Should you save for retirement while getting out of debt?

To contribute or not to contribute?

That is the question when trying to pay off debt. This is a question we battled with when I started working again. The financial experts are all over the place with this question. Some folks are adamant that you should not contribute while you are trying to get out of debt. Others say you should. So what should you do? Let me take you through my thought process.

Most people think about time. How much time can I afford to not make retirement contributions? For me, it wasn’t so much about time, since I knew how long it would take to pay off our debt as long as we stayed intense. For me, it was about other benefits and our ability to keep traction on our plan.

Do you have time?

Can you pay your bills? 

You should never invest if you can’t pay your bills. It doesn’t make sense to borrow money to pay your monthly bills so you can put money into your retirement plan. Too often I see people do this, just to end up taking money out later to pay off debt. If you take money out of a retirement plan, you will pay a 10% penalty plus your tax rate. Now you are further in the hole than you were before!

Does your company match 100%?

If you work for a company that matches your contributions, you are missing out on part of your compensation package by not contributing to your retirement plan. When a company determines how much to pay you, the company factors in the maximum cost of benefits (health insurance, retirement, life insurance, etc). Any benefits you do not take advantage of are savings to the company. I hate leaving that money on the table.

I have been very fortunate to work in an industry with incredible retirement matches. Over the last few years, if I put in $1, the organization puts in $1.60 or $1.80, up to 5% of my pay. That’s some serious money to leave on the table. I’m making 160% to 180% on my money instantly.

Are you making good progress paying off your debt?

If you are having trouble getting traction on your debt payment plan, would stopping your retirement contributions help you make some traction?

If you are putting $100 a month in your retirement plan, you would probably have an additional $85-$90 per month after taxes to put toward your debt. That may be the extra boost you need to start getting some traction, especially if you have a lot of smaller debts.

Making the decision to stop your retirement contributions means you need to get a fire under your ass. Generate some extra income and slash your expenses so you can get some breathing room and get that debt paid down. This should not be a 10 year plan. This should be a 2-3 year plan, depending on how much debt you have. You need to get the mess cleaned up so you can start saving for your retirement and living your dreams. No cable. No vacations. If you are willing to sacrifice your future, you need to sacrifice right now.

We have slashed our expenses and both do side work to generate extra income. Each month, 50% – 60% of our take home pay goes to debt repayment. The contributions that I make to my retirement plan (after taxes) is 1% of our take home pay. By making that retirement contribution, I decrease our debt payoff by $116 per month. That also means that I have $455 per month going into my retirement plan (including the match). The $116 is not going to move our debt free date but the $455 will move up my retirement date.

Is there a correct answer for everyone?

That’s the easiest question of all because the answer is no. Everyone’s situation is different. You need to look at your situation and determine what is right for you. If you need help making this decision, leave a comment or send me an email at kristin@paymentfreelife.com.

Are you contributing to retirement while getting out of debt? Does your employer match your contributions? 

 

Should you budget for this?

When we first started budgeting, we were unsure if we should budget every month for things like clothing, our semiannual car insurance or even things like Christmas.

At first, we did. We were building up funds for lots of irregular expenses. Each month we would put away a small amount for clothing, one-sixth of the car insurance and one-twelfth of the Christmas budget, plus money for a bunch of other things, like car maintenance and car taxes. As this money was building up, it bothered me. Here was all this money sitting there in a savings account making nothing, while we were paying interest on our debt. At the time, our car taxes were about $100 a year. Car insurance was $300 every six months. The Christmas budget was $400. None of these items were going to break the bank. We could easily cash flow these things in the month the bill came due or the event happened.

I stopped putting money aside for them and used the money toward the debt. How do I decide what to budget for monthly?

If I can pay the amount in full in the month I need to, I don’t budget for it monthly.

