401(k) loan to pay off credit card debt (?)

My money question is about taking a low interest loan from my company 401(k).  My sister has suggested this as a way that my husband and I can pay off our high interest credit card debt.  What do you think?

Thanks for the question.  I am happy to hear that you and your husband are seeking ways to get out of debt.  I can think of several reasons why taking a loan from your 401(k) could hurt you.

First,  the money that you borrow out of your long-term “don’t want to be a bag lady” account will not be available for growth while it is out of the account.  That’s was the expectation when you put the money into it via payroll deduction.  Don’t short circuit your earlier plans.

Second, is that if you leave your job (you quit, get fired, laid off, have to retire early, become disabled, etc.) you will have a VERY short period of time to pay back the entire loan balance.  If you cannot pay it back quckly, whatever balance is left outstanding will be “forgiven” and counted as a premature taxable distribution and you will have to pay income taxes on that money and if you are not yet 59 ½  you will also have to pay an additional 10% penalty.  I have seen this happen.

Third, (and this is the biggest of the three) is that borrowing against your 401(k) is just more borrowing – it does nothing to address the root problem (overspending your income).  More borrowing only masks the problem.  It doesn’t really solve anything.

Borrowing from one’s 401(k) would make perfect sense ONLY IF the issue is that your past overspending was financed by borrowing from the wrong place (from credit cards instead of from your 401(k).  But that’s not the case.  The issue is spending vs income.

MMQ feels much the same way about debt consolidation loans or a HELOC to pay off consumer debt.  They seems logical, and the interest rates and tax advantages often favor the strategy, but I have seen it go bad MANY more times than I have seen it work out.  If the underlying problem isn’t solved (too much spending for a given amount of income) then the problem will come right back, and often be worse than it was in the first place.

You and your husband may eventually decide to assume these risks and borrow against the 401(k) to leverage the lower interest rates and make the debt payoff go a little faster than it would otherwise, but don’t even think about doing so until you have proven to yourselves over 9 to 12 months that you have learned to live within your means and you have been paying off your debts on a steady basis.

- MMQ

Lump sum now or monthly payments for life?

My money question is about pension options.  I will be retiring in a couple of years from a large company here in town.  I understand that I will  be able to take my pension money all at once (several hundred thousand dollars that I can roll into an IRA) OR as a much more modest monthly amount every month for the rest of my life.  Which is better?

Hard to say.  Depends on your individual circumstances.  Please go slow on this decision.  It’s big.  One that you can’t go back and change your mind on after you make your election.

I’m assuming that you are vested in a traditional pension / defined benefit plan.  I’m also assuming that your plan payout options include a lump sum (that can be rolled over into a pre-tax IRA) or an “annuity” that will pay you X dollars per month.

I have seen many examples of couples in your circumstances who looked at the form and made a rash choice.  One they later regretted.  Don’t let that be the case with you.  There are some pros and some cons for taking the lump sum and some pros and cons for taking the annuity. 

I know the lump sum number looks like a lot of money and the monthly amount looks much smaller by comparison.  But they are not really as different as it might appear.  Under federal law (ERISA) the lump sum will be the “actuarial equivalent” of the stream of payments you would receive if you chose the annuity.  The lump sum will be the calculated “present value” of the number of payments that a person your age is likely to receive in combination with curent interest rates and several other factors.  So the lump sum is not usually clearly better than the stream of lifetime payments unless your health or other financial circumstances make it so.

For example, a person in bad health who is likely to not live as long as the government tables predict might be better off choosing the lump sum.  A person in very good health with good genes that predict a very long life might be better off taking the lifetime payout.

A person who is not skilled at managing a large amount of investable money and not willing to pay a professional money manager to do so, and/or who does not want to worry about the issue might choose the monthly payment.  A person who is married to a person who already has a pension benefit for them to live on might choose to take the lump sum.

One of the biggest differences is in who bears the risk of poor investment returns.  With the monthly pension, the company or the trust that administers the assets is responsible for making sure that the monthly payments get paid to you.  If you take the lump sum and invest the money, you guys will bear the risk of bad investment returns.

There are other factors, too.  Here’s a website I found that gives the major differences….  http://moneyover55.about.com/od/preretirementplanning/a/lumpsumorannuity.htm

Take a look, and talk with your spouse about it.  This is a question for which a good, unbiased financial planner can be very helpful.

VERY few people have a pension plan anymore, one that is promised for as long as they live, and one that is overseen by the US Government’s Pension Benefit Guarantee Corporation.  It’s a real benefit that you’ve earned.  Don’t let go of it too quickly, and without good reasons.

- MMQ

Best first step (?)

