Change Tax Withholdings & Retirement Fund?

[adaway]

I am learning so much about this subject by reading through posts here. I was hoping that I can get input on some personal finance changes that are on my mind.

Here is my situation:
Salary <50k
My 401 contribution is only 3% and the max I can contribute is 8%.
I have 0 allowances claimed for tax withholdings and last year my refund was around 2200.
My only debt is a big chunky student loan with min payments at ~600/m
Have a 6 mo emergency fund kind of built up (couple more k to go)

This is what I want to do:
I want to increase 401 to 6% (then 8% the following year)

I want to change my allowance to 1 so that I can offset the inc. in 401k contrib as far as takehome pay goes (I am thinking about 2 for allowances for down the road (maybe the year after) bc I think my st. loan deduction can be used as an additional estimate decision on whether to take another allowance? not sure...need to research this)

My emergency fund is in a dinky money market savings account (2.5%) so I want to move that to something with higher yield. I need to research online savings banks although I am not comfortable with the thought if there is no branch locally. I think reading in posts that putting in cd's is a good option also?

If anything is left for additional savings (I need to recalculate things) then I am pondering a Roth IRA to save. I thought it would be good to save for buying a home also bc I think I read that after 10years it can be taken out for that (or is it 5years.) If it's 10years I don't think I would use it for that purpose bc that is way too long for me to wait.

Does this rational for changes make sense? Does anyone have any concern about my approach and am I missing something. I have little background knowledge in finance basics but I recently started reading online and books. But, I think the changes I want to make need to be made now.

I am hesitant about changing the allowances part and learning about better options to save for home would be great.

I look forward to hearing your responses.

[sweeps]

Yes, increase your withholding to 1. But be sure to save the extra money that will be in your paycheck -- don't let it go to waste.

Does your company offer matching on the 401k? General rule of thumb is to put enough in your 401k to maximize the match and then put the rest in a Roth IRA. By the way, a Roth IRA should be for retirement. Yes, it can be used for other things, but it shouldn't be.

Aim for ~5% interest on your emergency fund and your house savings.

[adaway]

My apologies if two of the same replies appear. I posted a reply using the other "post reply" button and I have no idea where my message went. Maybe it takes a little while to appear or it went some other thread?

Sweeps, thanks for responding.
My thinking is that the extra that I would get from adjusting withholdings would balance me increasing 401k contribution. So no it is not money to be wasted.
I used this calculator to get an idea of these adjustments in relation to take home pay:

finance.cch.com/sohoApplets/Payroll.asp

Company matches >100% so that is why I am eager to jump from 3 to 6% and even considering to 8% this year. Again, the calculator above helped me get an idea of how take home would change. Also, I would feel better if I knew changing allowance to 2 is ok (If I owed back taxes it wouldn't be more than my refund from last year, right? No major life changes except for the EF in savings. Changing allowance to 2 would make me feel comfortable about inc. 401k contributions from 3% to 8%.

The Roth IRA shouldn't be opened until I max 401k, right? But what if I took a baby step and only inc. 401k to 6% (max is 8) for this year and find myself with extra in paycheck for savings. Should I proceed with opening the RothIRA anyways?

Thanks!

[sweeps]

Wow, 100% match for contributions up to 8%?!! Then it's a no-brainer to be contributing 8% to your 401k. That is an instant 100% return on your money.

I would say if you're making a jump to 2% to 8%, don't change your withholding to 2 -- just move it to 1 and see where you are later in the year. Keep in mind by increasing your (pre-tax) 401k contribution, you're lowering your taxable income so the change from 2% to 8% may not be quite as bad as you thought.

[adaway]

Yes, I realized it to be a no brainer just recently but it was impt for me to start low to see where I am at and build something in EF bc I was broke before starting the job.
The company match is 150% starting this year. I feel like the govt holding on to my 2200 was really wasted bc I could have contributed more to 401k and gotten 100% match all along and this year I start to get a 150% match.

Thanks again.

[MonkeyMama]

Originally Posted by sweeps

Keep in mind by increasing your (pre-tax) 401k contribution, you're lowering your taxable income so the change from 2% to 8% may not be quite as bad as you thought.

