Is high Investment debt forcing you to live paycheck to paycheck?

Student Loans, Mortgages, etc. Currently I am in this situation

I am married but I'm the sole income provider at the moment and I have student loan debt. 41k in my name (325 a month) and more in my mothers and I pay for both per month ( 308 a month for the ones in her name). I am trying to put some savings aside. Currently I have 2,000 dollars in my 401k (50 bucks per pay check) and my company does a 100% match at the end of the year. Health insurance went up, my current rent is 730 a month (705 if I did not have cats :0) and I pay for electric.

Now I know that I choose to go to school and expected the fact of the school debt. I just want to find out ways to save outside of my 401k in my current situation. I want to get a CD started with my credit union but the initial cost is 500 dollars to start one. I stopped 85% of my extra spending (restaurants, video game purchase, etc). I got more promotions at work (more responsibilities with the last one but same title) and they do not give salary increases because of promotions just performance bonuses at the end of the year. I been writing up a list of things that can potential give me a higher salary for example all the great work emails I get, my relationship with the consumers (I'm a contractor) which result into productivity increases, taking on higher challenges, extremely high ticket closures, etc.

What more can I do? I'm also planning to drop my smartphone when my contract is up (verizon is to expensive with two smartphones). Currently I am trying to get through my studies for my Microsoft and Cisco certifications (I'm 75% ready for the CCNET exam, and I will be studying for the 70-640 next week. Work experience has helped me with many topics).

Any Advice would be greatly appreciated, this forum is full of wisdom / help.

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Comments

azjag

Check out Dave Ramsey Homepage - daveramsey.com but get your spouse on board before making any drastic financial decisions. Otherwise you are doomed before you start. If you are serious (and i mean serious) and you have spousal "buy in" send me a PM with your address and I'll send you his book to get you started.

higherho

azjag wrote: »

Check out Dave Ramsey Homepage - daveramsey.com but get your spouse on board before making any drastic financial decisions. Otherwise you are doomed before you start. If you are serious (and i mean serious) and you have spousal "buy in" send me a PM with your address and I'll send you his book to get you started.

Thank you for the advice and link. Checking it out now. I also discussed with my mother on options with the loans she took out for me. She will be helping and their are some options apparently since she has been working with the state for 15 years so she is looking into that. If so this would free up at least 308 dollars a month which would be a significant help. When my wife graduates and gets her Masters she will be able to help out a lot more with the bills. Just right now it is rough to create any type of savings but I should be happy that I have at least some savings.

azjag

Personally I would still check out the link I sent you. Besides if you owe money to creditors you should not be contributing to a savings account. Not saying you shouldn't keep some money in the bank, I have a $2k emergency fund, but the interest rate on credit cards is far higher than the interest rate on CD's.

higherho

azjag wrote: »

Personally I would still check out the link I sent you. Besides if you owe money to creditors you should not be contributing to a savings account. Not saying you shouldn't keep some money in the bank, I have a $2k emergency fund, but the interest rate on credit cards is far higher than the interest rate on CD's.

I agree, I am checking out the link. I only have one personal line of credit with my credit union (interest rate 8.2%). I kept it under control and not used often (max 1k had it for 6 years). I pay all my bills on time (Student loans, phone, house bills, car). I would like to focus more money on my student loans and if my mother helps out on the loans in her name then I can put that extra money into the student loans or investing.

I will be getting back to you on the book AZ. I will be reading into it more later on today (its 5am now here, I need rest ).

azjag

I hear you, it is 2am here and I am just finishing up a module on the CCENT. Nothing like practicing sub-netting late at night to put you to sleep.

Cheers.

lordy

Before putting money into an investment account you should really get rid of your debt. Paying of debt, in your case, will give you a 8.2% return with zero risk. There is no investment that can top this return-to-risk ratio.

However, don't put every dollar you have into reducing debt. Put a few bucks on the side so that you are able to handle situations like your car breaking down or things of that sort.

