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Naked With Cash: Laura and Leon, January 2014

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Naked With Cash is an ongoing series at Consumerism Commentary in which readers share their households’ finances with other readers. These participants benefit from the accountability that comes from tracking their finances publicly and the feedback of the four expert Certified Financial Planners (CFPs).

For more information, read this introduction.

This year, we have four participants who will share their financial reports, exposing the results of their financial choices. Each participant is paired with one of our Certified Financial Planners. The experts will provide insight and guidance that will help our participants take their finances to the next level by the end of 2014. Learn about this year’s participants and experts.

Together, Laura and Leon make more than $123,000 a year. They have $44,000 in student debt. They max out contributions to tax-advantaged retirement accounts and hope to begin aggressively paying down debt. They are 28 years old and have no children, but they plan to start a family sometime. Laura has been concerned about their recent financial apathy as a couple, and the two are ready to shake things up. (Read last month’s update.)

After reading Laura and Leon’s comments, you can read commentary from Roger Wohlner, CFP. Roger Wohlner appears courtesy of The Chicago Financial Planner.

Laura and Leon’s Net Worth Statement

Laura and Leon’s Income Statement

Comments and analysis from Laura

From December to January, our net worth increased by quite a bit more than usual. This was largely due to the fact that Leon got an extra paycheck this month and my employer paid 2013 401(k) matching contributions. I also ended up traveling a lot for business though the month — which likely kept our day-to-day expenses down as well.

A notable milestone is we now have about $6,170 total in our Health Savings Accounts. This is significant because our current high-deductible health plan has an annual maximum out-of-pocket limit exactly at $6,100. This means that even if we had a major health crisis, all our medical bills for the year would be covered with tax-free dollars. The only thing that might change is if we choose to reimburse ourselves for a handful of prescriptions and doctor bills we pay for with regular post-tax dollars. We’re not hurting for cash right now, so I’m leaning toward just leaving it there to invest. I figure we’ll use the money for medical purposes eventually anyway.

Tax season is always an interesting time of year. It seems like every year we’ve been married has had a completely different combination of incomes, deductions, credits, and so on. We’ve had mortgages, student loans, investments, stimulus credit, one job, and two jobs — but never anything consistent from year to year yet.

The result has been that I have no idea what to expect on our return until we’re punching all the information into TurboTax. My hunch, though, is that we’re generally doing poorly at tax planning because we have always had tax refunds that were surprisingly large. Some of our refunds have even been in the thousands of dollars. I’m gradually getting better at tweaking what I can, but until we fall into a consistent pattern year-to-year, I don’t expect to become an expert any time soon.

2013 was the first year we both had incomes for the whole year and I expect that to put us in the middle of the 25% bracket. The only steps we took to decrease our liability were to maximize our contributions to our HSA and contribute the minimum amount to our 401(k)s to receive the maximum match from our employers. Admittedly, these steps had more to do with taking advantage of the benefits of the accounts (investing our HSA and taking advantage of our employers’ matches) than specifically trying to reduce our taxes.

This brings me to a question I have about allocating our money. Right now we are contributing the maximum to our Roth IRAs with post-tax money but we are not even close to maxing out 401(k)s. I like the advantages of a Roth IRA (taking out our principal if we needed it, fixing our liability while taxes are at relatively historic lows, controlling which funds we invest in, etc.), but I can’t help but wonder if it would make more long-term sense to pull back on our post-tax retirement savings in favor of pre-tax contributions while we are in a relatively high bracket. We discussed this a little bit in the comments section of December’s report, but I was wondering if anything since then has tipped us one way or the other.

Feedback from Roger Wohlner, CFP

As far as tax planning goes, it is difficult in your situation with changes from year-to-year. I would suggest this: once you put your information into TurboTax, and see where you stand in terms of a refund or paying in, you can take a stab at looking at 2014 in comparison to 2013. Check to see if things might be similar. If not, consider where the differences might lie. If the two years look similar, you can adjust your withholding up or down to try to get closer to where you need to be. You might also take another look at this mid-year and adjust accordingly.

The Roth vs. 401(k) question in part depends upon the quality of the 401(k) plan’s investment line-up and the level of expenses. Assuming both are good, certainly contributing to the 401(k) on a pre-tax basis will help your income tax situation. It is a good thing at your age to save via both methods in order to diversify your tax situation down the road when you retire. Nobody knows what tax rates will be by then, but this way you will have some options down the road.

The HSA is a great vehicle. As you said, you can cover the out-of-pocket on a major health situation and this is another form of savings. One never knows how your situation may evolve over time.

Feedback from Luke Landes

Even if you had a normal paycheck month, your cash flow would still be in a fantastic position.

I like the idea of taking advantage of at last some Roth-type investments now, even though you are in a higher tax bracket now than you might expect you would be in retirement. As Roger mentioned, it’s impossible to know the future of tax laws and tax rates, so taking advantage of a variety of vehicles today can help you hedge your tax bets in the future. I like to follow this list of retirement investing priorities to make the most of tax benefits as well as investing opportunities.

You’re aggressively paying down your student loan bills. That’s fantastic.

Last month in the discussion you wrote about some of your goals — eventually having one of you stay at home with kids, providing for education, and financial independence. At your ages and at your salary levels, this is all possible. For staying at home with kids, consider a separate savings or short-term investing account your “income replacement fund.”