I just wanted to add, the more you put in your 401k, the less tax is withheld, automatically. Just to clarify.

$2200 is about 2-3 exemptions. I'd go for 2. You'll still get a small refund. That will go a long way for your 401k.

[sweeps]

Originally Posted by adaway

The company match is 150% starting this year.

Is your company hiring? Let me send you my resume.

Originally Posted by adaway

I feel like the govt holding on to my 2200 was really wasted bc I could have contributed more to 401k and gotten 100% match all along and this year I start to get a 150% match.

Definitely. In fact, if I didn't have the money, I would consider borrowing the money in order to maximize my 401k at a 150% match. For every dollar you put into the plan you have $2.50. My God, man, RUN don't walk to your HR department and fill out the form to contribute 8% RIGHT NOW. Cancel the cable TV, stop eating out, do whatever you gotta do to take advantage of that benefit.

Originally Posted by MonkeyMama

$2200 is about 2-3 exemptions. I'd go for 2. You'll still get a small refund. That will go a long way for your 401k.

You're probably right. 2 or 3 would be fine. But I hesitate recommending to someone to make a big change in their exemptions right away. It's painful to give the govt a big interest-free loan, but it's even more painful for most people to owe the govt at the end of the year. It's possible the $2200 was atypical for that person.

[jIM_Ohio]

Originally Posted by adaway

I am learning so much about this subject by reading through posts here. I was hoping that I can get input on some personal finance changes that are on my mind.

Originally Posted by adaway

Here is my situation:
Salary <50k
My 401 contribution is only 3% and the max I can contribute is 8%.
I have 0 allowances claimed for tax withholdings and last year my refund was around 2200.
My only debt is a big chunky student loan with min payments at ~600/m
Have a 6 mo emergency fund kind of built up (couple more k to go)

my first impression was the tax return is too high (that is close to $200 per month). Second reaction was to pay down the debt with an extra $50 per month.

Originally Posted by adaway

This is what I want to do:
I want to increase 401 to 6% (then 8% the following year)

makes sense

Originally Posted by adaway

I want to change my allowance to 1 so that I can offset the inc. in 401k contrib as far as takehome pay goes (I am thinking about 2 for allowances for down the road (maybe the year after) bc I think my st. loan deduction can be used as an additional estimate decision on whether to take another allowance? not sure...need to research this)

I would do this without consideration for the 401k. Because if you own a home, you'll need to do this again (mortgage interest deduction will increase tax return).

Originally Posted by adaway

My emergency fund is in a dinky money market savings account (2.5%) so I want to move that to something with higher yield. I need to research online savings banks although I am not comfortable with the thought if there is no branch locally. I think reading in posts that putting in cd's is a good option also?

My EF is ion CDs. I have one CD maturing each month, then it rolls over to a 90 day CD. I have 3 CDs set up. Interest rate/return is not my objective here. Keeping money illiquid (so my wife cannot spend it easily) and liquid (so if an emergency happens, we can get to money within 10 days). The bank we use is open 7 days per week and located at all grocery stores... so we can get access to money by showing up to bank. If you have 6 months in EF, consider 3 months in 90 day CDs, then put rest in I-bonds, money markets or something similar.

Originally Posted by adaway

If anything is left for additional savings (I need to recalculate things) then I am pondering a Roth IRA to save. I thought it would be good to save for buying a home also bc I think I read that after 10years it can be taken out for that (or is it 5years.) If it's 10years I don't think I would use it for that purpose bc that is way too long for me to wait.

I would rethink this. Maybe open a balanced fund or bond fund with a portion of EF (the extra 3 months), then when student loans are paid off, add the $650/month to this investment. Use this savings for the house. Maybe consider a 401k loan for a portion of down payment. I would NOT withdraw retirement funds for a house purchase. I might borrow, depending on real estate market and housing costs. For a Roth the rule is 5 years. I think you should consider other options before removing money from a Roth.

Originally Posted by adaway

Does this rational for changes make sense? Does anyone have any concern about my approach and am I missing something. I have little background knowledge in finance basics but I recently started reading online and books. But, I think the changes I want to make need to be made now.

I am hesitant about changing the allowances part and learning about better options to save for home would be great.

