!
What should I do? I feel like my family is going to hate me for the rest of my life if I don’t do what they say. They are already holding it against me. I gave my father a 3500 check from my personal savings and he refused it and tore it up. I am willing to sell all my jewelry asap for them and give them that money, but I am very adamant about cashing out my IRA because it is the only long term financial security I have. They seem to think that I’m being ungrateful but I feel like even with the money that I could give, it will only be of very limited value. My other siblings, who do not have graduate degrees OR 200K in student loans, had no problem cashing out their IRAs. But they also haven’t had the financial courses and training that I have to know that cashing out the IRA is not a bright idea AT ALL.
Am I completely wrong about all this!??!?! Am I being too selfish?!?!? If I’m being out of line, please let me know you’re honest opinion.
BUT REMEMBER, my parents have been consistently terrible with money for many, many years. I don’t feel it is fair for me to take on their financial burden when I already have my own.
Please, someone help me, I am desperate and I don’t know what to do.
I forgot to mention I have a credit card debt of $1000.
The sums your are talking about are so big that an 11k IRA doesn’t mean anything in comparison. Frankly, I think it’s weird to tear up a check for $3500 when you’re in a pinch. You may say technically that the 11k is their money, but technically it is your money.
I’d not trade 11k in cash for 30k in a bracelet. As you point out, you can’t sell your ring for what it’s worth and the bracelet is going to be similarly hard to move. When everyone needs cash (and everyone does right now, or feels like they do) who’s going to give up cash for a little sparkle?
Your siblings should have kept their IRAs and your parents should have recognized it for what it is: money that was successfully sheltered from some bad luck or bad decisions. Money kept in the family and away from creditors.
Don,
Thank you for your support in this. The problem with everything on paper the way I have presented it, is that it takes out the whole issue of them being my family and the sentimentality behind everything. That is why I am having such a hard time coming to a decision. They feel my IRA is rightfully theirs because they put that money away for me in the first place. At the same time, I don’t want to see them destroy my financial security in their financial crisis. The main issue here is obviously helping my family keep the home, which I will do anything within my logical power to do. I don’t understand why my father is refusing money from my personal savings. He thinks that it isn’t “his money” so he can’t take it. When in reality, it doesn’t really matter how or where he gets the money from, so long as he gets it. I don’t understand why he isn’t seeing this logic. If I do cash out my IRA and take the bracelet, I am concerned that my parents are going to be Indian givers again and take back the bracelet as their financial problems continue to spiral. Then I will be right back where I started which is selling my own jewelry to maintain my finances.
So no matter how this turns out, I am most likely going to have to sell some jewelry at some time as the only way of maintaining my financial value. I think my other siblings don’t understand the value of an IRA, maybe I’m placing too much stock into it. I just can’t help it after so many lectures getting drilled into my head, over and over and over again, about the IRA issue, and the importance of saving.
I will do my best to help my family out and I will try again to give them money from my personal. Hopefully, they will be not be too proud to accept what I can give them. And hopefully, I won’t lose them as my family over this issue. Although the position they have demanded of me, has been really hard for me, and they don’t seem to care at all about where I am coming from, they just want me to hand it over.
Thanks again for your support.
Also, I pleaded with my other siblings to not cash their IRAs, and none of them listened to me. Recently, my mother has asked me to bail out my brother’s 12K credit card debt, which I refuse to do. Once again, I come off as being selfish and uncaring. As I have done my whole life, working through sweat, blood and tears to get where I am, I am trying to look out for myself and my future family. I would like to see my siblings get a graduate degree and see what its like to actually be held responsible every single day of your life.
I have one more question for anyone!!
If I cash the 11K Roth IRA, what would have been the projected value of it in 20-25 years?
Would it be worth about the same as the 30K bracelet???
I wonder where you are in that situation, SOS. I just read your post but it is very old at this point. You are right when you say there is “sentimentality behind everything,” which makes it difficult for strangers to give you advice. What will be the reaction of your parents, and can you live with it?