We could pay any of our regular bills that come due without setting money aside each month. Even when we had to replace the transmission on one of the cars, we cash flowed it. My snowball took a hit that month but we were still able to pay all of our bills, put some money toward extra snowball payments and not touch the emergency fund. Replacing the transmission was an emergency and we could have used that fund, but we didn’t need to.

If a bill is so large I can’t budget for it in a single month, I budget for it monthly.

If we had to pay our house taxes in a lump sum rather than paying into escrow, that is something we would need to budget for monthly. We could not afford that payment in July (in our town house taxes are paid annually). Look at the things you pay for on a quarterly, semiannually or annual basis. Could you afford to make that payment in full out of your monthly budget and still pay all your bills and buy gas and groceries? If the answer is no, you need to put money aside monthly for it. If you could pay for it, then you don’t need to put the money aside.

Some people like creating sinking funds or funds for larger irregular bills even if they have the money to pay them out of the monthly budget. If you want to do that, that is fine. Just consider how much you are paying in interest while the money sits there. Could you knock out another debt and free up more cash because you don’t have the monthly payment anymore?

The other thing I realized is that if I put money aside for clothes, I’m going to buy clothes. If I put money aside for home repairs, I will find something home related to spend it on (not necessarily repairs either). Stay intense and get yourself out of debt. Think of that you could do without any debt!

Using percentages to help stay motivated

If you haven’t yet figured it out, I’m a bit of a numbers geek. I am a Certified Public Accountant and my specialization is tax. Yes, I know. Most people would rather gouge their eyes out with a rusty spoon than do taxes and this is my chosen profession… but I digress. I am also the person in the household who does the monthly budget and maintains the snowball and the payoff schedules that go with it.

Yesterday, I made the first extra payment on one my husband’s student loan. It wasn’t a huge payment compared to the money we were throwing at the car and I got a bit discouraged. Then I realized that the payment I made was a pretty decent chunk of the balance. In fact, it was 8.2% of the balance (yes, I actually calculated it).

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The regular monthly payment is not even a fraction of a percent of the balance. I like 8.2%. Next month, when we make a full snowball payment, we are going to pay off about 50% of the remaining balance on that loan. I like 50% a lot better but I can live with 8.2% today.

The reason I can live with 8.2% is because we have made amazing progress. We paid off the car a few weeks ago. In the same budget month (remember we use the 28 day budget), I was also able to make a decent extra payment on one of husband’s student loans. Not a bad month and I’ve still got two weeks to scrape some extra money out of the budget. I’m hoping to get that 8.2% up to 10%. We’ll see how that goes.

Now for those of you who are following our debt snowball and are wondering how on earth I am going to pay off 50% of a $21,000 loan, husband’s total loan balance is actually two loans that we pay in one payment. The smaller loan has a balance of about $8,900, or at least it did before I made my snowball payment this month. My stretch goal is to knock that one out by April 15. It is a huge stretch but it’s tax season so it is mathematically possible. I’ll keep you posted.

Make sure to do your taxes early this year

I have been getting reports from some of my friends on the internet regarding larger than normal tax bills this year. This is due to a change in the tax code last year. In order to avoid a surprise in April, I suggest that you get your taxes done early this year. Here’s why:

In 2009, the Congress passed and the President signed the American Recovery and Reinvestment Act. In addition to other provisions, this act contained a provision called the Making Work Pay tax credit. This credit changed the withholding tables for working Americans to allow for a $400 per person ($800 if you are married) tax credit. Instead of mailing everyone checks, this credit gave everyone a bit more money in each paycheck. When people do their taxes this year, they may see some problems with this change in the withholding tables.

If you make more than $75,000 or $150,000 married, you don’t qualify for the credit and therefore must pay it back.

If you worked more than one job, you may have had too much taken out of your paychecks since the credit is $400 per person, not per job.

If you work a part-time job and are also on Social Security, you would have received a check for $250 last year, plus had the extra money withheld from your check, but the maximum credit is $400 so you might owe as well.