My money question is about getting started.  I’m completely clueless.  What’s the first thing I should do?

Sorry; I can’t limit my answer to only one thing.  I’d begin by doing four things at once.

1A.  Spend 15 minutes of serious thought and write out 3 or 4 financial goals for yourself and/or your family.

1B.  Start giving something, even if it’s just a few dollars, from every paycheck to your church or a Christian charity.

1C.  Start tracking every nickle of your income and spending.  On paper.  Do this for 30 days.  It will show you where your money is going.

1D.  Save up $1,000 for emergencies.  Keep half of it in cash hidden in the back of your sock drawer and put the other half in an FDIC-insured savings account at a local bank.

Don’t do anything else until you’ve done all four of these tasks.  After they’re done, get a copy of the Crown Money Map (Compass1.org has something similar) and determine what’s next.

- MMQ

 

We’re debt free. Now what?

My money question is about what to do next.  My wife and I are in our late 50′s and we just finished paying off our house.  That was the last thing we owed money on.  We have been contributing to IRAs and a 401(k) for a long time and have a little over $800,000 in retirement accounts.  We have no worries now.  We feel like we’re all set.  Any advice for us?   

Thanks for the question.  Congrautlations on being debt free finally and on being persistent savers.  That said, I think you are walking in a slippery place.  Please be careful.

MMQ traded e-mails on this topic with a wise friend a few weeks ago.  His advice to me applies in your situation, too.  Here’s the gist of what he said…..

The biggest danger in being debt-free is PRIDE.  You must actively resist it.  You’re probably already feeling the temptation (right?) to say “look what we have accomplished.”  “Look how smart and diligent we are.”  IOW, to think more highly of yourselves than you should.

“Others should be wise like me” you might be thinking…or “Maybe I should teach a class down at the church on this stuff – because I clearly know how to do it.”

I’m describing someone who has fallen prey to “the deceitfulness of riches” that’s mentioned in Matthew 13:22.  Beware this danger.  Read Luke 12:16-21.  Ask God how that parable applies to you and your wife now that you have so much surplus and so many options.

When you and your wife were working to pay off debt and build savings, you were probably more humble than you are now.  You were not as prone to trust in your wealth.  You were more dependent on God’s provision every month.  In this context, read and ponder Philippians 4:11-13, Hebrews 13:5, and Deuteronomy 8:16-18.

Remember that those who are wealthy, yet do not enjoy a close relationship with Christ are actually poor in the only way that matters.  Read Revelation 3:17 — it’s frightening.

I’m not saying you have too much money.  I’m just warning you that the “mass” of wealth that you have accumulated is large, and with that large mass comes a strong gravitational pull.  Scripture is clear (Deuteronomy 31:20 for one) that increase in possessions and wealth moves us closer to spiritual danger.

Your diligent saving over the years, coupled with God’s financial provision to you and your wife in excess of the bare necessities, has put you in an enviable position.  You have options now that most people never have and will find that it’s a real test of your obedience and faith.  Don’t become prideful, and don’t waste the opportunity to be strategic with the wealth that God has given you to manage.

- MMQ

Estimating my Social Security benefit (?)

My money question is about Social Security benefits.  I am trying to decide when to stop working and I want to know what I can expect to receive.  How is that calculated?

Thanks for the question.  MMQ hopes you will always be working at something productive, even after you stop working for a paycheck.  The prevailing American view of retirement is not at all biblical (but that’s a topic for another post).

The amount of your monthly Social Security benefit is determined by a host of factors — including when you were born, how many years you worked for pay, your earnings during each of those years, your marital status, and when you will begin receiving benefits.  The calculation is far too complicated to explain in a blog post.  That’s the bad news.

The good news is that you don’t have to do the calculation yourself — the Social Security Administration does it for you every year and sends you the updated amounts by mail in a four-page booklet.  This estimate booklet usually arrives in your mailbox a month or so before your birthday.  If you still have the last one you received, you can find your estimated monthy amount there.

Visit the Social Security Administration website and look at the menu on the left side of the home page.

That home page menu includes a link to an easy to use calculator that will produce an estimate for you using information specific to your record at the SSA.  It’s just an estimate, but it is an estimate based on your age and your earnings.

Regardless of the amount of your estimate, I hope you have made provision for income in retirement that is not limited to your Social Security benefit.  SS was never intended to be the sole source of income for retirees.  Without major (and painful) changes, the SS program won’t survive many more years.

The best retirements are those financed from a variety of income sources — some from SS, some from a company retirement plan, some from part-time work or other income producing investments, and some that you have saved for that purpose during your working years.

