Too much debt

[WarrenBuffett]

I have several major debts to deal with and I want to be sure I have looked at all my options.

The debts are a student loan for $40,000 ( forbearance has run out ) and credit card debts of $20,000. My other debts are my mortgage, $4000 left on a $550,000 home and a tax bill of $8000 caused by a capital gain I took last year.

I'm 68 years old and working full time. I bring home about $550 and week after all deductions including health insurance for my wife and myself. I am planning on working for another three years at least. Social Security will be about $2300 a month.

My financial assets are $400,000 brokerage account and $200,000 401(k). I am paying my real estate taxes and minimun credit card payments right now using dividends from the brokerage account.

My monthly expenses for the house are mortgage- $340, real estate taxes - $500, gas and electric totalling $350.

My concern is the time after retirement when my income will go down and I will have to pay for Medicare which I believe will be around $500 a month because of my wife's poor health.

We live very close to the edge right now and I'm afraid any event ( a new roof, a new car ) can tip things over and leave me and my wife dependent on my kids for support 15 years from now, something I refuse to allow to happen.

Is a mortgage refinancing my best option to pay off these debts?

[bjl584]

Need more info. What is your annual income, expenses, expected expenses in retirement?

[jIM_Ohio]

I have several major debts to deal with and I want to be sure I have looked at all my options.

The debts are a student loan for $40,000 ( forbearance has run out ) and credit card debts of $20,000. My other debts are my mortgage, $4000 left on a $550,000 home and a tax bill of $8000 caused by a capital gain I took last year.

I'm 68 years old and working full time. I bring home about $550 and week after all deductions including health insurance for my wife and myself. I am planning on working for another three years at least. Social Security will be about $2300 a month.

My financial assets are $400,000 brokerage account and $200,000 401(k). I am paying my real estate taxes and minimun credit card payments right now using dividends from the brokerage account.

My monthly expenses for the house are mortgage- $340, real estate taxes - $500, gas and electric totalling $350.

My concern is the time after retirement when my income will go down and I will have to pay for Medicare which I believe will be around $500 a month because of my wife's poor health.

We live very close to the edge right now and I'm afraid any event ( a new roof, a new car ) can tip things over and leave me and my wife dependent on my kids for support 15 years from now, something I refuse to allow to happen.

Is a mortgage refinancing my best option to pay off these debts?

You need to change the way you think about money.

You have 600k in 401k+brokerage account. In a decent year this MIGHT earn you 12% and you are taking a decent amount of risk to get this 12% return... if you lowered risk because you are close to retirement, your "probable" return might be closer to 8% or even less.

You have 20k in cc debt and are probably using the yield of the 400k (maybe 2% annually??=$8000 to pay down debt which is costing you **probably** around 20%.

You are slowly bleeding your money away.


Here is what you do
pay off the 20k in cc debt by selling 20k worth of stuff in brokerage account
pay off the $4000 mortgage too
pay off the $8000 tax bill too

then from that point forward, change how you deal with money. Basically this means you need to CONTROL your money so it never (EVER!) controls you again.


Here are the steps to help you

You need to know the following

1) Income (all sources)
2) Expenses (all expenses, including cars, house, utilities, groceries, play money and similar)
3) all debts (none should be left, but it is something to analyze)
4) all investments

In general do NOT include investment income (dividends, interest) in the income for #1.



When you add up expenses, it will tell you (eventually) how good a retirement you have.

For example...

If you spend 72k per year
that is $6000/ month

SS covers $2300/mo
so you need your brokerage to cover the other $3500/mo ($6000-$2300=$3700)

Multiply the $3700 times 12 (12 months) and then multiply by 25 (4% withdraw=1/.04=25X) and this is what you want brokerage to have in it when you retire.

3700*12=$44k per year brokerage needs to supply
$44K*25=$1.11 Million needed in brokerage

Keep in mind this is an example- if you have less than 72k in annual expenses, these numbers will change.

Then keep analyzing expenses and see if you can cut some things out and run the math again.


In a separate analysis, you have 3 years to "correct" the brokerage/401k account and analyze it another way. You have 600k now (minus about 32k to pay off debts). You have a mortgage payment, tax payment and cc payment you are no longer making. Those payments should be invested in hopes of getting the account balance higher than 600k in 3 years.

Your current 600k supplies you with 4% per year in income (more on the 4% below). 4% of 600k is $24,000 per year (2k per month).

Meaning your retirement income (if you retired today) would be $2300/mo of SS plus $2000/mo from the investments. If you can find a way to live on $4300/mo, you could retire today and money would **probably** not run out.


Keep analyzing this aspect of problem to boost retirement income and manage the risks you have investing.