Forsaken_GA

I'd put in another vote for Dave Ramsey, as I've been living by his principles for the last 3 years, and it's made a huge difference. If you can't afford a copy of The Total Money Makeover, then go see if your local library has a copy - it's worth the read if you're serious about your financial health. Nothing he talks about is rocket science, it's just a good ol' boy talking good old common sense, but it's one of the hardest things (yet one of the most rewarding) you'll ever do.

To give you the short version of Ramsey's program -

Step 1 - Put $1000 in the bank. This is your emergency fund.

Step 2 - Pay off all your debt except a mortgage (that comes later). This means no investing. Get rid of any debt you are liable for as soon as possible. This frees up your income to actually start building some wealth

Step 3 - Build that $1000 in the bank up to 3 to 6 months of expenses in the bank.

Once you've done all that, you'll be sitting in a much better position.

tpatt100

I listen to Dave Ramsey's podcasts, really like them. The emergency fund is fine but in today's economy I tend to lean towards building a bigger emergency fund first before paying off your debt. I went through 6 months being unemployed and my extended emergency fund which I focused on first prevented losing my home, cars, etc. I was listening to Dave mainly for motivation, I paid off two credit cards, cancelled cable, coupon clipping, etc. Then I got laid off during my "gazelle intensity" and gazelled half of my year's worth of emergency funds towards debt. Not bad since I figure most do not even have six months saved up.

Since it sounds like you only have student loan debt you could probably follow the advice already given. I tend to lean towards having a big savings first due to possible unemployment but if your situation seems stable then attack the debt first.

bigmantenor

Putting money in a CD is an extra bad idea when you still have debt accruing interest. You're better off putting the $500 towards your debt than getting 2-3% on the CD.

MentholMoose

bigmantenor wrote: »

Putting money in a CD is an extra bad idea when you still have debt accruing interest. You're better off putting the $500 towards your debt than getting 2-3% on the CD.

Agreed. CD rates are actually under 1% unless you do a multi-year term, so you're better off putting your money pretty much anywhere (including paying off debt). That is below inflation so the real rate is negative... the value is depreciating (slightly) less than if you just held cash.

higherho, if you want to save then adding more to your 401(k) may be the best option. If at all possible you should be contributing enough to "max out" the contribution from your employer... different employers do their matches in different ways but they all have some maximum so check your new hire guide, intranet, or contact HR (their job is to help you with this stuff, after all). If you aren't maxing out your 401(k) you are essentially leaving free money on the table. Besides being juiced by the employer match, the money you put into the 401(k) is also juiced by tax savings. Contributions to a (standard) 401(k) reduce your taxable income so you will pay less tax. Another option is a traditional IRA. There is no employer contribution but your contribution is pre-tax so there will be immediate tax savings.

In your situation you should focus on two things: 1) increase your income and 2) reduce expenses. For 1), is your wife studying and/or attending class 16 hours a day, 7 days a week? If not, she can probably get (at least) a part-time job somewhere. Many people even work full-time while going to school, including graduate level. For low stress jobs, look at on-campus jobs... maybe she can be a TA or do some work-study position. Besides that, you can look for side work, for example check Craigslist or do something like what is discussed in this thread: http://www.techexams.net/forums/jobs-degrees/68950-found-great-contract-work-site.html

For 2), it sounds like you've made progress but maybe you can do more. Get creative and think outside the box about every expense. Note that expenses include more than the things you write a check for every month. I can think of a few that might help you get started.

Check your benefits enrollment at work. You may be paying for stuff you don't need. At a previous job I had a coworker realize one day that she had been paying $10/month for a legal assistance program that she had not used once in 10+ years. You might not be able to change these things right away, though. She actually did need some legal assistance, so she contacted them and they couldn't even help anyway! What a waste.

Check if your employer has any extra benefits you may not be utilizing. For example, there may be an employee stock purchase plan (ESPP). Even if you don't want to mess around with stocks, an ESPP can give you extra money because you should get a discount on the stock and can cash it out immediately. For example you might get a 10% discount on the stock price on a certain day, and if you can put 10% of your salary into the ESPP it is essentially a 1% bonus.