As a rule, people are surprised at how small their Social Security benefit turns out to be.  It’s a good idea to estimate what your future benefit is likely to be and then take steps (now) to cultivate other sources of monthly income.

- MMQ

Money lessons for my kids (?)

My money question is about kids.  What are the key lessons I should be teaching them regarding money management?

Good question.  You’re wise to be concerend about what they are learning, and from whom.  I wrote a short article on this topic a couple of years ago that was published in the Oakleaf Village Journal.  Here’s the text of that article:

“Your child’s ability to handle money and credit is more important than what college he attends, or even what career she pursues.  Most parents spend hundreds of hours sharing their knowledge of a particular sports team or hobby but very little time teaching the basics of money management. 

I make it a point to ask my wealthy clients where they learned how to work, save, and invest so well, and most say they learned it from parents.  I ask clients who are struggling with debt, overspending, and lack of savings where they learned their habits and I usually hear the same answer.  What you teach your children about money (either good or bad) has a great influence on their success in life.

The skills you teach will vary by age, but eight to ten principles form the basis for all of the lessons.  Here are three of those principles, with some example lessons to get you started:

Needs are different from wants
Without guidance, most everything children buy is a want, because parents already cover their needs.  Parents who fail to teach the difference aren’t being fair to their children.  Have young children make lists of needs vs. wants, or give them a list of items to put into the correct category.  Talk with your children about your own spending decisions.  When you want something, but decide not to buy it because of other priorities, explain your reasoning to them.  As they get older, begin to give them some of the money that you would have spent on their needs and make them responsible for managing it and making those purchases.  I’ve seen teenagers become careful shoppers almost overnight when they realize that the clothing allowance they’ve just received from Mom is all they will get for clothes for the next three months.

Financial decisions have consequences
Good decisions lead to more security and increased options, bad decisions to stress and constant shortages.  For young children, find simple ways to let them experience both good and bad consequences.  If you normally give your daughter a $5 allowance on Friday, offer her $7 if she will wait until Monday.  Permit your son to spend all of his money on the first thing he sees in a store, and then continue to point out other desirable items that he can’t have because he already spent all of his money.  Add “interest” to your children’s piggy banks based on how much is in it to reward their decision to forego spending all of the money they receive.  For older children and larger purchases that require accumulating money over several months, match their savings dollar-for-dollar to encourage persistence toward the goal.  Don’t worry about being manipulative; that’s the point.  Talk with your children about these lessons, what you’re doing, and why; their questions and your answers will make the lessons even more instructive.

Saving and giving can be just as satisfying as spending
Teaching this principle requires extra effort, but it’s likely the most valuable one.  Make saving for emergencies and future purchases an expectation and a habit.  A planner in my office with two young sons bought each of them a piggy bank with three compartments; one for Giving, another for Saving, and a third for Spending.  Their dad set ground rules for the minimum percent of their allowances and birthday money that must go into each compartment, but beyond that, the boys are free do as they wish.  They love making decisions, and the chance to do three things instead of one with their money is a treat.  I shared his experience with George, a client of mine, and George built a similar bank for his son Andrew.  Over the course of several months Andrew saved (with a generous match from his dad) enough to buy his first new bike.  The excitement of the bike purchase lasted a few days, after which Andrew turned his attention to the money in the Giving portion of his bank.  “That’s for sharing with others,” his dad explained, and the following Sunday Andrew enjoyed “spending” that money into the offering plate at his church.  George enjoys the financial planning that he does with his son, and he feels great about the life lessons he’s teaching.

Just like George is to Andrew, so you are your children’s primary source of information about money.  Schools don’t teach the principles well, if at all, and no one has the credibility you do.  Talking to your children about wise money management may force you to confront some of your own failures, but don’t let that dissuade you.  It’s a critical life skill, they’ll thank you later, and your retirement years will be much more pleasant if your adult children are financially independent.”

 - MMQ

 

Giving from a settlement (?)

My money question is about giving.  I won’t go into details, but I recently received a check from a settlement.  What should I do?

MMQ tries to avoid telling people the specific amount they should give.  I do this because I think there is too much interest in “rule following” these days and insufficient generosity.  Giving a particular amount or particular percentage only because somebody told you that you had to isn’t real generosity.  It’s just rule following, and it’s not cheerful giving.

MMQ’s advice is always the same – pray and ask God to guide your giving decision, and then give an amount that you know is real generosity.

Spend some time studying II Corinthians 8 : 1 – 5.

It’s one of the best passages on generous giving in all of the Bible.  The author (the apostle Paul) is writing to the church at Corinth and in his letter he is describing the churches in Macedonia as a model of real generosity.  Paul doesn’t mention the percent or the amount, or how the givers came to have the funds – but he is clearly impressed with the attitude of their hearts and their willingness to give even in extremely difficult / uncertain circumstances.