The 4% rule is the same as the 25X used in first calculation. What this did was suggest if you take a moderate risk investing the money (meaning hold between 40% -60% stocks and 60%-40% bonds/cash) you can withdraw the following from portfolio

4% of initial balance (so 4% of 600k=$24k)
add 3% to this each year (so the $24k increases by 3% each year; 3%*24k=$720, so year 2 adds $720 for a withdraw of $24,720 and year 3 is 3% higher ($24,720*3%=$25,462) and this continues for 30+ years. Each year withdraws 3% MORE than the previous year.

There are online calculators which will give you more info on this. What I presented was the basics only. Those calculators will tell you "success rates". If you get a 100% success rate, that means all past market behavior never had you run out of money. If you had an 80% success rate, that means out of 1000 market cycles tested, about 200 of them failed which meant at some point you ran out money in retirement (the brokerage account went to zero).

When you analyze this there will be 3 variables which affect the results more than the others

1) Length of time- 4% works GREAT for 30 year periods, if you expect to live longer, pay close attention to the length of time in any calculations done (you might have 100% success for 30 years but only 80% for 40 years).

2) % stocks held. If you put all 600k into CDs and bonds you will see low success rates for long periods of time, but high success rates for short periods of time. If you plan to live longer you need a decent amount of stocks (40% or more is my suggestion).

3) The initial withdraw rate. 4% is the starting point. You may be comfortable from age 68-78 spending more than you do from age 78-98, so you could plan to start with 5% then slow spending down as you get older. If you bump starting withdraw rate up to 6% you will see lower success rates (you are spending more), if you drop it down to 3% you will likely never run out money if you keep at least 25% of the money in stocks.

A fourth variable is the market performance early in retirement. If you have a way to make sure stock market does not lose money the first 5-8 years of retirement, your success rates shoot way up (an 80% success rate with a big bull market the first 5 years of retirement changes things considerably).

If you want to leave money to spouse, kids or charities, that also impacts the calculation.


A fourth analysis is you have a house worth 500k now, plus other assets which total about 600k. Your house is almost half your net worth.

If you sell your house and downsize it, you can add about 350k to the brokerage account. This lowers your expenses (lower taxes and utilities) and raises your cash on hand (more to invest).

4% of 350k is $14k. This means selling house adds over $1000/mo to income in above calcuations. In my area 3 BR ranches go for 150k-200k, so if you move to a low cost of living area, you can save more money if you choose to make this decision.



Ask questions- this is a lot to digest I am sure.

**edit to add**
I missed student loans in my original response, this leads to 2 other issues

1) liquidate the brokerage account to pay off that debt
2) why does a 68 yo person have student loan debt?

[littleroc02us]

First question is, "Why do you still have school loans at 68?"

[WarrenBuffett]

Thanks for all your responses. They all were helpful. Here are a few answers.

Brian: My annual income now is around $50,000. My expenses in retirement will be about the same as they are today. My retirement income will come from my social security of about $2300 a month plus what I earn from my brokerage and 401(k) account. I'm hoping that will be about $2500 a month.

Jim_Ohio: Please tell me where I can earn 8% return without much risk. Right now I'm lucky if I'm getting 3%. The student loan is from my daughter. Hey, I put three kids through college and I promised to pay for it all. They all graduated and this is all I have left to deal with. It looks like you expect me to double my savings in just three years to $1.1 million. Good luck with that. My question remains: Should I refinance to pay off the student loan? And thanks for all your ideas. It is a lot to digest but it's all good advice.

[KTP]

[QUOTE=WarrenBuffett;269065]
Hey, I put three kids through college and I promised to pay for it all. They all graduated and this is all I have left to deal with. It looks like you expect me to double my savings in just three years to $1.1 million. QUOTE]

Huge mistake. Fund your retirement first, worry about kid's college second. Kids will find some way of getting an education even if it means working part time or going to a cheaper state school at least for the first 2 years. They will also appreciate later in life when you don't have to move in with them because you ran out of cash.

[jIM_Ohio]

Thanks for all your responses. They all were helpful. Here are a few answers.

Brian: My annual income now is around $50,000. My expenses in retirement will be about the same as they are today. My retirement income will come from my social security of about $2300 a month plus what I earn from my brokerage and 401(k) account. I'm hoping that will be about $2500 a month.

Jim_Ohio: Please tell me where I can earn 8% return without much risk. Right now I'm lucky if I'm getting 3%. The student loan is from my daughter. Hey, I put three kids through college and I promised to pay for it all. They all graduated and this is all I have left to deal with. It looks like you expect me to double my savings in just three years to $1.1 million. Good luck with that. My question remains: Should I refinance to pay off the student loan? And thanks for all your ideas. It is a lot to digest but it's all good advice.

