Live Debt Free

Pay off debt. Save. Give. Live your mission.

401(k) Contributions With Outstanding Debt

by //

Have a question of your own?  Ask DFA writers for free!  🙂

Stop 401(k) contributions to speed debt reduction?

DFA Reader James P. asked:

Should I stop 401(k) contributions of $546 a month to pay off the car loan faster??? This will bring my monthly excess for debt payments to $1100. I use the 50/50 plan (50% of excess income goes to pay down debt, 50% is saved).

Matt, I would like to say your blog is one of the first websites I check in the morning for inspiration and knowledge. My family of six embarked on the Dave Ramsey journey in June 2008. Since then, we’ve paid off $47,000. $34k of that was credit card debt (ALL GONE!!!!) My wife and I are 34 and our sons are 14, 13, 10, and 10 so we are very proud of ourselves and the amount we’ve paid off considering the responsibilities we have.

I am currently putting 7% in my 401(k) (receiving a 2.5% match). My wife is currently putting 4% (receiving a 1% match). Our remaining debts include a mortgage, a car loan ($32,000 @ 6.9%) on an ‘08 Toyota Sienna (worth $26,000) and two student loans (totaling $23,000 @ 6%). The Dave Ramsey plan would pay the smallest debt (a student loan) first, but I’m conflicted as to what to do next. My thought is pay off the car next because it is my biggest payment, but I would have to stop my (not my wife’s) 401(k) contributions to make it happen in 1 year. My fear is, if I stop the 401(k) contributions I will miss out on a significant rise in 2010. I will keep the student loans for now because they are tax deductible. Getting the car payment off me would lift an emotional burden but my 401(k) contributions are making me have second thoughts.

Congratulations!

Anyone who has paid off nearly $50,000 in debt in two years deserves a pat on the back. You have been doing a great job, let’s have a look at your situation and see if we can help speed you toward debt free living.

Your Plan or Dave’s Plan?

You want to pay off your car because it carries a higher interest loan, but Dave says you should pay off a student loan, because it is smaller and he wants you to have fewer debts regardless of the numbers. Well, I agree with you. Dave’s debt snowball makes sense for people who lack motivation, have a multitude of smaller debts (3 credit cards, 4 store charge cards, and a couple major appliances) and can benefit from the visible progress of paying off individual debts. However, the amount you paid off this past year shows you are VERY motivated, and down to three big debts. The other reason I agree with you, is that the student loans are unsecured, your education cannot be repossessed, and while the tax deduction isn’t a great reason for keeping the loan around, when combined with the lower interest rate, it isn’t costing anywhere near as much as the car loan. You already owe more on the van than it’s worth, which is not a desirable situation.

A Better Rate of Return

Having established that your plan to pay off your vehicle before the student loans is sound, we will now look at how to do it. A 1-year timetable is a good goal; dragging debts out is never good and the amount is only slightly higher that what you paid off the last two years. You tell us the money you need to pay off your car in one year is currently being contributed to your 401(k). The way to do it then is obvious, your 401(k) contributions must be adjusted, and I am going to address how and why.

You are currently contributing 7% of your salary, and 4% of your wife’s into 401(k)’s although you are only being matched for 3.5% of those contributions. That means you have 7.5% of your salaries that I would consider “extra” contributions. I always recommend that people in debt (including a mortgage) not contribute any more to a retirement plan than is matched by an employer. When contributions are matched, you get a 100% return on investment with zero risk. There is no better investment than that, but for unmatched contributions to net a profit, they must produce returns in excess of what you pay in debt interest. On average, the stock market returns 8% over 30 years. While that is higher than the interest you pay on your debts, ask your self if a volatile investment with a 20-30 year timetable is worth 1%-2%. Paying off your debts offers an immediate guaranteed return of 6%-7% in your case. That is a much better deal.

Planning For an Uncertain Future

You mention your concern that next year may be a good year for the market, and you want to get in on it. Since none of us can know the future and because different “experts” are all just guessing anyway… I would counsel that your investment decisions should be based on where you are financially, not what the markets are doing. Get out of debt, save money, avoid future debt, then invest your surplus.

I would recommend reducing your and your wife’s 401(k) contributions to the amount that will be matched. You will then have the necessary money to pay off your car, then shift your attention to the student loans. Once they are gone, bring your emergency fund up to at least $10,000 if you have not already, and then turn the hoses on the mortgage. Once you are completely debt free, you will have the excess income necessary to max out your 401(k) contributions (as well as a Roth IRA if you are eligible) and your retirement savings can grow steadily without interference from debt.

Do You Have Any Other Advice for James?

Something you think I missed? Drop a line in the comments below.

Have a question of your own?  Ask DFA writers for free!  🙂

*Disclaimer*
We accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material. Our comments are an expression of opinion. While we believe our statements to be true, they always depend on the reliability of our own credible sources. Any advice taken from this site does not in any way establish a client/adviser relationship.  We always recommend that you consult with a licensed, qualified professional before making any financial or investment decisions.

SEP IRA Contribution Question: AJ Answered

by //

Have a question of your own?  Ask Matt Jabs for free!  🙂

SEP IRA contribution dilemma

DFA reader AJ asked:

Hi, Matt – Just a quick question (I think.) I am a self-employed contractor receiving a 1099 from my contracting company where I provide marketing services. This represents 100% of my income. I have an SEP IRA which I contribute to. Do I set it up to contribute to my SEP IRA as an employee or an employer? Does it matter?

SEP IRA contributions as employee or employer?

If you are looking for more a more in depth information on this topic check out our article on SEP IRA contribution limits and deadlines.  If you’re considering a 401k, be sure to consider current 401k contribution limits.