For what it’s worth, here’s my opinion: you sound like you are financially responsible, and you have invested heavily in your own future. Maybe it’s time to become financially independent. Give them the 11k back, don’t take the bracelet. Make it on your own & start saving, and on the other side, don’t bail out anyone else in your family for their own lack of financial planning (like your brother’s credit card debt). I don’t really understand how your parents feel like 11k will bail the out of a $3M lien, but apparently there is a strong sense of ownership that runs in your family. Don’t take this the wrong way, but I think you may have inherited that trait. So avoid calling “your own” anything (like the IRA) that somebody else still might have claim to.
I don’t know if another story will give you a different perspective, but here goes. I am not close to my family at all. Barely talk to them, not due to any issues, we just have never been that way. At one point, my Dad gave me $11k… you know, in writing this, I notice an interesting correlation in the amounts. I know my Dad chose this number due to some max in the amount you could make a one-time “gift,” and I think it gave him some kind of tax write-off. Now I’m wondering if your parents “gift” didn’t have some kind of motivation behind it, rather than an act of generosity???
… Anyway, I have never really considered that money to be mine. My husband & I own a business, and the economy stinks, and there is a moderately-strong possibility that we will be bankrupt within the next year. But if my Dad wanted that money back, I wouldn’t have any problems returning it. It wouldn’t be because I was worried about being cut-off from my family, because that really wouldn’t be much of a threat. It’s just because I never felt it was mine to begin with. Maybe if you looked at it this way, it might ease the decision to return it?
Just my humble opinion.
Back to the original topic. It’s been some time since the originating post, and the economy has not been good. I pretty much like the original listed order of things, and was wondering: of the people who thought it would be better to max out retirement plans before saving an emergency fund, how many may have changed their minds & said, jeepers, I wish I had an emergency fund right now?
I only wonder because I know my own perspective has changed. In a time when the future is uncertain, and I cannot “bank” on getting a regular paycheck, I wish I had the peace of mind to know that I have enough money set aside to ensure I can keep my house, my car & pay groceries for the next 6 – 12 months.
Before I list my order, I should say: I have adjusted the interest rate for my debt to an “effective” rate. These are my own calculations, I haven’t verified them from any financial wizards out there, and make no assurances or guarantees should you decide to use them for your own calculations. 🙂 Basically I figured that the effective rate for my mortgage interest & my student loan interest should be less, because they are tax deductible. Effective rate = [interest rate]/(1+[marginal tax rate]). EX 1: Vehicle loan interest rate = 8.9%. This is NOT tax deductible, so effective rate = 8.9%. EX 2: Second mortgage interest rate = 9.75%. This is tax deductible. My marginal tax rate is 33%, or 0.33. Effective rate = 0.975/(1+0.33) = 0.975/1.33 = 0.733 or 7.33%. So although the 2nd mortgage rate (at 9.75%) appears to be higher than the vehicle (8.9%), the impact on my finances of paying the second mortgage is actually less (effective rate of 7.33%). So I want to pay off the car first.
My order:
1) Major Medical health insurance, cheapest.
2) Fund Traditional 401k up to match.
3) Pay off debt that has an effective rate of 10% or higher, paying off highest rates first.
4) Create Emergency Reserves, fund 2-6 months. (See #8 below.)
5) If you have a mortgage that is or will become an ARM, you may want to consider saving extra money right now. This can either help make the payments if the rates go crazy, or help pay down the mortgage enough to allow you to re-fi.
6) Max out Roth IRA.
7) Change health insurance to HDHP (high-deductible health plan), add dental. Max out my HSA contributions. (I love my Health Savings Account, but I guess that’s a whole other topic.)
8) Finish funding emergency reserves (6-12 months total. 12 months for me, due to my particular job circumstances, probably 6-9 for most people.)
9) Start Traditional 401(k) if you haven’t already; either way, get contributions up to 10% of pay.
10) Pay down rest of debt, not including low mortgages.
11) Consider disability & life insurance, depending upon age & # of dependents. Move this up or down the list, depending on your circumstances.
12) Save towards a house down payment, if applicable.
13) Save for your children’s education.
14) Convert to Roth 401(k), if available; either way, continue to fund to max.
15) Pay down your mortgage.
16) Invest money in taxable accounts.