I see several principles in Paul’s description:

  • They first gave themselves to the Lord, asking Him to direct their giving.
  • They gave liberally (not some stingy minimum)
  • They gave sacrificially (more than anyone (even Paul) thought they could afford)
  • They gave strategically (to causes where they could have a significant impact)
  • They gave freely (with no regrets and no strings attached)

Mediate on this passage, and then pray for God’s guidance on how much you should give.  I’m confident that if you’re serious about the question, He will give you direction.  Do what He guides you to do.  No more and no less.

- MMQ

I already co-signed. Now what (?)

My money question is also about co-signing, specifically your post on 6/12/12.  I have already co-signed for a friend of mine.  I didn’t realize the risk I was taking.  What should I do now?

Good question.  I should have included this issue in my response to the previous question. Unfortunatly, there’s not much you can do at this point.  Nothing easy, anyway.  The lender wanted your signature on the loan as protection agains loss, and that lender is under no obligation to let you off the hook just because you changed your mind.

Proverbs 6:1-5 gives some good counsel on this.  Read that and see what you think.

I can think of only three options for you:

One is to go with your friend to the bank where the loan is and ask the bank to review the loan balance and the collateral and your friend’s payment history and (please) take your name off the loan.  The chance that the bank will do this is very low.  Almost zero.  There’s no upside to the bank for doing this.  But it’s worth a try.  If the bank shows mercy and grants your request, ask for a written release that you can keep in your files.

Another option is to go to the friend you co-signed for and ask him or her to refinance the remaining balance using a new (replacement) loan that does not include you as co-signer.  This assumes that your friend has improved credit now AND that your friend is willing to do this.  There may be some costs to doing this that your friend (or you) will have to pay.  If this doesn’t work, step up the pressure on your friend to pay off the existing loan as quickly as possible.

A third option is for you to prepare yourself to take over the payments or pay off the loan in the event that your friend cannot / does not.  This is something you can do that does not require cooperation from anyone else.  Increasing your cash emergency fund, reducing your monthly expenses, and increasing your income are ways to get ready.  It’s very common (see the previous post) for co-signers to have to make the borrower’s payments.  Being ready financially to do this will make it a tiny bit less painful for you if it happens.

That’s all I can think of.  It’s tough situation – sorry it happened.

- MMQ

MMQ readers — do you have any other / better ideas (?)

 

OK to co-sign?

My money question is about helping my sister-in-law get a decent car.  Her bank is requiring a cosigner before making the loan to her.  Anything wrong with me helping her this way?

Yes.  A lot.

The Compass Navigate study has a great summary of what the bible says about cosigning:.

“Anytme you cosign, you become legally responsible for the debt of another person.  It is just as if you went to the bank, borrowed the money yourself, and then gave it to the person who is asking you to cosign for them.  In effect, you are promising to pay back the entire amount if the borrower does not.

A Federal Trade Commission study found that 50 percent of those who cosigned for bank loans ended up making the payments. And 75 percent of those who cosigned for finance company loans ended up making the payments!  Those are pretty good odds that if you cosign, you’ll pay.”

The professional lender knows the loan is a bad risk, and is refusing to write the loan without getting someone who is financially responsible to guarantee its payment.

The Bible gives clear direction about cosigning.  It’s one of the plainest money passages anywhere in the scriputre.  Proverbs 17:18 — “It is poor judgment to countersign another’s note, to become responsible for his debts.”

The words that are translated “poor judgment” in this New Living Translation can also be translated “destitute of mind”!  IOW, it’s stupid.  It’s crazy.  Don’t do it.

Proverbs 22:7 says debt = bondage.  Why would you “help” a friend or relative put themselves in bondage?  Even the lender (who is in the business of renting out money) thinks she cannot afford the payments without help.  Further, why would you allow yourself to be put into bondage if that other person doesn’t make the payments?

Please use sound judgment.  Don’t cosign.  Help you sister-in-law, of course.  But do it some other way.

- MMQ

 

 

Give, Save, and Spend from our tax refund (?)

My money question is about what to do with a tax refund.  We were late filiing this year and did not receive it until last week.  We got back almost $2400 and we are trying to decide what to do with it.  The church we attend recently distributed some unspent offerings using a simple plan — 30% of the surplus was given away to Christian ministries, 30% of it was placed into an emergency fund, and the remaining 40% was used to pay down some debt and make some fun purchases.  Do you think we could do something similar with our tax refund?

Yes.

- MMQ.