I think you need to continue asking questions. I also think you will learn most the last sentence will change once you learn more. If you are getting a $2200 tax refund, you are suggesting the US government can borrow money from you for free. Last I checked, I can make my money work for me better in 11 months at $175/month than a one time payment of $2200 would help me. Saving for a home can be tough. My advice is get a house as quickly as reasonable (are you living in the city you want to live?). Once you get the housing payment into the budget, more of your money will be working for you. Consider a small condo or small house for starters, making sure it is not a fixer upper.

Originally Posted by adaway

I look forward to hearing your responses.

see above

[Broken Arrow]

150% is insane. I've never heard of that before. And to think they're willing to contribute up to 8% of that.

[adaway]

Originally Posted by MonkeyMama

I just wanted to add, the more you put in your 401k, the less tax is withheld, automatically. Just to clarify.

$2200 is about 2-3 exemptions. I'd go for 2. You'll still get a small refund. That will go a long way for your 401k.

MonkeyMama...thanks.
If the pay calculator I listed above is accurate then changing my w/holding allowance to 2 and increases contributions to 8% still leaves me with a slight increase in take home pay. So looks good if accurate. If I overestimated allowances and had to pay back in taxes if it were less than 2200 I believe it wouldn't be a problem. I just wanted to make sure I wasn't missing anything in the equation.

[adaway]

Originally Posted by sweeps

Is your company hiring? Let me send you my resume.


Definitely. In fact, if I didn't have the money, I would consider borrowing the money in order to maximize my 401k at a 150% match. For every dollar you put into the plan you have $2.50. My God, man, RUN don't walk to your HR department and fill out the form to contribute 8% RIGHT NOW. Cancel the cable TV, stop eating out, do whatever you gotta do to take advantage of that benefit.


You're probably right. 2 or 3 would be fine. But I hesitate recommending to someone to make a big change in their exemptions right away. It's painful to give the govt a big interest-free loan, but it's even more painful for most people to owe the govt at the end of the year. It's possible the $2200 was atypical for that person.

Re: comment on hesitating to make big change on exemption and the possibility of the large refund being atypical.

Yes that is something to think about. I think I might me ok bc the year prior the refund was 1200 or so and it went higher the following year bc the introduction of the student loans in the equation.

I will have to think about this for a bit.

[adaway]

Originally Posted by jIM_Ohio

my first impression was the tax return is too high (that is close to $200 per month). Second reaction was to pay down the debt with an extra $50 per month. makes sense I would do this without consideration for the 401k. Because if you own a home, you'll need to do this again (mortgage interest deduction will increase tax return). My EF is ion CDs. I have one CD maturing each month, then it rolls over to a 90 day CD. I have 3 CDs set up. Interest rate/return is not my objective here. Keeping money illiquid (so my wife cannot spend it easily) and liquid (so if an emergency happens, we can get to money within 10 days). The bank we use is open 7 days per week and located at all grocery stores... so we can get access to money by showing up to bank. If you have 6 months in EF, consider 3 months in 90 day CDs, then put rest in I-bonds, money markets or something similar. I would rethink this. Maybe open a balanced fund or bond fund with a portion of EF (the extra 3 months), then when student loans are paid off, add the $650/month to this investment. Use this savings for the house. Maybe consider a 401k loan for a portion of down payment. I would NOT withdraw retirement funds for a house purchase. I might borrow, depending on real estate market and housing costs. For a Roth the rule is 5 years. I think you should consider other options before removing money from a Roth.

I think you need to continue asking questions. I also think you will learn most the last sentence will change once you learn more. If you are getting a $2200 tax refund, you are suggesting the US government can borrow money from you for free. Last I checked, I can make my money work for me better in 11 months at $175/month than a one time payment of $2200 would help me. Saving for a home can be tough. My advice is get a house as quickly as reasonable (are you living in the city you want to live?). Once you get the housing payment into the budget, more of your money will be working for you. Consider a small condo or small house for starters, making sure it is not a fixer upper.

see above

jIM Ohio, thanks for your input.

