Next Money Move- Need Assistance with overall personal finances

[Money? What Money?]

Hi All,

First, let me just say this is a great forum and I stumbled upon it a couple of days ago and have been reading as much as I can to try to learn. I am very private with our finances, but I need assistance on what to do next. Here is our "dirty laundry"

My wife and I are in the process of paying $43k off in credit card debt and will have it paid off by August 1st of this year! Yay! We bought our first house shortly after getting married in 2005 and was living beyond our means and quickly racked up $25k on one credit card. We had our first child in 2010 and that is when we got serious about changing our spending. We paid the credit down to $19.5K by July 2011 and was on track to have it paid off by August 2012, however, I had the opportunity take a promotion that required me to have to move closer to my new place of work and we took an $18K loss on the sale of our house which was put on another credit card, bringing our total credit card debt to $37.5K as of August 2011. Learning from our first home purchase mistakes, we bought a house that was much more affordable and took the extra income from my promotion and applied the extra to the debt. As we sit today, as soon as I make the next payment on April 1st, we'll have a balance of around $9k. The $9k is on one credit card with a 0% interest for 18 months. My question is...after we pay this $9k off, what do we do with the extra income that we've focused on getting rid of the credit card debt? Focus on car loans, student loans, college, retirement, emergency fund?

I've read enough of these posts to know that you're going to ask me the following questions. Please let me know if you need additional information.

Wife is 34 and contributes 5% of gross to her 403b. Her employer matches 50% up to 6%.

I'm 33 and contribute 5% to my 401K like plan and get 100% matching on 5%, plus I will be eligible for a pension from my employer that will equate to about 30% of my high 3 years. In current dollars and salary about $26K a year in a pension.

Current Incoming/Savings:


Take home: $7400/mth
My monthly take home average after 401k contribution, taxes, health insurance etc is about $4300
Wife monthly take home average after 403b, taxes, etc is about $3100
Wife's 403b balance $25K
My 401K balance $44K
Checking $3400
Savings $600

Outgoing: $4689
Outgoing (minus credit card that'll be paid off on August 1st)

House $1318/mth includes tax/insurance (Paid $200K, balance remaining $185K, worth about the same. 30 year, 5.125% fixed (lender paid PMI)

My car $676/mth, balance due $38k, loan has 60 months left at 2.5% fixed
Wife's car $397/mth, balance due $25k, loan has 66 months left at 1.9% fixed
Student loans $130/mth, balance due $11k, 2.38% fixed
401K loan $90/mth, balance due $1700, 3.125% which goes back to me
Heating Gas $38
Trash: $20
Water/waste $40
Car Insurance $90
Electric $158
DirecTV $60
Daycare $338
Verizon $125
Car Gas $450
Groceries $500
Extra "Play money" $350

So, after we pay off our credit we will have $2711 per month to apply towards additional debt reduction, building savings, retirement, etc. I know I've typed a lot of information and appreciate any guidance you have to offer. I

was initially thinking about building a $12k emergency fund and focus on mortgage reduction. Now I'm wondering if I should use a Roth IRA as an emergency fund so my money works for me when I don't need it and if I do I would have my contributions available to me versus letting the money build in a savings account earning less than 1%.

[lorraineb]

A couple of quick thoughts.

You want some of your emergency fund in cash -- if something happens suddenly, it will take time to get it out of the Roth IRA. I would say a minimum of $5k and probably $7.5k since that is equivalent to one month's take home pay.

You can knock the 401k loan off right away, which I would do. I would then go for the mortgage. The other loan interest rates are low enough that you might be able to make more in interest than you would paying them off in the stock market -- there is a risk there, but I think it would be something I would do.

I would also not upgrade with any bonuses or pay increases you have until the debt is all paid off -- if you can keep living within your current budget, you should be able to knock off most of that debt fairly quickly.

[sblatner]

Other people will give you a lot of advice but I'll start with a few tidbits.

I would build up my cash emergency fund and do a Roth. I always like 8 months emergency fund but since you have other debt, maybe build up $20k in an emergency fund and then do a Roth.

I would try to finance the mortgage. I think you can get 3%+ for a 30 year fixed.

Others will probably suggest that you get rid of the cars as those are long mortgages but since you have so much extra cash, I'm not going to suggest that.

Also, you could also start a college savings account. We never did a 529 plan but have an account that we have designated as college savings.

[bUU]

Wife is 34 and contributes 5% of gross to her 403b. Her employer matches 50% up to 6%.

I cannot see how 1% of gross could be better spent than earning an instantaneous 50% interest, even though you cannot touch the money. I've got to believe that there are other ways to move things around to allow you to take full advantage of the company match.

I was initially thinking about building a $12k emergency fund and focus on mortgage reduction. Now I'm wondering if I should use a Roth IRA as an emergency fund so my money works for me when I don't need it and if I do I would have my contributions available to me versus letting the money build in a savings account earning less than 1%.

You want some of your emergency fund in cash -- if something happens suddenly, it will take time to get it out of the Roth IRA. I would say a minimum of $5k and probably $7.5k since that is equivalent to one month's take home pay.

I would build up my cash emergency fund and do a Roth. I always like 8 months emergency fund but since you have other debt, maybe build up $20k in an emergency fund and then do a Roth.