Further comments on the whole retirement savings planning. I think free money (company match) has got to be near the very top. I also like the Roth IRA next, as that can help act as an emergency fund, if needed, so it kinda pulls double-duty. I like starting with a trad 401k, as the tax savings can help you meet your other goals, and then switching to a Roth 401k when the finances are a little healthier.
Also, the mix will probably (depending on individual circumstances, of course) help out in retirement; you would owe taxes on the withdrawals taken out of the traditional, but if this was a relatively small amount, your tax burden would be much less, and then the Roth withdrawals would help pay expenses (and hopefully fun stuff too), with no taxes due.
I have had a Roth and a 401k for 15 years. After the economic crash, I’ve basically lost all my interest gained since opening my accounts. Please some one, tell me why we are penalized if we want to take our own money out of our own retirement acconts. If I had taken it out when the bowl started to flush, I could have saved myself 50,000 dollars. And why should I continue to take out my money to put it into an account that draws a pithy 1.5 % annually? I am losing more than this every year on inflation alone. I think the whole retirement investment scene is a giant scam to fill banks with my hard earned cash.
I am self employed and I have no 401k or IRA account. I am 32 yrs old I have investments (40,000) and a broker. I am wondering what sort of retirement account I should open and how much i should put into it every month. I recently also inherited 50,000 and I am wondering where I should put it. Any advise?
Wouldn’t you recommend now paying of the mortgage? (after paying down your high-interest credit card debt or transfer to new 0% intrest card and after Investing in your 401(k) up until the match)
I don’t see much of the option at this moment unless you are willing to risk.
Some pre-2008 advice. I wonder if priorities have changed for you and others. I believe that 401K is absolutely the worst idea unless you have a company match large enough to offset the potential 10% penalty. A Roth IRA is also terrible if you cannot generate enough return to . Alternatively, making small contributions that you cannot feel is alright in my book. Yet starting at 19 and contributing 1,000 per month just to end up with 229,000 in the end is ridiculous. Don’t you know that 10 billion in 1998 was worth less than 2 billion was worth in the 1960’s? Do you realize that in the case of a severe recession you can count on merciless taxation? Don’t you want to have your savings liquid so you can FOREX it or buy futures quickly? My advice is pay your taxes now and get it over with. Have your money in a brokerage account with margin (to use intra-day interest free, but mostly to eliminate waiting for transaction settlement – also interest free), options trading, futures trading and FOREX (currency trading). You cannot put your money into stocks and hope that they will rise again once they fall based on historic data. You need index funds and you need to average into a position. As the index fund falls, you need to buy more to bring your average price down and you need to sell call options to offset losses. “Buy and hold investment” is dead. More than 70% of trading is now algorithmic. It’s you against mighty computers that can analyze the tape and hedge their institutions perfectly. So my advice:
1) Learn to trade EVERYTHING.
2) Save everything you can while making sure that you debt doesn’t increase even if that means just paying enough to cover interest… for now.
3) Once you have over 30,000 you can start paying off debt more aggressively. You need money to make money. At least 25,000 to open a day trading account. Even if you don’t plan to day trade, the ability to actively trade if you need to gives you the option to get out of losing position. (Holding a position on the way down just because past S&P data says it might appreciate again within 30 years is madness). With 30,000 you can generate at least 50% return by trading stocks and OPTIONS. Learn price action, option pricing and hedging. Learn macroeconomics and stay informed. Avoid the hype.
4) Insurance is always imperative. Don’t tempt fate.
I am not going to bother sorting out the rest. I just wonder why would anyone want to pay off a 4% mortgage? With 400,000 you can become a millionaire in a year if you learn the stock, derivative, and currency markets.
And I forgot one thing… If you want to beat inflation, all you have to do is move to a state that doesn’t impose state tax. No sales tax would be nice too, even though clearly most of the people here are not big spenders. Still it would be nice to get a car and not pay sales tax.
New Hanover anyone?
Pay cash for a car if you can afford it instead of paying interest on a car loan. If do take out a loan but can’t pay it off within 36 months then the car is too expensive for your budget.
Hi Jonathan,
Would you be willing to update this post for 2020? I am particularly interested in where to invest money for retirement or long term saving when the 401k match is maxed out as well as the Roth IRA’s.