Besides an ESPP, check if your employer has any discount programs. Does your company sell anything (goods or services) that you need to buy? Food, utilities, insurance, etc.? If so, they may give you discounts on it. Even if they don't, they may have agreements with other companies (especially their vendors and partners) to give discounts. These things might not be advertised well (or at all) by HR so bug them and ask around. For example, my wife and I receive a 20% discount on our cell phone plan through my wife's work (previously Verizon, but currently AT&T). You may also get discounts on things you can resell on eBay... hey, every dollar counts, right? At a past job (an internship, actually, so money was tight) I had a discount on software from a particular vendor, so I could buy it and resell at a profit (limited to three copies of a particular software per year, though).

Another thing you can try is to verify your W-4 form (and the equivalent state form) was filled out correctly, because your employer may be withholding too much money. This is the case if you expect to get a tax refund. Some people like getting fat refund checks, but not me... paying too much tax during the year and being refunded is an interest-free loan to the government. You can use the IRS Withholding Calculator or other calculators, and if you need help just go to HR.

tpatt100 wrote: »

I was listening to Dave mainly for motivation, I paid off two credit cards, cancelled cable, coupon clipping, etc.

There are a lot of web sites that help with reducing household expenses, just search Google. Couponing is something worth looking into. My wife and I do this and even on a limited basis it helps... also, it's kind of satisfying when you get a something you need for free or dirt cheap.

One thing I will suggest is to just call whoever you are paying and ask for discounts. In many cases they will simply grant your request immediately. If it doesn't work the first time, call again. The CSRs all have the same power but some may be more willing to help you than others. If not, (if applicable) threaten to cancel whatever service your are paying them for. This will usually get you transferred to a "retention" department who can give you discounts.

If that still doesn't work, check if they offer any promotions to "new" customers and if it's not too much trouble, actually go ahead and cancel the service, then open a new account under your wife's name. I used to do this with my cable Internet when I lived in a different area with a different cable company with better discounts. Their new customer promo varied from $20-25/month for 4-6 months, so we'd cancel and resubscribe 2-3 times per year.

Forsaken_GA

MentholMoose wrote: »

higherho, if you want to save then adding more to your 401(k) may be the best option. If at all possible you should be contributing enough to "max out" the contribution from your employer... different employers do their matches in different ways but they all have some maximum so check your new hire guide, intranet, or contact HR (their job is to help you with this stuff, after all). If you aren't maxing out your 401(k) you are essentially leaving free money on the table. Besides being juiced by the employer match, the money you put into the 401(k) is also juiced by tax savings. Contributions to a (standard) 401(k) reduce your taxable income so you will pay less tax. Another option is a traditional IRA. There is no employer contribution but your contribution is pre-tax so there will be immediate tax savings.

The tax savings are only worth it up to the match. Putting any money in above and beyond the contribution match is not so smart. The funds contributed are tax deferred, *not* tax free, and when you finally do start withdrawing them, you're taxed at your ordinary income rate. Once you hit the employers match, you should be doing a Roth IRA, not a 401k.

Example math -

Contribute $1000 to your 401k. If you'd taken that $1000 as taxable income, it would have cost you $250 in taxes that year, assuming a 25% tax bracket.

After 40 years, at 12%, that $1000 is worth $118,648.09. Except that you'll pay your ordinary tax rate on that money when you take the distribution. Let's say that's 15%, which is about $18k. So in order to save $250 bucks 40 years ago, it'll cost you $18k at retirement. That's a *great* deal. For the government.

If you invested the same $1000 in a Roth IRA for the same term at the same rate, it would grow tax free, and you'd get to keep the entire amount at retirement.

Now, that changes a bit with your employer contribution matching. Say your employer matchs that $1000 dollar for dollar. After 40 years, that $1000 (really $2000 because of the employer match) becomes $237,293.28, and after the government takes it's cut (right around $35k), you're still pocketing over $200k, which is significantly more than the gains for the non-matched contribution.

