September 9, 2019 By

Q&A: Avoid this big mistake when paying off debt

Dear Liz: I am 49, single, with no kids. Until about three years ago, I wasn’t even sure how much credit card debt I had. I had less than $200 in savings and I was just plugging along making minimum payments. It turns out I had over $14,000 in credit card debt and $12,000 in student loan debt. The credit card debt was accumulated not from extravagant purchases but rather from living in an expensive city and trying to pursue a dream career. (I worked only three days a week in my “day job” for about 12 years.)

My living expenses have always been modest, but I made a budget, lived even more frugally, and made large monthly payments. In the process I also cashed out my small 401(k), as I have done a couple of times previously. Fast-forward to now — my credit card debt is paid off, my student loan is paid off, I have about five months of living expenses in savings and a reasonable annual income of $60,000. I have no retirement savings, though. What is my next best step to get money accumulating for my old age?

Answer: You’re to be congratulated for taking charge of your financial life, but it’s unfortunate you sacrificed your 401(k) to do so. It rarely makes sense to cash out retirement funds to pay debt. The interest you saved is typically far outweighed by the taxes, penalties and lost future tax-deferred returns you incurred by tapping your 401(k) prematurely.

Fortunately, the budgeting skills you learned will come in handy now that you’re focused on saving for retirement. Continue to make large monthly payments, but direct the money into your 401(k) if you still have one or an IRA if you don’t. If you max out your tax-deductible options, you can continue to put money into a taxable brokerage account.

You should plan to continue working as long as possible and to delay starting Social Security, preferably until your benefit maxes out at age 70. Social Security is likely to be your largest source of income, so the bigger your check, the more comfortable your ultimate retirement will be.

Also, take steps to protect and enhance your biggest current asset — your ability to earn money. Many people are derailed financially in their 50s by unexpected layoffs and health problems. You can improve your chances of being able to earn well into your 60s by taking good care of yourself, investing in new skills and trying to be a top performer at work.

Filed Under: Q&A, Retirement, Saving Money Tagged With: , ,
May 23, 2016 By

Q&A: More on Saving for Retirement

Dear Liz: Here is another take on your response to the reader who questioned whether retirement calculators were a hoax that promoted excessive savings rates. You mentioned that current retirees had enough pensions, Social Security and savings to replace nearly 100% of their working income, while younger people likely would have only enough to replace 50%. You closed your advice by asking if the letter writer would be comfortable living on 50% of that person’s income. For a non-saver, that is a fair question. But for a saver, it isn’t an accurate comparison.

If one is presently saving, say, 10%, then that person is already living on 90% of current income. If saving 15%, then that person is already living on 85%. When you analyze the expected impact of having the compounded savings at retirement, the true “step down” in income is really the difference between the current 90% or 85% figure and what you will have with Social Security, part-time job income, pension (if you work for the government) and savings. The gap becomes much more manageable, because you already are used to living on 10% to 15% less than your current income.

The point? Savers are already accustomed to living on less — in some cases, significantly less — than current income. Between the already lowered current disposable income and the benefit from the accumulated savings and investments, the “step down” gap is made manageable. Saving helps on both ends.

Answer: That’s an excellent point. Taxes are another factor to consider. Working people pay nearly 8% of their wages in Social Security and Medicare taxes, an expense that disappears when work ends. Income tax brackets often drop in retirement as well.

Still, there are good reasons to shoot for a higher replacement rate than you think you may need. Investment markets don’t always cooperate and give you the returns you expect. Inflation can kick up and erode the value of what you’ve saved. Careers can be disrupted, leading to lower wages or an earlier retirement than you planned. People who have “oversaved” will be in a better position to deal with these setbacks than those who save only enough to scrape by.

Filed Under: Q&A, Retirement Tagged With: ,