Re: the debt...the min is 600/m for 30 years. I think it's best to pay just that bc I don't think I can put a significant dent in it before then. Interest rate is less than 5%. I'm stuck with it and have to live with it.

Re: EF and CD's...so in your case, you chose to put into a CD provided by a local bank despite other options which might provide a higher rate. I think that was my concern also, I would feel more comfortable if there is local branch.

Re: RothIRA...I am thinking I might hold off or if I open one contribute only a small amount. I want to start building on savings for short term use (<5years) for possibility if I need new car and/or down for home.

[jIM_Ohio]

Originally Posted by adaway

jIM Ohio, thanks for your input.

Re: the debt...the min is 600/m for 30 years. I think it's best to pay just that bc I don't think I can put a significant dent in it before then. Interest rate is less than 5%. I'm stuck with it and have to live with it.

Re: EF and CD's...so in your case, you chose to put into a CD provided by a local bank despite other options which might provide a higher rate. I think that was my concern also, I would feel more comfortable if there is local branch.

Re: RothIRA...I am thinking I might hold off or if I open one contribute only a small amount. I want to start building on savings for short term use (<5years) for possibility if I need new car and/or down for home.

$600/m for 30 years is a lot to pay for student loans. If you can press a 15 year repayment schedule, you will see cash flow open up considerably. I am guessing you consolidated the loans and lowered the payment, in the process the bank increased the repayment period from 10 to 30 years.

You will probably find the student loans get in the way of the house savings. You can't earn 5% "long term" in a savings account or high yield money market. The loans are costing you 5% per year.

Your choices would be
a) pay off loans quicker (consider this a 5% rate of return on money used to pay down).
b) set aside "extra payments" in a money market. You can earn close to 5% short term. This account is subject to frequent moves in interest rates, and 5% rates are a 20 year high, I believe, for money markets.
c) come up with another way for house down payment- maybe a balanced fund or something with a 7-9% type long term return.

In the case of b) and c), I think you will see your budget stretched. Because the accounts grow slower and you have to take on more risk than a) to do it. I am guessing this based on what I know from you online (meaning it's a hunch, not much behind it).


FYI-My CDs are between 1-2% interest rates. I earn around $250 in interest each year on the CDs. A money market would earn me $500. I make $250 in two nights training soccer teams, so I don't consider the interest I lost each year on the CDs to be a big deal. I more than earn that somewhere else, that money from soccer is invested at rates of return much higher than 1-2%. (I send it to PRPFX, which is my mortgage paydown fund).

I think you need to do 2 or 3 things which are independant of each other

1) create a budget. Make sure you know your expenses and what can be cut out if needed (if times get tougher).

2) establish short term, mid term and long term savings goals.

3) establish short term, mid term and long term spending goals. What do you want out of life?

I mention do all 3 of these things independantly, because you may need to re-prioritize things based on a given goal- some long term goals are nearly impossible to attain if you delay them (saving for retirement) where as other short term spending goals might not really be that important, or can be changed when the issue comes up (car).

Do not cloud "how" to achieve a goal with what the goal actually is. Do the "how" after all goals are known. Do not relate one "how" to the other. For example, to pay off student loans requires an extra $50 per month to the loan. To fund retirement is a 10% per paycheck requirement. To save for a car is another technique (maybe $100 per month??). Make sure each how is realistic, but independant of the other goals.

Then prioritize based on what you want out of life. You might find one of the other goals which was long term (paying off student loans) becomes mid term because the money used to pay the student loans could also be used to pay for a house.

For example, if getting a house is the biggest goal, I would tell you I think the priority would be:

a) set aside 10% of income for retirement
b) pay off/pay down student loans
c) get a house
d) establish car fund

You need to start a) now,, when you are young, and build this 10% into your lifestyle-whether this 10% is put into a 401k, a Roth, or some other retirement plan is not important- just make sure it gets done. Experience tells me if you don't start now, you may not start until it's too late. Do not forsake long term financial goal (retirement) for a short term spending goal (get a house). Again, this is why each of above should be a list independant of the others.

In my case- I graduated college with a salary of 39k and student loan debt of 80k at rates around 9% (1997). I also had a monster car payment ($420) which was at a high rate. I started saving 10% for retirement the day I started working. It is the longest term goal I see right now.