Long story short, always take the 401k up to the match, it's the best deal around. Above the match, it's not such a great deal. The only exception to this *may* be if contributing above the match will put you in a lower tax bracket, but not many people live that close to the bubble, and the people that do, don't tend to stay there for long. And at levels of compensation high enough for that to potentially matter, there may be limits in place that prevent you from taking advantage of it (read up on the rules for 401k and Highly Compensated Employees, and then figure out how they apply to your company).

The only reason to open a traditional IRA is to roll over your 401k into when you leave your company. Opening one on your own instead of a 401k is just a bad deal. The perceived tax break benefits of a tax-deferred investment is a red herring, it's not a good reason to choose that investment, and if you think it is, you've fallen prey to some really good marketing.

stlsmoore

I feel your pain, I forced my self to stay at home for an extra 2 years to pay off 30k private loan student debt. And then I bought a 23k car, not the smartest move but I can at least sell the depreciating asset if ever needed. I have an emergency fund but I'm building up extra in case I'm out of work for 6 months or need to move across the country for work.

After expenses I have about 30-40% of my income left which is okay but I want to get it to 50% at least. Once I have enough money to cover myself for 6 months I'm putting the rest in a savings account most likely for a future business I will start whenever that day comes.

Everyone

I know how you feel, try adding 3 kids into the mix. :P

In my situation, the student loans aren't mine, they're my wife's, and instead of rent, it's a mortgage.

Aside from what everyone else has already said (pay off the debt first!)... another area you could cut expenses on, if you have it... is TV. If you have cable or satellite, they can be expensive. I cancelled my cable TV and switched to Netflix, saved $50/month. That's $50/month I can use to pay off a debt faster.

For your electricity, check this out: Introduction to ComEd hourly electricity pricing The Frugal Nerd

If ComEd isn't your electric company, whatever company services your area probably has a similar program.

I haven't tried it yet, but I found it while looking into something I got in the mail that said I could lock in a rate for 1 year on my electricity charges. The hourly rate seemed like it would actually be better and save more.

One thing that will help you feel less broke, and get you away from "living paycheck to paycheck" is to sit down and map out your finances. Get a calendar, mark when and how much you get paid on it. Get all your bills, mark when they are due, and how much you pay on them. Then balance your bills between your paychecks. Your payments may not be flexible on some bills, but others they are, and a lot of places will work with you on the due dates for things.

I get paid twice a month now, before I did this, my 1st paycheck was always gone almost as soon as it was deposited. We had very little to get by on until the 2nd one came. Now after all bills are paid, I have about $1k left over for food, gas, and other expenses until the next paycheck, and it feels a lot better.

Once you've balanced things out, and freed up some money by cutting a few expenses, you have to put that "extra" money to work. Remember it isn't "extra" money until your debts are paid off. Keep your belt tight, start applying the "extra" towards 1 bill. Pay off 1 at a time, as soon as 1 is paid off, apply the money you were using to pay that debt off towards the next one, until they're all paid off.

You can either start with your debt that has the highest interest rate, or start with your debt that has the smallest balance. I prefer to start with the smallest balance. Write down what you were paying on it every month. Add the money you freed up to that payment, until it is paid off. When it is paid off, move onto the next debt.

Turgon

Forsaken_GA wrote: »

The perceived tax break benefits of a tax-deferred investment is a red herring, it's not a good reason to choose that investment, and if you think it is, you've fallen prey to some really good marketing.

Which is precisely what really good marketing does. It generates sales and takes your money. It is nothing to do with giving you what you really want or need.

Mishra

My g/f\wife has 180k in student loan debt. >_<

Aldur

Mishra wrote: »

My g/f\wife has 180k in student loan debt. >_<

Wow! Was that for medical or law school? Man, that's more than I owe currently on my mortgage.

Xcluziv

Mishra wrote: »

My g/f\wife has 180k in student loan debt. >_<

WOW!!!! that's a very substantial amount...hope you are chopping that down month in and month out

Mishra

Not touching it...

