海角大神

401(k): Are you saving enough? Run the numbers.

401(k) math is easy with a retirement calculator. Question on 401(k) is No. 7 in the reader mailbag.

What鈥檚 inside? Here are the questions answered in today鈥檚 reader mailbag, boiled down to five word summaries. Click on the number to jump straight down to the question.
Employee Stock Purchase Program help
Divorce mess (and follow up)
Unsure about next steps
Understanding tax brackets
A big mess of debt
Student loans or mortgage
Retirement path
A Game of Thrones
Self-employment questions
College student with some debt

Many people seem to think I have a thing against television. I don鈥檛. In fact, I think that a well-constructed television series is one of the best forms of entertainment for telling a complex story with well-defined characters.

There are two things I dislike about television, though. One is the advertising, not just during the commercial breaks, but during the programs in the form of product placement. The second is the convenience of using television channel surfing to fill downtime in our lives with nothing valuable or productive. Those two things add up to enough to keep me from turning on the television without clear purpose.

I鈥檓 all in favor of scheduling a date night once or twice a week and watching a few episodes of a great television series without commercial interruption off of a DVD or off of a streaming service. That can be fulfilling in a lot of ways.

Q1: Employee Stock Purchase Program help
For the past 3 or 4 years I have been working through the debt snowball method of debt elimination. I am now free of all debts other than my mortgage, have about 3 months of emergency savings (working on getting that to 6), and am funding my company-provided 401(k) at 6% (working on getting that to 10 or moving to a Roth IRA). For the 401(k) the company match is 2%. I feel like I finally turned a corner on my financial situation and have gone from being a slave to the banking industry to slowly starting to build wealth and plan for my retirement.

I am now debating on whether it makes sense to participate in my employer鈥檚 Employee Stock Purchase Program (ESPP). It works like this: there are two enrollment periods per year, and during an enrollment period I can elect to have a percentage of my gross income deducted from my paycheck (on a post-tax basis, of course) to buy company stock. At the end of each 6-month period they add up the payroll contributions made during that period and buy the appropriate amount of shares at the price at which the stock traded on the first day of the period or the last day of the period (whichever is lower). Shares are purchased at a 15% discount and are fully vested.

Every piece of investment advice I鈥檝e read so far (including your blog) generally suggests that the beginning investor stick to index funds, and/or highly-diversified holdings. So my question is this: as a beginning investor, does it make sense for me to take advantage of the discount the ESPP provides and contribute aggressively to buying company stock, or would I be better suited to putting that money in an index fund or other diversified holding? In other words, does the discount provided by the ESPP outweigh the risk of holding one specific stock in my portfolio? I am fairly young (34), unmarried, and currently own a home that will meet my needs for at least 10 years, so I have no immediate goals other than to continue to build wealth. I have a fairly high tolerance for risk, so seeing the value of company shares fluctuate day to day wouldn鈥檛 bother me too much as long as they were generally trending upward. Also, I鈥檓 not sure if this should factor in, but my company is very successful in its market, and has an earnings growth projection of 22.5% for the next five years.
- Brian

If the stocks are purchased at a discount and you鈥檙e fully vested, you could theoretically immediately sell the stocks and earn a profit each time, which seems like a good move.

The question you鈥檙e really asking, I think, is whether it makes sense to buy and hold the stocks of a company that you work for. Because you work for that company, you have some intimate knowledge about how the company is doing. If you feel good about that company, by all means, hold the stock.

When should you diversify? I would just sit on your investment until the amount of stocks you hold reach a point where you would feel devastated if those stocks were suddenly worthless. At that point, sell off some portion of your holdings and diversify widely with them, probably through an index fund.

Your intimate knowledge of this company means that you have good reason to invest in them. It makes sense to maintain stocks in that company as a significant part of your portfolio. It鈥檚 just foolish, though, to have all of your investments (or even the majority of them) tied up in the stock of one company.