Within 3 years I had student loans down to 60k, car paid off, and got a condo. Within 5 years I got married and inherited around 40k of wife's debt. After moving into condo, it took 5 years I had all loans for ME paid off (8 years to pay off 80k) and we bought a 3400 sq ft house (which we live in now). I also racked up 10k of credit card debt my senior year, that was gone before I got the condo. That credit card got up to 20k after we paid for our wedding. That was since paid off before we moved into our current house. The only debt remaining is 3k of wife's student loans, and those will be paid off early (6 months early)- as we need that $220/month for twins in June.

My experience tells me the banks will want to see your debt low (student loans and car payments). Two reasons. The ratios they calculate need to work out in your favor to get good interest rates. Second, if you are choosing between a new car (with a car payment) and a house, get the house first... as the car could prevent you from getting the house, but the car company won't care what debt you have (the house), they'll finance a car to just about anyone with a paycheck. After we bought our big house, we got new cars within 6 months. We drove junkers while saving for the house (some of that 20k debt was car repairs).


I realize I mixed in my experience with some advice to you. This is worth what you paid for it. HTH.

[adaway]

j_IM Ohio, I really appreciate the detailed response. Sharing your experience makes me feel better especially handling of a student loan out of proportion to salary. I now realize that it might be possible to pay it off before 30 years.

BTW, the SL I have is via the US Dept. of Education and is in excess of 100k. I have several payment options: ~600/m fixed for 30 yr, a graduated payment that starts slightly less then that and gradually inc. over 30 yrs and then and option for ~1200/mo for a 10yr plan. Right now, the last option is unrealistic given my current financial status but it certainly might be realistic a few years from now. You provided me with some great ideas that will help in redirecting my focus. thanks again!

[sweeps]

Sorry, I didn't read the very lengthy responses above, but I would state again that you should be maxing out that 401k with the 150% match. Paying extra on your student loan should be a far lower priority.

[jIM_Ohio]

I would second sweeps comment. I just caught the post which stated match was greater than 100%. If employer matches up to 8%, then I would start the plan there (contribute 8% to max out the match), and work backwards on budget and other issues to maximize the free money offered by your employer.

If company matches 12%, put that in, if they match 20% put that in. Then work backwards to make rest of this work. The match is free money and I would not pass it up.

You mentioned buying a home, have you looked into how this would reduce your tax bill? You might need to change exemptions when you do this. What is cost of renting vs cost of owning where you live?

[adaway]

Sweeps, jimOhio...yes I will make changes to max out 401k contributions (change from 3 to 8%.) I have to wait a few months before I am permitted to make the change but it takes first priority on my list of changes to make.

After I make that change should I at some point look into an IRA to contribute an additional 2% of salary? That would total up to 10% salary going towards retirement...I thought I read that this is the recommended percent that one should contribute. I am in my mid-30's and I had a late start to retirement contributions. Current total in 401k is only ~6k.

[jIM_Ohio]

Originally Posted by adaway

Sweeps, jimOhio...yes I will make changes to max out 401k contributions (change from 3 to 8%.) I have to wait a few months before I am permitted to make the change but it takes first priority on my list of changes to make.

After I make that change should I at some point look into an IRA to contribute an additional 2% of salary? That would total up to 10% salary going towards retirement...I thought I read that this is the recommended percent that one should contribute. I am in my mid-30's and I had a late start to retirement contributions. Current total in 401k is only ~6k.

I might suggest increasing from 10% contribution to retirement to around 15 or 20%.

8% into 401k is a good step.
You can put up to 5k into an IRA in 2008.
I don't see any comments about single or married- if married, spouse can also contribute 5k to an IRA.

6k right now is not much, but adding to the accounts a little each month will make a huge difference. In 5 years, You will probably have between 60k and 100k set aside, within 10 years you might have 200k. It takes patience and time. Being in your 30's is not behind. You have 35-40 years to let money compound.

[anonymous_saver]

Originally Posted by adaway

Sweeps, jimOhio...yes I will make changes to max out 401k contributions (change from 3 to 8%.) I have to wait a few months before I am permitted to make the change but it takes first priority on my list of changes to make.