Numbers work out around this

70k for a really expensive worthless Humanities degree
40k in interest for a really old expensive humanities degree
20k in Pre-reqs for Nursing
50k in accelerated expensive 1 year nursing program

When she starts working as a nurse, her entire pay check will be dedicated to the loan for 5-10 years.

Already warned her that we both will have to work through children.

Her "plan" as a kid was to use inheritance to pay it off... Grand parents and mother died, father spent every dime at the casino.

mog27

I follow Suze Orman and I think some of Ramsey's ideas make no sense at all. $1,000 for an emergency fund? That is NOTHING. You should have at least an eight month emergency fund because that is at minimum how long it could take you to find a new job if you lose your job. What is $1,000 going to buy you? That won't even cover 1 month of a mortgage payment in most instances.

Granted I have not read Ramsey's books but someone told me he recommends paying off the smallest debt first regardless of the interest rate to make you feel better. That makes no sense at all. You pay off the debt with the largest interest rate first.

Pick up Suze's latest book, The Money Class.

Bl8ckr0uter

mog27 wrote: »

I follow Suze Orman and I think some of Ramsey's ideas make no sense at all. $1,000 for an emergency fund? That is NOTHING. You should have at least an eight month emergency fund because that is at minimum how long it could take you to find a new job if you lose your job. What is $1,000 going to buy you? That won't even cover 1 month of a mortgage payment in most instances.

The wife and I are reading his book and following some of the principals and the 1000 dollar thing is the only thing I take issue with. I don't think that saving 8 months worth of salary is realistic (for people to do before they start paying off debt). I think he chose 1k because it would be relatively easy to do. When we got to 1k, I told my wife we need to start burning through our debt. We are firing our bank and moving back to our credit union as it has better interest rates. We have also paid off 3 credit cards and now we have only one left. I have a 5 payments left on my car and a small amount of student debt (less than 3k). We will probably be debt free by June of next year. My goal is for us to have 10-12K saved up by then.

Mike-Mike

cut off your cable if you have that, i went to just OTA and Netflix years ago, and I have never regretted it

Forsaken_GA

mog27 wrote: »

I follow Suze Orman and I think some of Ramsey's ideas make no sense at all. $1,000 for an emergency fund? That is NOTHING. You should have at least an eight month emergency fund because that is at minimum how long it could take you to find a new job if you lose your job. What is $1,000 going to buy you? That won't even cover 1 month of a mortgage payment in most instances.

It's not so that you can survive something like a layoff. It's so that you can deal with the little emergencies that come up, like the car needing a new alternator. Or replacing a busted washer/dryer. All those little things that turn into big hairy deals when you're living paycheck to paycheck. If you know you've got a major life event coming up (impending lay off, baby on the way, etc), he recommends stopping his program and piling up cash until you're safely through the major life event. Following the 1000 bucks in the bank is to get out of debt as quickly as possible, and then after that, save up 3 to 6 months of expenses as your full emergency fund, depending on your circumstances.

Granted I have not read Ramsey's books but someone told me he recommends paying off the smallest debt first regardless of the interest rate to make you feel better. That makes no sense at all. You pay off the debt with the largest interest rate first.

He recommends that because he holds the opinion that the majority of financial health is related to behavior (and I happen to agree with him). If you see progress early, you're more inclined to stick with it and see it through. Think about going on a diet - if you do it for a month, and you end up gaining a pound, you're going to say screw this, it ain't working. We live in a society that demands instant gratification.

Now, from a purely mathematical standpoint, paying off the debt with the largest interest rate first makes sense.