Q2: Divorce mess (and follow up)
A while back I asked you how to get my husband on board with cleaning up our finances. He was refusing to talk about anything and you suggested counseling ASAP. Well, he refused to go to counseling. Then I found where he had taken out title loans on one of our vehicles and that same month he spent our entire emergency fund ($1,000) on one dinner out with his friends and a new TV. When I asked him about the title loans, he said it was none of my business what he did with 鈥渉is鈥� money and he left鈥�for good. My hours have been cut at work and I do not meet my basic living expenses without child support.

Fast forward a month or so. I am in the process of filing for divorce. Two cars are in my name and that brings me to my question. They are both older cars (a 2000 Nissan Maxima and a 2001 Dodge Caravan) and have substantial mileage on them (90,000 and 120,000). The insurance on them isn鈥檛 too bad, under $100 per month for both. I have a teenage daughter who will have her driver鈥檚 license before the end of the year and wants to get a job. Should I keep both cars so she will have one to drive and we will have a spare in the event one breaks down, or should I sell one (my mechanic says to sell the Nissan 鈥� higher upkeep costs)? The Kelly Blue Book value on the Nissan in its present condition is between $4,000 and $4,500, which could fund my emergency fund, plus pay some upcoming expenses.
- Jill

That sounds like a relationship that it was good for you to get out of now rather than later on. Eventually, the situation would have collapsed, and it might have collapsed with you in a much worse financial state.

As for the cars, you should absolutely sell one of them, and I鈥檇 likely sell the one your mechanic recommends that you sell. Upkeep costs are a major factor in this decision, and if you鈥檙e minimizing costs, losing the vehicle with higher upkeep costs is the best move.

Take the money you earn and bank it. You鈥檒l be glad you did.

Q3: Unsure about next steps
After our credit cards are done being paid off estimated at the end of this year here is what we have left to tackle (numbers are very close guesses to the balance in January of 2012):

Mortgage: Approx. $282,500 鈥� Payment is rounded up to $2,280 鈥� 5%
Car Loan: Approx. $22,000 鈥� Payment is $507 鈥� 2.89%
Student Loans: Approx. $38,000 鈥� Payment is $305 鈥� rates vary from 2.75% to 4.25%

The question I have is, what do I tackle next? I see from the math, the Mortgage is the highest interest rate and should be next. I guess the issue I have is that since it is so underwater, is that still my best bet? Or do I really start contributing the max to my Roth IRA and open one in my husband鈥檚 name too?

We were hoping to be moving out of NJ to NC next year, but it鈥檚 not realistic with the housing market (the house across the street, with one less bath, just sold for $216,000 鈥� or about $60,000 less than what we paid, not to mentioned what we鈥檝e put into the house). We are hoping to be moving in 3 years, and I鈥檓 not sure I want to buy another house after what we鈥檝e experienced with this one and the market being what it is. I鈥檓 not sure I鈥檓 willing to tie my money to an asset (depreciated asset in my case) again. IF that is the case, I understand that I am liable for the difference between my mortgage and what my home eventually sells for. Does it make sense to mitigate any potential loss there, or am I missing something?
- Diane

You鈥檙e correct in that if you sell your house, you鈥檒l be responsible for the difference between what you owe and what you sell the house for (assuming you鈥檙e underwater).

You can discuss a short sale with your lender, but they鈥檒l generally only be interested in your request if it looks like you鈥檙e heading toward foreclosure.

Assuming you鈥檙e not looking at just walking away from the house, your best bet is to just start paying down that mortgage as fast as you can. At some point, you鈥檒l no longer be underwater and can sell it if you so choose.

