Budgeting Tips to Get out of Debt and Build Wealth

You know that it’s financially responsible and recommended to save your money – save for an emergency fund, save for retirement, save for the kids’ college.  Yet you also know paying off debts is a huge priority in order to find “financial peace” as Dave Ramsey likes to call it.  You are committed to throwing every last dollar you can at paying off your debts.

So does that mean you have to wait on starting a savings account until your debts are paid off (all except the mortgage, anyway)?

Wouldn’t you know, the answer has to be, it depends.  Let’s look at the three big reasons people are told to save up their money, then consider whether you need to begin saving immediately for these, or wait until you pay your debts off.  Think about your own situation and decide what is best for you.

SAVING UP AN EMERGENCY FUND: While the precise guidelines for how much you should have in your emergency fund varies widely from expert to expert, one thing is clear, it is a very good idea to have money stashed away in a secure but liquid spot for that “rainy day.”  Often we are told to save from 3-6 months worth of expenses to a years worth of salary, but at the very least, a couple thousand dollars.  Yet even a couple thousand dollars could put a dent in a credit card bill if you used it to pay debts rather than save for emergencies.  So think about these points and decide whether you should save up for an emergency fund now or wait until your debts are paid:

1) If you lost your job or your car was totalled or someone got very sick in your family, would you be able to turn to a family member or close friend to give you financial assistance until you got back on your feet? (In other words, your folks become your emergency fund?)  Are they agreeable to this plan??

2) Are you disciplined enough to sock away money in an emergency fund and NOT TOUCH IT unless you had a TRUE emergency?

3) Would your situation be much less dire, should an emergency strike, if you had a couple less monthly payments to make – i.e. less credit card bills to pay?

Here is what we are doing:

For me, it is true that I have loving and generous parents who would probably bail us out in the case of a true emergency (they always have before thank God).  Yet it could happen that they might have a bad month just at the time we have our “rainy day.”  And it would mean a lot to my self-esteem to know I could help myself out at least for a short-term emergency.  I personally am shooting for the $2000 emergency fund while debts are paid off.  Some of that will be kept in cash-on-hand, and neither I nor my husband will touch it (on pain of sin) unless we have a serious financial emergency on our hands.

SAVING UP FOR RETIREMENT: Retirement savings are often the last thing on the mind of someone who is in the prime stage in life to start saving for it.  By starting early, with 20-30 years ahead of you to build up your 401K or IRA, you will be doing yourself a real favor if you start now and save automatically for the rest of your working career.  Yet you would also do yourself a favor to pay off your high-interest consumer debt.  So let’s consider a couple of points regarding saving for retirement vs. paying off debts:

1) Does your company do a match, or even double or triple your contributions to your 401K?  That would be free money, my friend, and I would have a hard time turning that down if you could possibly afford to make your part of the contribution.

2) Exactly how far are you from retirement?  The further away you are, the less you need to worry if you don’t start immediately on your retirement savings (though you also will lose out more in the long-run on the money you could have made starting this early).  You may be able to afford to delay saving for the 3, 4, 5… 10, 12 years it takes for you to pay off your debts before you start your retirement savings.  Then you can put the maximum contribution into it, with your monthly payments down to life’s basic necessities and maybe a mortgage.  But you have to admit there’s no combination in the world like time and compound interest.

Here is what we are doing:

We are in a situation where my husband has a company match on his 401K at work.  We’re 30-somethings, and we don’t think it would be smart to put off retirement savings, not if we don’t want our kids to have to support us someday! However, even with the 401K it may not be enough to keep us living at the standards we are used to or want to be at at that point in our life.  So we’ve discussed starting up a Roth IRA for me, as someone who is self-employed and working part-time. But for now, that idea will be put on the back burner until we either pay off or at least make some serious progress on reducing our debts.

SAVING FOR KIDS’ COLLEGE:  As soon as you find out you’re pregnant, you start getting reminders and offers related to saving for your child’s college tuition.  It seems like a pipe dream, that you’ll ever be the parent of a young adult entering higher education. That age of matriculation will be upon you sooner than you think.  Our oldest is 7, and those first 7 years of his life went by in a blink.  A couple more blinks, and he’ll be almost ready for grad school!  So, let’s consider the facts and you decide whether to start saving for college now or wait until the debts are history:

1) Financial aid complicates the whole issue.  These days the college savings vehicle of choice is the 529 plan, in which money is saved (invested like a 401K) for one beneficiery, to be used for college and related expenses (if withdrawn for other purposes, taxes and a 10% penalty apply).  It is tax-deferred, so your contributions to it may be deductible from your state income.  The earnings (interest on the mutual funds its made up of) and the money invested itself are tax free when withdrawn as long as the money is used for college costs.  But the 529 is considered an asset, and taken into account by the gods of financial aid.  According to Wikipedia http://en.wikipedia.org/wiki/529_plan, the best thing to fix this scenario would be for a person other than the student or parent to own the account.  Can you convince grandma to start saving for junior’s college while you pay off debts?

2) Sing with me now, “Ti-i-i-ime is on [our] side.”  On the one hand, planting those seeds of future college money as early as possible will give those saved dollars a chance to incease and multiply.  On the other hand, if you delay for a few years to throw as much as you can at getting rid of your debts, it won’t necessarily derail your child’s future at Harvard.  (Or MIT.  Okay, honey.)  As long as you start saving by the time the child is, say, 10 years old and you keep up your frugal habits so you can contribute the maximum $2000 per year per child, and as long as the funds get at least a decent rate of return you can at least have part of the child’s college paid for (maybe 1/3 – that depends a lot on tuition inflation, which institution s/he goes to, living on or off campus, cost of books etc.).

This is what we are (thinking of) doing:

In a perfect world, we want to make maximum contributions to a college fund for each kid, but we need to get rid of the debts first.  It’s not a priority to save up ALL the money they’ll need for college.  The kids themselves can work summer jobs (or become young entrepreneurs) and save up a chunk in another 529 plan of their own when they are old enough (could be as early as 12-14, babysitting, working for family etc.).  And they can be spending their free time in high school applying for financial aid.  They’ll manage, somehow, there’s a way for everyone to go to college, it seems.  Heck by then it’ll probably be 100% taxpayer funded anyhow, the way things are going in this country.

In the meantime, we are doing some saving and investing on behalf of the kids, and helping them to learn how to save and invest from their own allowance money.  These investments are separate from college money, meant to be left untouched until after they are done with their education if at all possible, to give them a bit of personal wealth to start out their adult lives with someday.  God-willing, they will never have to be pounding their heads against whether to save money or pay of debts.  That’s why they are getting a financial education, and that’s another topic for another day.

Posted By: Becoming Debt Free - Paying Debts, Savings by Darcy