What to do when you're treading water with over $100,000 per year?
Beth helps Anna — and anyone else who has trouble handling income and debts — manage her money.
Thanks to Debtors Anonymous, Anna now knows she can't keep spending more than she and her husband earn. But that realization won't bring financial security by itself. Anna and her husband also need to focus on the details; otherwise, they will be dogged by debt, could struggle to pay for their kids' college educations, and may well lack the money to retire comfortably. With all that hanging over their heads, where do Anna and her husband start?
- Keep a budget — together.
Anna has never kept tabs on her money. That's why she's been paying $40 per month for credit insurance without knowing what little protection that gives her. It's time to find out exactly how she and her husband are spending their money. The first step is to talk about where their cash is disappearing to — something they haven't done so far.
Anna and her husband should keep a log of their spending. Then they can figure out which expenses are set and can't be avoided (fixed expenses), which ones change from month to month (variable expenses), and which ones they choose (discretionary expenses). Figuring out the finances might be easier if Anna uses a personal finance site like Mint.com or Wesabe.com. These sites track expenses, income, investments, and taxes, among other things. And Anna and her husband should definitely check out our budget calculator. - Seek additional help with debt.
Although Debtors' Anonymous has helped Anna change her spending habits, she seems to need a push to deal with her existing debt problems.
Tackling debt is easier for some people if they have outside help. One way is to join a credit counseling service, such as Consumer Credit Counseling Services, which doesn't charge its clients anything if they can't pay. CCCS sets schedules for people to pay off their debts, taking money from their bank accounts automatically each month to reach that goal.
(Note: See how the Credit Counseling Service helped Liz.) - Eliminate high-rate credit card debt.
Whether Anna uses a website or a credit-counseling service, credit card debt is the first thing she should tackle. She and her husband owe $8,015 on their Visa Card, which has an interest rate of 24.5%, and $4,772 on their Discover card, which charges a 24.9% interest rate. Their American Express balance is $3,506; that interest rate is 23.9%. They are also carrying $4,821 in overdraft charges on their checking account, which charges them 19.5% interest. That's an awful lot of high-rate debt.
Anna and her husband could erase half of this debt fairly easily. They currently have $11,654 in two money market accounts, where it earns less than 2% interest. Using that cash, they could retire the $4,772 of the Discover card debt and $6,882 of what they owe their Visa. That would leave them with $9,460 in high-rate debt, which they should try to transfer to a card with a lower rate than 19.5%. (But not to a card with a teaser rate: last time they tried this, they made one late payment, and the interest rate rose considerably.)
Psychologically, of course, using all your savings to pay off your debts is difficult — it often feels better to have more cash on hand. And Debtor's Anonymous doesn't condone the use of credit cards, so it would be hard for Anna and her husband to deal with an emergency under DA's philosophy if they eliminate their savings. But maintaining a large emergency fund gives Anna and her husband a false sense of security when they're actually losing money. Right now, they are incurring more than $4,000 in credit card fees while making about $233 in money market fund dividends each year, for a net loss of $3,767. But this loss would be slashed to $1,800 if they used all the money market assets to pay off credit card debt now.
Meanwhile, Anna should negotiate with her current credit card companies to get lower rates. Her chances are good because she has several cards and at least one is likely to covet more business from her. She could also try to find a card with a lower rate using websites like CardTrak.com and Credit.com, but she might find it difficult due to the negative items on her credit report. She has been paying her bills on time for more than a year, though, so she may well qualify for a new card. If she does, she should transfer as much as she can from the high-rate cards to the new, lower-rate card. And if not, she can always try again in a few months. - Focus on retirement.
Anna is just 27 years away from retirement age, so she'd better start thinking about it. She and her husband have $37,000 in an IRA rollover account with a major brokerage firm, and her husband contributes some money to his company's 401(k) plan, but that's it.
Anna's husband should contribute 10% of his salary, or $10,000, to his employer's 401(k) plan, because that's what the company will match. He'd make those deposits with pre-tax earnings, and the money would grow tax-free until he took it out when he retires. Each member of the couple is also eligible to save up to $5,000 per year in a Roth IRA. That would provide tax-free growth, too, and it wouldn't be subject to taxes when they withdraw the money upon retiring.
Anna and her husband may want to reconsider their existing IRA. That's because keeping it at the brokerage house is costing them a lot in fees. In the first year the account was open, for example, they were charged about $500. Most of that total came from sales charges on mutual funds. But there are several IRA providers that would do the job much more cheaply. An IRA with Vanguard would provide access to scores of funds without sales charges ("no-load funds"), which could give Anna and her husband more money when they retire. - Save to send the kids to college.
Anna has generous in-laws who have promised to pay part of her two children's education expenses. But it isn't clear if the grandparents will cover all of the costs, so Anna should save for the kids' college years, too.
After the family credit cards are paid off and Anna and her husband are maxing out their retirement accounts, they can think more seriously about saving for college. The good news is that the money Anna and her husband save in his 401(k) plan and in their Roth IRA can help fund college for the kids.
And once they're no longer paying the credit card companies so much money every month, they may be able to divert some of their income to a specialized 529 account, which works like an IRA for education. The money grows tax-free and withdrawals for tuition, room and board, and other higher education costs are exempt from state and federal taxes. As an added bonus, New York State's 529 plan would let them deduct as much as $10,000 in yearly contributions from their state income taxes.