However, if you could do math, you wouldn't have debt in the first place, so that dog just don't hunt.

mog27

Forsaken_GA wrote: »

It's not so that you can survive something like a layoff. It's so that you can deal with the little emergencies that come up, like the car needing a new alternator. Or replacing a busted washer/dryer. All those little things that turn into big hairy deals when you're living paycheck to paycheck. If you know you've got a major life event coming up (impending lay off, baby on the way, etc), he recommends stopping his program and piling up cash until you're safely through the major life event. Following the 1000 bucks in the bank is to get out of debt as quickly as possible, and then after that, save up 3 to 6 months of expenses as your full emergency fund, depending on your circumstances.

He recommends that because he holds the opinion that the majority of financial health is related to behavior (and I happen to agree with him). If you see progress early, you're more inclined to stick with it and see it through. Think about going on a diet - if you do it for a month, and you end up gaining a pound, you're going to say screw this, it ain't working. We live in a society that demands instant gratification.

Now, from a purely mathematical standpoint, paying off the debt with the largest interest rate first makes sense.

However, if you could do math, you wouldn't have debt in the first place, so that dog just don't hunt.

ehh still makes very little sense to me. In this day of high unemployment, if you dont have a very large emergency fund you are SOL. So let's say I have 1K and lose my job. How am I going to build up the money to live off for the next 6 or 8 months (if not much longer) to supplement the little I get from unemployment. Plus, many emergencies will cost more than $1,000. There are a host of things that can go wrong that will cost you 5 times that.

If paying off the lowest debt first and ignoring the interest rate helps someone pay off debt when they would otherwise not to do, then that's great. For me, I am tackling the highest rate first becuase I don't want to pay anymore than I have to.

Forsaken_GA

mog27 wrote: »

ehh still makes very little sense to me. In this day of high unemployment, if you dont have a very large emergency fund you are SOL. So let's say I have 1K and lose my job. How am I going to build up the money to live off for the next 6 or 8 months (if not much longer) to supplement the little I get from unemployment. Plus, many emergencies will cost more than $1,000. There are a host of things that can go wrong that will cost you 5 times that.

Well, that's certainly your choice. I'd suggest you look at the numbers of how much the debt is going to cost you in order to save up that much money first (and keep in mind, your savings will be eaten away by paying the debt you're carrying while you're laid off), and then consider that number against the likelihood of a major life event. Honestly, it doesn't make much sense to me that you're a proponent of paying off the largest interest rate debt on the one hand, but you think you should postpone paying off the debt first to stockpile a large amount of money first, you're paying a hell of alot more in interest if you do it that way, so your viewpoints seem to conflict each other.

And while I certainly understand the what if's, again, I did the math. I looked back at my historical expenditures. Turns out that I didn't really have that many emergencies that cost more than $1000. The vast majority of expenditures that were larger than that were me buying crap that I shouldn't have. If something comes up that you need more than that for, you *do* have the option of altering your budget for that month.

I refuse to live in fear of what might happen. I hedge against the badness happening, but I don't let it rule my decisions. I stay focused on making progress, not treading water. By clearing out my debt first, I was able to save up a comfortable emergency fund in a relatively short amount of time (because I could now bank EVERYTHING that I used to pay debt on). Once I had that done, I was able to save up and pay cash for a new (to me) car, while still being able to invest for retirement. Now, I'm saving for a house.

If paying off the lowest debt first and ignoring the interest rate helps someone pay off debt when they would otherwise not to do, then that's great. For me, I am tackling the highest rate first becuase I don't want to pay anymore than I have to.

That's certainly your choice. When I worked my way out of debt, I did the math, and the amount I saved by paying off the highest interest rate first wasn't worth my time and effort when I compared it against the hassle of having to keep that many accounts open to make payments on. Getting rid of the low hanging fruit first helped me streamline the process. After four months, the only thing I had left to worry about was my car payment (which was my highest interest rate), and that made things much, much simpler.

azjag

mog27 wrote: »

ehh still makes very little sense to me. In this day of high unemployment, if you dont have a very large emergency fund you are SOL. So let's say I have 1K and lose my job. How am I going to build up the money to live off for the next 6 or 8 months (if not much longer) to supplement the little I get from unemployment. Plus, many emergencies will cost more than $1,000. There are a host of things that can go wrong that will cost you 5 times that.