Make sure that when filing your taxes, you complete the new Schedule M or you won’t get any credit for the tax credit.

If you are penalized for underpayment of taxes, you can appeal based on the Making Work Pay credit. According to the IRS, they will waive penalties related to this credit.

I urge you to get your taxes done early this year so that you can plan in case you do end up owing. Also, do not go out and make a big purchase because you think you are going to get a large refund this year. Wait until you have your refund in hand before spending it.

Please feel free to post questions here or email me at kristin at klingtocash dot com.

Starting a small business

A friend of mine asked me a question relating to starting a small side business via Facebook last week. I thought that this might be a good weekly series. Many people have small side businesses or have thought about starting a small business, but just aren’t sure where to start or how to maintain their records. Over the next few weeks, I’ll be addressing some of the things to think about when starting and running a small business. If you have questions regarding small businesses, feel free to ask them in this post or send me an email.

My first rule in small business is start it with cash. If you can not start a business without going into debt, this might not be the right direction for you to go into. 80% of small businesses fail. That doesn’t mean that your small business will fail, but I don’t want you getting into debt over it. Do your research, see how much start up money you need and start saving. You may not be able to go all out when you start your business, but starting slow and growing with cash will leave you in a much better financial situation.

My friend had asked me about getting a credit card to start her business because the representative she was working with said she could get miles or points for her purchases. Plus, it would help her keep all of her expenses seperate. You can do all this without paying any annual fees or interest charges. Open a free small business checking account. I work with Webster Bank in Connecticut. I get free checking, plus my debit card earns rewards points. Just open a checking account in the business’ name and get a debit card if you need one.

Here is my pet peeve with small business owners. Your business account is only for business transactions. Your personal account is only for personal transactions. Keep them seperate. If you want to take money out of your business because you have profit, write yourself a check and deposit that check into your personal account. If your business is low on cash, write a personal check to the business and deposit the money into your business account. Once you start mingling your funds, it becomes very difficult to keep everything straight for tax purposes. Keep the business stuff in the business account and that’s it.

When you keep your business finances separate, it makes doing business a lot easier, especially when tax time comes around.

Tax season almost over!

I know most of you think that tax season ends on April 15th but no. That would be too easy. Each year the government gives people a full six months extra to file their taxes and each year I have at least one client who comes in at the last minute.

So while I finish those last minute filings, I’ll leave you with a fun link. My sister-in-law, who I love very much just started a new blog. She’s the mom of four, stepmom of five more and how she’s kept her sanity this long is beyond me. I’m fairly certain she’s a weirdness magnet and she’s got lots of great stories to share. Today’s post was especially funny and I hope you all go check it out.

Taxes due tomorrow!

Just a reminder that your individual tax return is due tomorrow. If you need more time to file you can file form 4868. Here’s the catch: an extension does not give you additional time to pay. It only gives you additional time to file. If you think you owe taxes, this extension is not going to help you.

If you need more time to pay, there are a lot of options out there. The IRS have a special page set up with all the information you need. Make sure you act if you owe money. Do not wait for the IRS to track you down. By asking for an installment agreement, you can cut your penalties and move toward paying off your debt.

Are your taxes filed? I’ll be submitting mine tomorrow. As a CPA, mine are always the last to be filed.

Assigning value to noncash donations to charity

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I love donating items we no longer need to charity, but I hate having to figure out the value for our taxes. Last year, we donated a lot of stuff to charity when we cleaned out the house. Twenty years ago, this was a daunting task but the internet has made it so much easier to assign value to those donated items.

Clothing and household items

The Salvation Army as a valuation guide on their website. It doesn’t have everything on it, but it does have commonly donated items and has been very helpful in assigning value to my clients donations.

When donating to thrift stores, make sure you make a list of what you donated (4 pairs men’s pants, 3 pairs women’s boots, etc). Don’t just write down 3 bags of clothing. If you get audited, you are going to have a tough time getting that deduction to stick. If you are really worried, take a digital picture of the stuff you are donating. Then you have real proof. Remember, when donating items to charity, you can only claim a deduction for the fair market value of the item. I use the thrift store value to be safe.