With regard to the "emergency fund in a Roth IRA" issue... The tactic is grounded in this principle: "For Roth IRAs, you can always remove post-tax penalty contributions (also known as “basis”) from your Roth IRA without penalty. Consult your tax advisor about your particular situation." Folks who use their Roth IRA as part of their allocation for an emergency fund use this as basis for saying that the actual amount the contributed to the Roth (i.e., not including any gains, and not including any reinvested dividends) is essentially accessible for emergencies. However, one other fundamental aspect of what is typically considered criteria for emergency funds is expressed in this advice: "Having a cash reserve can help protect you against unexpected financial difficulties that can have lasting consequences, even if you feel you are in good shape today." [Emphasis added.] So in order for the Roth to be considered a source of legitimate emergency funds, that amount of funds needs to be invested in (according to the provided link) money market funds, CDs, or in cash, directly. That's generally not the best way of taking advantage of a tax-advantaged account, like a Roth IRA.

[MonkeyMama]

I personally often recommend the ROTH emergency account, but would not recommend it in your situation. You have a 401k loan - you don't have the discipline to deal with that strategy (most people don't).

Forget the mortgage, I would redirect your energy to retirement savings. After building up some cash savings. 401k, and maybe IRAs if you are eligible.

That said, get rid of that 401k loan ASAP (maybe I missed it and that is part of your plan?)

I live in California, and your car payments are more than my mortgage. O.M.G. I would very seriously consider downsizing. It just strikes me as absurd.

Aside from focusing on retirement, it may be worth paying down home enough to negotiate better terms. I don't know with your credit and equity how a refinance would pan out today, right now, but is worth looking into. You could significantly cut payment with a lower interest rate.

These are just the things that jump out at me.

Congrats on your plans to be debt free and your progress thus far!

[Money? What Money?]

Thank you all for taking the time to provide some advice! I think everyone has a valid point in recommending as they did.

MonkeyMama- I totally agree about the vehicles, unfortunately I feel like I'm stuck with them for the current time as I would lose significant money if I dumped them. I did refinance my car from a 72 month at 3.2% to a 60 month at 2.25% in an effort to pay it off quicker. You were also right about the house refi. We looked into a 15 year mortgage but the appraisal came back low due to a couple of comps in the neighborhood being low. The house appraised for $200k in 8/2011 when we moved here.

bUU- I see your point about increasing my wife's contributions and will do that asap.

loraineb and sblanter- good points on emergency funds and paying off that small 401k loan.

I have a couple of follow up questions:

I think everyone mentioned building the emergency fund as the top priority, there was a little difference in opinion on using a ROTH or a good ole' fashion savings account.

If I were to put my goals in priority would I be way off base with the following:

1. Emergency Fund
2. Work on paying principle on house with a goal of refinancing to a 15 year note as soon as the value rebounds or my principle falls enough.
3. Max out 401k
4. Start and contribute to a ROTH (Can I do $5K a year for me and another $5k for my wife?)

Is it best to approach this as an all in approach? Meaning, put all extra money in EF until it is at the appropriate amount, before moving on to paying the mortgage and maxing the 401k? Or is it best to put some money in all 4 places at the same time?

One final question. Saving for college is something I'd like to do, however, is a 529 the best way or is utilizing a ROTH a better option? My daughter isn't 3 yet, so I've got about 15 years to save. Our gross income last year was about 130k with our agi being about 118k, would doing a 529 impact her ability to get assistance or does our income make that a null point?

I would like to get this set up to where the plan is in place so as soon as I make the last payment on the credit in August, I immediately move into the new plan. We are so used to not having that extra money it would be so much easier to just keep that mindset if I had the new plan ready to start.


Again....thank you all for your advice.

[~bs]

I know contributions can be pulled out of a roth tax free, but im not a big fan of withdrawing from roths unnecessarily. The limit on roths is only 5500 per year. So it would take you 10 years just to contribute 55k to it. Once the money is pulled out, youre stuck attempting to replenish it at 5500 per year.

The only time it could be recommended is if ally you have is a couple grand a year to save. In that case, it wouldnt matter much if you used your roth as an emergency savings account because there's no real opportunity cost to keeping the funds in the roth

[MonkeyMama]

On the cars, I think you likely lose more money if you keep them. But, just put a pin in that as you have a lot to work through. I wouldn't give up on the car thing - but fair enough for now.

Since you can throw significant sums at the house, I would do so. I'll change my answer. Do so in order to get a lower interest rate. That will save you a ton in the long run. Real estate is going up right now and you can pay down about $25k in a year. So that might buy you a chance to refinance at low rates? I think worth shooting for.

I'd tackle one at a time, as building up some cash savings is very important to stay out of debt, and lowering your housing costs will be of significant benefit. Retirement is important too, but you will kill it once you get everything else squared away. In the interim, I would contribute to get the full match (which you are just about doing?).

A ROTH is generally a better tax shelter than a 529 plan (less limitations, and not considered for financial aid and such). If maxing out your 401ks was ample for your retirement goals, I would also work on maxing out ROTHs and using for college/other savings. It's kind of tricky because ROTHs are great short-term tax shelters, but pay off the most when you invest in them for the long run. But, it also seems silly to invest in taxable accounts when you do have ROTHs at your disposal. That is my opinion.

As an aside, conventional wisdom is to contribute 401k up to match, then max ROTHs, then 401k up to max. This is just because ROTHs are less restrictive than 401k plans.

[Money? What Money?]

Thanks again for all the information.

MonkeyMama: I am interested in hearing more of your thoughts on my car situation. I am here to learn

How does one know how much is enough for retirement? Is there a good calculator somewhere or a general rule of thumb?