If paying off the lowest debt first and ignoring the interest rate helps someone pay off debt when they would otherwise not to do, then that's great. For me, I am tackling the highest rate first becuase I don't want to pay anymore than I have to.

I had no idea recommending Dave Ramsey would spark such interest in the forums.

I tend to lean towards the 1k emergency fund myself. Having read both Dave and Suze's books I came to the conclusion that Dave's method will work best for my situation. While I don't agree with everything Dave recommends nor disagree with everything Suze recommends it really comes down to what you can stick to.

They both have the same recommendation when it comes to paying off debt. Start with the lowest balance first. When that is paid off take the amount you were paying and add it to the payment on the debt with the next lowest balance. If you have two debts with the exact same balance then focus on the one with the highest interest rate.

If I happen to become unemployed I would not sit around for more than 1 day without finding another source of income. I have no problem delivering pizza's or washing dishes. Sure it may suck, but it pays more than unemployment. I would also turn off any non essential services and finally get through the backlog of ramen in my pantry.

But how one handles their financial situation is entirely their own.

cyberguypr

azjag wrote: »

Having read both Dave and Suze's books I came to the conclusion that Dave's method will work best for my situation. While I don't agree with everything Dave recommends nor disagree with everything Suze recommends it really comes down to what you can stick to.

This is the big takeaway here. There is no universally accepted solution. The best plan is that one that you follow and can produce results. Read as much as you can on the subject and look at your individual situation through the lens of each of the plans and see what works for you. I may be one, the other or a hybrid. The only certain thing is that any plan is better than no plan at all.

mog27

Still much prefer Suze's philosophy over Dave's. But, hey, whatever works for your particular situation.

MentholMoose

Forsaken_GA wrote: »

Example math -

Contribute $1000 to your 401k. If you'd taken that $1000 as taxable income, it would have cost you $250 in taxes that year, assuming a 25% tax bracket.

After 40 years, at 12%, that $1000 is worth $118,648.09. Except that you'll pay your ordinary tax rate on that money when you take the distribution. Let's say that's 15%, which is about $18k. So in order to save $250 bucks 40 years ago, it'll cost you $18k at retirement. That's a *great* deal. For the government.

If you invested the same $1000 in a Roth IRA for the same term at the same rate, it would grow tax free, and you'd get to keep the entire amount at retirement.

Yes, the distributions from a 401(k) are taxed, but the contributions grow tax-free and benefit from compounding. By your example math you will have to pay 25% tax on that $1000 of income you want to invest, so actually you'll only have $750 left over to contribute to the Roth IRA. After 40 years at your projection of 12% compounded monthly, that $750 only grows to about $88,986. Even though you don't pay taxes on the distributions (you save $17,797), because your account balance is $29,662 less that you'd have in the 401(k), you have a net loss of $11,865. That Roth account is not such a deal after all.

And what if you did have $1000 in a Roth account? You would have needed a pre-tax amount of $1333, which you could have put in a 401(k) to grow tax-free, and by your example math you'd still be worse off. Next time you want to make a Roth account look good, you should assume a LOW current tax bracket and a HIGH future tax bracket, not the other way around as you have done here.

Forsaken_GA wrote: »

Above the match, it's not such a great deal. The only exception to this *may* be if contributing above the match will put you in a lower tax bracket...

How does this statement make sense with a progressive tax system? In any case, the fact that contributions to a traditional 401(k) or IRA grow tax-free is possibly quite beneficial, again, because of the power of compounding. There are many more "exceptions" you are not considering.

Forsaken_GA wrote: »

The only reason to open a traditional IRA is to roll over your 401k into when you leave your company. Opening one on your own instead of a 401k is just a bad deal.

If you have contributed enough to your 401(k) to max out your employer's contribution, they are not much different.

Forsaken_GA wrote: »

The perceived tax break benefits of a tax-deferred investment is a red herring, it's not a good reason to choose that investment, and if you think it is, you've fallen prey to some really good marketing.