Furniture and larger items

If you are donating items that have a higher value (more than just a few dollars), you might want to check out ebay to see how much that item is going for. Print out a few listings and attach that to your donation receipt. This is especially important when donating items that will not be resold but will be used by a program.

High value items

If you are donating items worth serious dollars (art, collectibles, etc), you should get an appraisal. Attach the appraisal to the donation confirmation.

As you start your spring cleaning (ya, right), see what you have around the house that could be donated to a good cause. Since monetary contributions are down, you can really help a charity by donating your stuff. The charity gets much needed income and other frugal people, like you, can get some awesome deals!

What is the strangest thing you saw donated to a charity or that you have donated to a charity?

Don’t overlook Flexible Spending Accounts

I want to thank Amy in Connecticut for suggesting this topic. Remember it’s not too late to enter the contest to win a Kill-a-Watt energy monitor.

FSAs or Flexible Spending Accounts are one of those benefits that I find a lot of my clients overlook. I want to shed some light on this benefit so more of you will participate in your plans. Not all companies offer FSAs but if your company does, you really need to consider signing up.

There are two popular types of FSAs: Medical and Dependent Care. Medical FSAs are used to pay for, you guessed it, medical expenses. Dependent Care FSAs are used for day care expenses.

Here’s how it works: You decide how much money you want to go into your FSA over the course of the year. You fill out a form and your employer deducts the money from your paycheck each week. The money is deducted before employment and income taxes. Therefore, you will not pay social security, medicare, federal or state income tax on the money put into the account. If you live in Connecticut and are in the 25% tax bracket, you could save 37.65% in taxes on the money put into your account (7.65% social security and medicare tax, 25% federal income tax and 5% state income tax). Not a bad deal, right? When you spend money on “qualified expenses”, you submit receipts to the plan and get a check in the mail. Some plans have debit cards they will load the money on for you. When you make the election to have money withdrawn from your paycheck, the entire amount you indicated for the year is available on day 1. Therefore, if you need your wisedom teeth out on January 2, all your FSA money is available. If your daycare bills are more than you’ve put into the plan so far, that’s okay too.

With these plans, the employer sets the limit for how much you can put in each year. Most of the plans I have seen allow employees to put in up to $5,000 per year. Here is the catch: the money is “use it or lose it”. If you do not use the money by the end of the plan year, kiss it goodbye. There is an exception, though. Most plans will allow a 2 1/2 month grace period to use up your money. Check with your specific plan to make sure this exception is in place. For dependent care FSAs, I have never seen a client who put in the full $5,000 not get all their money back. Child care is expensive.

For a medical FSA, you would be amazed what qualifies for reimbursement. Not only can you be reimbursed for co-pays and prescriptions, but the plans also cover over-the-counter medications, dental and vision care (including glasses) and medical supplies. A plan I was enrolled in even covered condoms and pregnancy tests. You’ll have to check your individual plan to see what it covers.

The first thing you’ll need to do is get the information from your employer. Then sit down and estimate your annual medical spending. Don’t forget eye exams, glasses (if needed), dental visits, prescription copays and at least one copay for a doctor’s visit.  If you have children, don’t forget about their medical expenses as well.

You can save hundreds of dollars in taxes each year by putting money in a FSA. This is much better than trying to take the medical deduction on your tax return. First, when deducting medical expenses on your tax return, you must be able to itemize. Second, your medical expenses must exceed 7.5% of your adjusted gross income. The amount that exceeds the 7.5% is the amount you get to deduct; you lose the first 7.5%. Plus, when deducting medical expenses on your tax return, they are still subject to social security and medicare tax.

These plans are a great way to put more money in your pocket. Go see your HR representative today to see if your company offers FSAs!