When I received this question from AJ I immediately emailed her back to ask a few questions that needed to be cleared up.  Here is the conversation that ensued and what we came up with as an answer:

Me to AJ: Hi AJ, who is asking you to differentiate between your status as an employee or an employer?  Are you filling out a tax form that asks this info?  Are you being asked by a brokerage firm to supply this info?

AJ to Me: Hi Matt, when going in to make the contribution with my brokerage firm, the firm asked me whether it was an employee, employer, or individual contribution.  I actually talked to someone at the brokerage firm and they said that when you contribute as an individual it’s like contributing $5K to any type of IRA.  And that contributing as an employee only applies to SAR/SEP IRAs and so the answer is that I should contribute as an employer.  Hopefully that is in line with what you thought as well.  Thanks.

Me to AJ: Right, that makes sense… but remember that when you make employer contributions, you must also make contributions to the SEP of all eligible employees.  If you’re the only employee (Sole Proprietor) then it doesn’t matter.

AJ to Me: Yes, right.  Luckily, it’s just me!  Thanks for responding.  Hopefully this will help others.

In summary…

AJ is a sole proprietor so she must contribute as an employer.  This is also correct if the business had employees and business income, but if she did have employees she would need to contribute to the SEP IRA of all employees along with her own.  As I understand it, her brokerage firm was looking to decipher whether or not AJ’s business had employees.

Do you have an SEP IRA?

Is there any other advice you would give to AJ other than to keep saving?  🙂

Have a question of your own?  Ask Matt Jabs for free!  🙂

*Disclaimer*
We accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material. Our comments are an expression of opinion. While we believe our statements to be true, they always depend on the reliability of our own credible sources. Any advice taken from this site does not in any way establish a client/adviser relationship.  We always recommend that you consult with a licensed, qualified professional before making any financial or investment decisions.

Help with Debt and Retirement Savings – T Collins Answered

by //

Need help with your situation? I offer free personal finance advice.

Visit the Ask Matt Jabs page and fill in the form to ask your question for free.

Who can I trust for help with debt?

DFA reader T. Collins asked:

I’m lost, I don’t know where to begin, or whose advice to trust. I’m broke and 53 years old, spouse is 55.  We have not saved a dime for retirement.  When I had a little extra I wasn’t paying attention, I lost the business and lost the home.  I work full-time and also a second job, spouse gets SSI.  I’m in debt from credit cards, losing house, etc. and am renting now.  I can barely make everyday bills because I’m so poor.  I have to take money used to pay necessities to get started on this debt so I don’t end up living under a bridge.  I currently make $23,000/yr. – my spouse gets $9,000 after medicare payments.  I just woke up financially… can start a 401k?  HELP!

Debt counseling

Simply put… you need debt counseling, debt management, and financial education.  We could single out the subject of your debt or your lack of retirement savings, but I think the best decision is to steer you in the direction of someone who can help you on a more personal and on-going basis.

Do not feel bad, the need for debt counseling is not something you should be ashamed of, rather it is a common reality for many Americans today.  Our culture and education system have failed to provide most of us with the personal financial skills necessary to live a healthy financial lifestyle.  The reality of this fact is evidenced by the national credit crisis and record levels of consumer debt… among other things.  Couple our excessive culture with aggressive corporate marketing and our lack of individual personal responsibility and we have ourselves a perfect personal finance storm – and T. Collins is but one of many who suffer.

Where can we go from here?

T. Collins, you are not alone and since you did not give specific numbers and are just asking for general advice that is where we’ll focus our efforts.

Trustworthy debt counseling

We need to designate between two opposing business models that confuse the average consumer and erode confidence in debt counseling.

  • “For profit” debt settlement companies.
  • “Not for profit” debt counseling companies.

A trustworthy not for profit debt counseling company will typically offer to help you help yourself and will steer you toward debt settlement and bankruptcy only as last options.

The financial weapons you need, and the ones a trustworthy company will help equip you with are:

  1. Debt counseling – Trained counsel to help you better understand your situation so you can gain an emotional foothold and prepare yourself and your family for the road ahead.
  2. Debt management – Helping you find and work toward real solutions for your specific financial needs.
  3. Financial education – Helping teach you the basics of personal financial responsibility so  you can dig yourself out of the hole and avoid future troubles.

Specific people to contact for help

T. Collins, I will give you two organizations to contact, both of which are trustworthy and not for profit.

  • National Foundation for Credit Counseling – Look around the NFCC website making sure to utilize the Find a Counselor feature.  They offer debt counseling over the phone, the Internet, or in person so be sure to take advantage.
  • Green Path Debt Solutions – Visit their location page to see if they have an office local to you.  I have not had much interaction with debt solutions companies but this is one I can vouch for.

A few personal finance starters

You need to keep a written budget.  You need to live below your means.  You need to sacrifice your wants for your needs… there is no time to waste.  You need to work your tail off to earn as much as possible.  You need to spend as little as possible.  You need to destroy any credit cards you have and implement the cash envelope system to curb any bad spending habits.  Do not fore go necessities to repay debt, make sure the heat is on and there is food to eat, what is left over can then be split between creditors accordingly.  Do not focus on retirement savings now, focus on getting control over you situation then worry about your nest egg.

Think on these things and contact a counselor from one of the sources above.  Godspeed.

What do you think?

What are some tips I may have missed that T. Collins should use to gain control over his dire financial situation?

If you need personal finance advice… ask Matt Jabs.

*Disclaimer*
We accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material. Our comments are an expression of opinion. While we believe our statements to be true, they always depend on the reliability of our own credible sources. Any advice taken from this site does not in any way establish a client/adviser relationship.  We always recommend that you consult with a licensed, qualified professional before making any financial or investment decisions.