Come on now.

In your very own example, the Roth account doesn't even work out to be better. In some cases, though, it will. It's just not as simple as "Roth account = always better".

My impression from the OP is that right now every dollar counts. Saving a few bucks on taxes could help him reach his near-term savings goal. Maybe it won't, I can only guess based on the available info. I figure he may currently be in a low tax bracket so a Roth account may make sense, but that might just not be achievable. He might just be able to scrounge together $500 for a traditional IRA, or contribute a bit more to his 401(k), whereas he might not have enough to open a CD or Roth account because of the taxes he'd have to pay. It's possible to have multiple IRAs so he can always open a Roth account later when he can afford it.

higherho

Thank you all for the advice! Its great to hear to have such an active community to help other IT guys / people. Especially about the 401k and Roth accounts. I did not know much about Roth IRAs

I been chopping down one debt at a time. However, its just taking longer than I expected. I get paid on the 15th and the 30th every month and apparently something always happens on either of those dates (two new tires last month (at the end of the month), Glasses broke, etc). I been pressing my wife more into earning more money when she can and how much it would help me / us.

I talked to my mother to take more of the loans that were in her name (I wish I lived were she lives, 600 bucks a month and everything included) and this extra money that I would give to her will go to my little debt first. For example; I would like to take the 308 dollars I give my mother and put it all towards my CC and pay it off in 2 months instead of 6. Come to think of it I might go that route. Yes, I know it sounds selfish but it will free up more money in the long run to put on the school debt.

I agree with the posters here about getting your smallest debt out first, it makes you feel really good inside when you see one of those credit cards down to 0.

I will be adjusting my federal tax issues soon. Right now I'm still listed as single with 0 dependents 0_0

I have netflix, I changed all our light-bulbs to energy saving bulbs (this saved me 15 bucks last month). Plus, buying food in bulk has helped me a bit. Today was the day we go shopping for food and typically I would like the food to last a month but I always spend over 120 bucks on food. Today, I dropped that down to 65 by purchasing bulk with certain products that would last longer, can foods, and using coupons. I am trying to make every dollar count to the best of my ability (even when temptation comes running at you).

EDIT

I also forgot that I was awarded 300 stock options at work too. Though I get 100 every year that I'm employed (Just got my first hundred). Stock prices right now are 45 bucks a share.

Forsaken_GA

MentholMoose wrote: »

Yes, the distributions from a 401(k) are taxed, but the contributions grow tax-free and benefit from compounding.

No, your contributions do *not* grow tax free in a 401k. That's why it's tax deferred growth, not tax free growth. A Roth 401k will grow tax free, but it's funded with after tax dollars, the same as a Roth IRA, so you realize no tax benefit from the contribution.

With a regular 401k, the only thing you're doing is pushing off your tax payment. Your contributions and it's earnings are taxed at your ordinary income rate when withdrawn, which tends to be less when you've retired. That's how they get you, it sounds like a good idea...

If you're still going to insist that 401k's grow tax free, I'm going to have to insist on some proof, because I can drown you with a bunch of links that demonstrate quite clearly the opposite.

By your example math you will have to pay 25% tax on that $1000 of income you want to invest, so actually you'll only have $750 left over to contribute to the Roth IRA. After 40 years at your projection of 12% compounded monthly, that $750 only grows to about $88,986. Even though you don't pay taxes on the distributions (you save $17,797), because your account balance is $29,662 less that you'd have in the 401(k), you have a net loss of $11,865. That Roth account is not such a deal after all.

I'm going to ignore the rest of your math, since it's based on the assumption that 401k's grow tax free, which makes everything you've said incorrect. Obviously if you're comparing a lesser investment to a greater one, the numbers are going to be different, it's apples to oranges. In order to contribute $1000 to a Roth IRA, yes, you're eating the taxes on that $1000 for that year. The difference in my example is that I can either pay $250 bucks the year I make the $1000 investment, or I can pay $18k when I cash out. I'll pay the $250, thanks.