Q4: Understanding tax brackets
Can you help me understand tax brackets? According to bankrate.com, the 2011 tax rate for my gross income ($43,260) as HOH should be 15%. Today, I asked my payroll dept for a tax deduction breakdown for what the company deducts from my salary. This is the breakdown I received:

8.7% 鈥� Federal
4.2% 鈥� State
4.2% 鈥� Social Security
1.45% 鈥� Medicare

Along with my 3 exemptions, how does this align with the 15% tax bracket I supposedly fall into? I do have a 6% pre-tax contribution & $1000 pre-tax deduction for my medical flex spending account.
- Lacey

If your gross income is $43,260 and you鈥檙e filing as head of household, you鈥檒l be paying 5% of your income for all income you earn between $0 and $12,150, and 15% of your income between $12,150 and $46,250. So, for the first $12,150 of your income, you鈥檒l pay $607.50 (that鈥檚 5%), and then for the next $31,110 of your income ($12,150 up to $43,260), you鈥檒l pay $4,666.50. Your total tax will be $5,274.

Now, that amount changes depending on how many dependents you鈥檝e stated on your W-2. If you listed, say, four dependents, they鈥檒l subtract $3,750 times 4 from your initial salary, changing how much is taken from your paycheck. In this case, you鈥檇 pay $607.50 on the first portion of your income and $2,416.50 on the second portion. This adds up to $3,024, which is right around 7%.

I鈥檓 guessing that you have three dependents or so 鈥� you, your spouse, and a child. That鈥檇 get you pretty close to the 8.7% you see here.

Q5: A big mess of debt
I graduated from college in 2007. My student loan payments started in late 2007. I could not find a full time job until March 2008, although I was paying the minimum on my student loans, which is all I could afford. In March 2008 I got a full time job, but still could barely afford to pay all my bills (about 1,100 a month which includes cell phone, rent, student loans, 2 credit cards (one is now completely paid off), car insurance, but does not include gas/car maintenance, or food, or clothing, or entertainment of any sort). I was making about $1,400/month (after taxes, health insurance, and at the time, a 401k), so after necessary expenses, food and gas, etc. I never made it to the end of the month with any money in my bank account. Needless to say, I couldn鈥檛 save anything, and couldn鈥檛 afford to pay more than the minimum on my student loans (which looks like it鈥檚 JUST interest). I should mention that I only get paid once a month

I stopped paying into my 401k in the beginning of 2010 because of furlough days, and haven鈥檛 contributed to it since (which I REALLY want to start again since my employer matches up to 4%). In May of 2010 I got a raise, so that I was bringing home about $1,600 a month (after taxes and health insurance and furlough days). At the time I had just purchased a high end camera (about $1,500) which I used financing for through Best Buy (photography is my favorite hobby, so I felt justified in using financing to buy the camera). That was paid off in February 2011, after which I then decided to go after my other credit card (which I describe below) and I鈥檓 sure was the wrong decision, but I don鈥檛 have a choice now.

I have one credit card paid off leaving about $1,900 on another that I am working on (I recently transferred the balance of this card from my oldest credit card (which I kept open for my credits sake) and put it on a 0%-interest-for-12-months card so that I could aggressively pay it off without wasting money on interest. That should be paid off by January 2012 and I plan on cancelling that card, unless I can talk them into giving me as good of an interest rate as my current oldest card which is about 9%.

Anyways, my big problem are these student loans. Here is a breakdown:
Private loan (not able to consolidate with any other loan) from Sallie Mae (9.25% interest rate):
鈥� Original loan amount= $10,500/Outstanding principal= $10,326.17.
Consolidated loan from Sallie Mae (5.625% interest rate):
鈥� Original (combined) Loan amount = $23,096.91/ Outstanding principal (combined) = $22,337.76.

These numbers make me want to cry since I have been putting so much money from my tiny salary toward these payments for almost 4 years and they鈥檝e only gone down by a tiny tiny bit! I鈥檝e been keeping up with your blog about loan situations and I know that I should save a small emergency fund (which I have about $430 in so far) then throw everything extra at the highest interest loan and only pay minimums on everything else until I pay that one off, then move onto the next highest interest loan etc.