I make that long post and you focus on this comment LOL

You have 600k in 401k+brokerage account. In a decent year this MIGHT earn you 12% and you are taking a decent amount of risk to get this 12% return... if you lowered risk because you are close to retirement, your "probable" return might be closer to 8% or even less.

You are probably "even less". However depending on things, I can probably come up with ways to sustain 6-7% returns IF you can handle holding around 40% equities. Big IF. But before you look for investing solutions, did you agree with this?

pay off the 20k in cc debt by selling 20k worth of stuff in brokerage account
pay off the $4000 mortgage too
pay off the $8000 tax bill too
liquidate the brokerage account to pay off the student loan

This lowers balance by 72k, but it LOCKS IN the rates of return equal to the debt- so if the student loans had a 6% interest rate, I just gave you a 6% return on a portion of your money.


I also did not see you reply to this comment, and this would possibly help you better than any other decision.

A fourth analysis is you have a house worth 500k now, plus other assets which total about 600k. Your house is almost half your net worth.

If you sell your house and downsize it, you can add about 350k to the brokerage account. This lowers your expenses (lower taxes and utilities) and raises your cash on hand (more to invest).

4% of 350k is $14k. This means selling house adds over $1000/mo to income in above calcuations. In my area 3 BR ranches go for 150k-200k, so if you move to a low cost of living area, you can save more money if you choose to make this decision.

You gave good information here, can you detail this budget out so if I want to cherry pick expenses, I could?

My annual income now is around $50,000. My expenses in retirement will be about the same as they are today. My retirement income will come from my social security of about $2300 a month plus what I earn from my brokerage and 401(k) account. I'm hoping that will be about $2500 a month.

I do NOT want you to increase debt and pay off the student loan, I want you to remove debt and use the next 3 years to prepare for retirement. Best way to do this would be to have LOW EXPENSES. Paying off debt reduces expenses, so that is why all that other stuff is above. The lower your expenses, the less risk you have in retirement.

If your income is $50,000 per year and you expect to need $4800/mo, that is $57,600 per year. How are you making up for the $7600 deficit now?

The first thing you want to do is analyze your yearly expenses. List them. If you expect an expense in 5-10 years (like a new car or new roof) you need to look at those problems too. Focus on the annual expenses for most of the problem solving, but make sure whatever the final plan is accounts for large one time expenses like a replacement car.

$2500/mo from brokerage account is $30,000 per year. The 25X/4% number for initial portfolio (on retirement date) is $750k. This means in next 3 years you want the brokerage account to increase about $200k in value. This could be $200k from some contributions (like take the payments you no longer make on mortgage and contribute them to to brokerage account) and account returns.


Once you have $750k you can retire (if 2011 is a good year, why wait?). I would invest the $750k in a portfolio of "about" 40% stocks and 60% bonds. Some funds hold this allocation (I can think of one quickly) and if you prefer more diversification, consider something like this:

15% US large Cap stocks
15% foreign large cap stocks
5% US small cap stocks
5% REITS or foreign small cap stocks
20% TIPS (Treasury Inflation Protected Securities)
5-10% foreign bonds (government+corporate)
20% Diversified US bonds (government+corporate, short term and long term)
10-15% cash (CDs or money markets)

In year 1 you take out 4% of the $750k (30k)
In year 2 you take out 3% more than previous year (30k+3%=$30,900)
in year 3 you take out 3% more than previous year (30,900+3%=31827)

The 3% are yearly inflation increases- as costs go up, you increase spending
If there is a down year (there will be a few), you can do a few things to help, like not take the 3% inflation adjustment.

You can use a calculator like this to simulate all the above
Flexible Retirement Planner

I received a 98% success rate with a 40-60 portfolio (meaning just investments)
and a 100% success rate when SS was factored in.

There are many details about this not discussed- for example the 750k has a median portfolio ending value of 715k. Meaning you did not spend all your money. But the opposite of this is that 20 of 1000 runs (2%) had the portfolio run out of money too. If these are not desireable, you need to communicate this.

In addition there is the issue as to whether the SS will get taxed, and I did not factor that into any of the above (because expenses are above 44k, its possible, but because much of this is in a taxable account, that also means that $35000 withdrawn from account is not necessarily 35000 of income (because I presume you have a cost basis higher than 0).

If you plan to die in the house you have now, most of above assumes that.
If you plan to sell house at some point, you need to factor in more investable assets.


Most of your focus needs to be on expenses and getting investments aligned with how much risk you are comfortable taking.