After I make that change should I at some point look into an IRA to contribute an additional 2% of salary? That would total up to 10% salary going towards retirement...I thought I read that this is the recommended percent that one should contribute. I am in my mid-30's and I had a late start to retirement contributions. Current total in 401k is only ~6k.

If I understand things correctly, that's great that you are increasing your contribution to 8%, only put up to their match though, if there is an 8% match, your lucky!

Then, yes, increase your witholding to at least 1, no reason to give the government a loan! Here is good calculator on the IRS website to figure out how many allowances you should take. IRS Withholding Calculator

What is your interest rate on your student loan? It does sound like a large loan (in the $100k range?). Depending on your age, I would probably pay this down a bit before you save up 6 months worth of an emergency fund (unless that would only take you a month or two. Also, I would hold off on the Roth IRA until you get you student loan down a bit. If you pay extra money on your school loan do they put it towards principal or interest payments? Finally, have you consolidated your loans already?

As for your emergency fund, why not put $1 in one of the higher interest online banks (I highly prefer EmigrantDirect over all of the others), once you feel comfortable with them and your $1 has been transfered, you could put more money in there. Don't lose out on the interest! Here is a calculator that let's you compare how much more interest you will earn with changing banks. The Ultimate Interest Rate Chaser Calculator » My Money Blog

Some of what you said about taking out $10,000 from your Roth for a first time home buyer is true. However, this is not advised at all. Keep your retirement money for your retirement. Roth IRA - Wikipedia, the free encyclopedia

Once you have your 6 month emergency fund, and get your student loan in order, start saving for a down payment for a house. You can easily set up subaccounts in any of the online banks (labeling one as "Emergency fund" and one as "Down payment" can help with your organization of your money).

How much extra money do you have after each month of bills?

I'll look forward to hearing about your decisions that you make.

[jIM_Ohio]

a few points about anonymous saver's advice.

Depending on your age, I would probably pay this down a bit before you save up 6 months worth of an emergency fund (unless that would only take you a month or two

In an earlier post I mentioned sending an extra $50/month to student loans. This is the same as sending one exta payment per year. This would probably shorten repayment from 30 years to 22 or 15.

Also, I would hold off on the Roth IRA until you get you student loan down a bit.

Disagree. The student loans are costing you 6% or 7%, and you get a tax deducation, which lowers the real rate you are paying. The Roth could earn 10-15-25% if invested properly. You are young, get compounding to work in your favor by investing money early. That loan payment is not going away anytime soon, and delaying retirement savings makes it harder (the more time you give yourself, the easier it is).

Once you have your 6 month emergency fund, and get your student loan in order, start saving for a down payment for a house. You can easily set up subaccounts in any of the online banks (labeling one as "Emergency fund" and one as "Down payment" can help with your organization of your money).

How much extra money do you have after each month of bills?

I agree with much of this. The order of "paying down debt", "saving for retirement", having an "emergency fund" and "saving for a house" will be the priorities which push and pull you one way or the other.

My suggestion was to write down each goal, then indicate a plan which accomplishes that goal. Do NOT link the goals. Look at how to solve each issue independantly. You will probably then see a "path of low resistance" to complete each goal you list.

For example

$50 extra to student loans each month lowers repayment period from 30 years to X years.

$200 to IRA each month increases savings rate from 8% to z%. In X years I will have $Y.

$100 to savings each month creates an emergency fund of $A in B months.

$100 to house fund each month creates $C in D months.


If you also did the budget anonymous saver mentioned, you will see if it's possible to do all these things at same time, or if you have to make choices. Some of these are short term (once emergency fund is there, that $100 a month is freed up in budget).

I don't see any problems with original post or what is going on, this suggests to me the best approach is a broad one (investing some, paying down debt some, saving some for a house). I would not think that selling out for one goal (house) would supercede the other goals (investing or student loans) with some minor exceptions in this case.

The debt the OP is carrying is bad only that it will take 30 years to pay off- student loans are tax deductable and I do not consider them to be bad debt (like credit card debt).

The OP should be commended for getting close to 6 months expenses saved already. And should also be commended for examining his 401k and realizing OP was leaving free money on the table.