My problem is I barely have enough money to get me through the end of the month let alone throw more at this student loan, which is also hard to think about since it seems I am getting NOWHERE even though $300/mo of my paycheck gets thrown at Sallie Mae just to cover the MINIMUM payment. I feel like I have no ability whatsoever to get ahead on these student loans. I think I should have avoided transferring my credit card balance to a 0% interest rate credit card because now I am spending about $90/mo more on that payment just to avoid pay interest on that amount.

I guess I鈥檓 wondering what you would do in my situation? Come January when my credit card is paid off and I will have an extra $190/mo, should I put it ALL toward the high interest student loan (which still won鈥檛 make that much of a difference in my mind), or should I put that money into my 401k? Or should I save it? Or should I split it somehow?
- Lisa

If I were you, I鈥檇 keep doing what you鈥檙e doing for the time being. In January, I鈥檇 get your emergency fund up to a point that鈥檚 equal to two months of living expenses, then I would start retirement contributions and focus on that higher interest loan with what鈥檚 left.

When you鈥檝e got so much of your monthly income accounted for, you don鈥檛 have much room for an emergency. An emergency fund is a must-have, even if it feels like it鈥檚 keeping you from really knocking down the debts.

Yes, this is a frustrating path to follow. Yes, it feels like you鈥檒l never get out of it. The things in life worth having are never, ever easy.

Q6: Student loans or mortgage

My wife and I do ok with managing our money. We don鈥檛 carry consumer debt but never seem to do much better than breaking even each month. Lately we鈥檝e decided to try to really get in to good financial shape. We鈥檙e establishing an emergency fund and are hoping to start saving more towards retirement and general savings (I currently contribute to a 401k at work for the matching benefits, but that is it.)

My wife and I bought our house two years ago. When we bought it we figured that if we made one extra house payment a year we would knock ~7 years off of our mortgage. Now we鈥檙e trying to decide if it is better to do that or to pay down our student loans. We know that we aren鈥檛 going to be in this house more than another year or two. We will probably sell it when we move, but we have considered renting it out instead.

My wife鈥檚 loans are about $11k and mine are about $21k. Our only other debt is a personal loan I鈥檓 paying off at the end of this month. We use our credit card to pay bills (so we can build rewards points), but never carry a balance. We always pay it off every month.

Do you think it makes more sense to make the extra house payment each year, or to use that money to pay down the student loans?
- Aaron

I would look first and foremost at interest rates. What has the highest interest rate among your student loans and your mortgage? That鈥檚 the debt I would focus on.

If you pay down your mortgage fast, when you sell it, you鈥檒l have more proceeds than you would have otherwise, which you can then apply to the other loans. If the mortgage interest rate is higher, you鈥檒l save more over the year or two you still have the mortgage than you would by putting that money into a lower interest student loan.

Of course, another vital question to ask is whether you鈥檙e underwater on the mortgage. If you are, I would strongly suggest hitting the mortgage as hard as you can.

Q7: Retirement path
I am a married attorney in Seattle. We have a home with about $250,000 in equity. We have 22 years left on the mortgage. I am 37. I鈥檝e been at a company with great retirement for the past 5 years: 4.5% match for my 6% in the 401k and 4.0% cash balance plan. I only contribute 6% and have been doing so for 5 years. Would you make any changes?
- Chris

The first thing I鈥檇 do is and see what it suggests. Assume that investment returns will be the worst they possibly can 鈥� don鈥檛 get optimistic with your projections.

I can鈥檛 tell for sure if you鈥檒l be all right. If I were to guess based on the information you鈥檝e provided here, I鈥檇 say you鈥檙e on the low end of being all right, but you鈥檙e not in devastating shape.

Run the numbers.

Q8: A Game of Thrones
I saw that you really liked the novel A Game of Thrones by George R. R. Martin. Have you read the rest of the books in the series? Are you watching the T.V. series?
- Roger

I鈥檝e read all of the books in the series. I鈥檝e read A Game of Thrones three times, and I鈥檓 currently reading it a fourth time with the intent of re-reading the entire series.

I watched the first episode of the series and it seemed to duplicate the first ten chapters or so of the book with only minor changes. The characters didn鈥檛 look quite like I envisioned them but the heartbeat of a very strong story was still there.

The series is fantastic. The only thing I鈥檇 say about it is that it can get bogged down in too many characters, especially later on.

Q9: Self-employment questions
My husband just started his own trucking company. He鈥檚 the only employee as an owner-operator of an 18 wheeler. We are both co-owners of the business. I have a full time job making about $32,000 a year. We expect our company to gross about $90,000 a year. That would put us in the 25% tax bracket. How much money should we be putting aside for taxes? I know we have to pay them quarterly, but do not want to end up owing a lot of money next year when we file. We do not have any children together, but he has two kids with his ex-wife. The divorce decree says she gets to claim them, but may let us claim them like we did last year beacuse she doesn鈥檛 work, isn鈥檛 married and doesn鈥檛 file taxes. I have been put 30% of his check aside to pay the quarterly taxes. As a small business, I know we can claim a lot of business expsenses. Do you think I am putting emough aside? We both contribute to Roth IRAs so that will not bring our taxable income down like a traditional IRA would.
- Rebecca

My strong suggestion to you is to use and run the numbers with the attached worksheet. I think that 30% will be plenty for what you describe, but you鈥檙e better off running the numbers.

I will say that I find the methods for tax collection and calculation to be particularly burdensome for the self-employed and people who run very small businesses. The IRS seems designed to discourage self-employment and encourage just working for an employer, sadly enough.

Where鈥檚 the entrepreneurial spirit that made America great?

Q10: College student with some debt
I am a senior in college graduating next month with my BS in civil engineering. This summer, I will continue with my education in pursuit of an MEng in civil engineering. After graduation, I expect to have a starting salary anywhere from 45k to 60k (depends on market and field). However, during my time at school I made a few bad decisions. I opted to focus on my grades and extracurricular activities while working as little as possible. In doing so, I will graduate with a 3.8 GPA and numerous awards and leadership roles for my resume, but at a cost. So far I have accumulated 12k in student loans and around 6k in credit card debt (APR > 20% on each). This summer I will try to find a part time job since I will only have 6 credit hours divided into 2 days. As well, I secured a teaching assistant position this coming fall. My projected income from teaching assistantships and scholarships for the fall is $2000/mo and spring is $800/mo (without considering additional student loans and possible additional part time jobs).

I am having a hard time deciding what set of actions will put me in the best position after college. I could either continue to pay the credit card payments at roughly 300.00/mo (currently, I pay more than the minimum) or I could consider taking out a non-federal loan at an interest rate below 12% and using that to pay off the credit card bills. This will also give me a little more wiggle room with my monthly expenses. Both options will have me finding part time jobs for the summer and spring (since I have a job lined up for the spring). Do you think applying for a loan just to pay off my credit cards for good is a good idea since my interest rates are so high?
- Adam

I would never consolidate credit card debt into a student loan. Student loans exist under different regulations than credit cards and can follow you no matter what happens in your life. It is much easier to resolve a credit card debt than it is to resolve a student loan debt.

I would seek out other methods of reducing the rate on that credit card debt. You may want to consider a 0% balance transfer offer to another card if you鈥檙e eligible. You may also want to try directly contacting the credit card issuer and requesting a rate reduction, though there is a risk that they may reduce your line of credit.

I wouldn鈥檛 panic about it, though. Just make sure that it doesn鈥檛 get worse and keep your credit report in the best shape possible.

Got any questions? Email them to me or leave them in the comments and I鈥檒l attempt to answer them in a future mailbag (which, by way of full disclosure, may also get re-posted on other websites that pick up my blog). However, I do receive hundreds of questions per week, so I may not necessarily be able to answer yours.

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