I like to separate the various goals into different accounts so everything is labeled and set aside for specific purposes. This way, if you have to “borrow” from one account to handle another, the transfers have meaning and can affect your choices. For example, you might not think twice if you’re transferring money from your general savings to pay for a vacation, but if you have to transfer money from your “children’s education” fund to pay for your vacation you may make a different decision.

Published or updated February 26, 2014. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes, also known as Flexo, is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow Luke Landes on Twitter. View all articles by .

{ 5 comments… read them below or add one }

avatar Anne

Forgive me if this was discussed earlier (and perhaps you can point me to it?) but I’m curious about what your numbers would look like if you used your taxable investments and put that toward your student loan. Or perhaps do it in a few months when you can knock it out entirely.

The $730/month minimum payment is huge, and it really really would be ideal to have that thing gone before kids are on the line. Paying $2k+ each month toward it is outstanding!

But just think — in a few months, if you eliminated that loan, you could max out one 401k and then some. It’s just that much more money that will compound and grow for your future.

Run the numbers, anyway. It may not be worth it to do that scenario, but it might.

Reply to this comment

avatar Laura

Hi Anne,

There are a number of nuances when considering the taxable investments and student loan accounts, too many for a single post so I’m glad you brought it up and I can elaborate here. I don’t claim every decision made to this date has been the right one, but here are the facts as they stand now.

The $730 amount comes from the amount required to pay off the entire loan from the time deferment ended within a ten-year time period. Interest accrues daily for the loan but does not compound. If we sign up for automatic deductions, the lender drops half a percent point on the accruing interest (giving us our effective 6.55%). If we pay down interest ahead of schedule, that pushes our next official “due date” out accordingly. If we were to stop payments for whatever reason, the interest would continue to accrue but we would not be hit with any extra fees or penalties. At this point in time, we’ve paid far enough ahead that we could completely stop payments for a full 24 months before our next due date. All these details when come into play further down.

Now we move on to the taxable investments. Most of money is in low risk, low yield income funds that were purchased in April and May of 2013 using the returned portion of our down payment on the house we sold earlier that year. At the very least, I plan to hold it until at least May 2014 to be taxed at the capital gains rate instead of our income tax rate. In my mind, I see the entire amount earmarked for 20% down payment on a house plus emergency fund for the move and transition. By my estimate, we are still about $14.5k short of where I would like to be before we decide to buy another house.

The current plan is this: Leon focuses on paying off his student loans with his paycheck while I pay all our costs of living and “save” any extra from my paycheck toward our next house. Once the loan is paid off (our goal is July 2015), all the money he was putting toward that debt would then go toward the house savings which would close the remaining gap very quickly (possibly winter 2015).

I have often thought about whether it would be better to liquidate the taxable investments for the student loans, but he’s why I have not pulled the trigger:

-Paying off the existing loan with the taxable account would both dry up our existing emergency fund as well as our “hidden” cash flow fund that comes in the form of the extended grace period on the student loans. If we needed cash in a hurry, we can always temporarily stop/reduce our student loans and/or cash out some of the emergency fund until the crisis is over. If we drain the taxable account for the loan, both options are no longer available even if that $730/month payment is gone.

-Putting $34k toward the loans would shorten our payoff timeframe to about May 2014 but we would have to start from zero then in saving for a house. For whatever, that feels more psychologically draining than paying off the loan a little bit slower.

-I started working right out college while Leon took a year off and then went back to school. Almost all the amount in the investment account is from money I personally earned through those years of supporting us. Spending the entire amount would be like watching all those years just evaporate away.

-Conversely, Leon is the only one of the two of us who has paid anything toward these student loans. This keeps him both actively engaged in our finances as well as psychologically empowered that he is working through his situation even if it’s a little bit at a time.

On reflection, I see that this all boils down to the unique dynamic in our relationship where we are both supportive of each other as well as independently strong. Now if the numbers worked out where there was a dramatic advantage to be gained by cashing out the taxable account, I’d set aside everything above and make it happen, but it just doesn’t seem to shake out that way.

I hope I actually answered your question somewhere in there. Thanks.

Reply to this comment

avatar Anne

Thank you for your response! I’m sure others will pop in with the same question in future months, and you may need to point them to the comments section here :D.

It does sound a bit complicated from a tax perspective and more.

At any rate, you are paying the loan off FAST, and if it’s gone in roughly a year, then it probably doesn’t much matter how you do it.

Finances do have a big psychological component as you’ve observed, and if this approach keeps you more motivated, well have at it.

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avatar EL

If debt is a major goal to achieve why hold the debt when they have the funds to pay it all off. If you add up the checking and taxable investments you get about 46K, the student loan is at 41K. If it were me I rather take all the funds and pay it off. Doing this will alleviate the couple from sending the student loan lender $2100 dollars in loan payments. Granted I did not go back and review what they paid in other months, but I rather save the cash flow going forward. Then when you are free you can really invest the right way.

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avatar Leonard @ The Wallet Doctor

Luke’s advice about having different accounts for different goals is great. When you have so much variability in money matters year to year, keeping things organized and clear is key. Thanks for breaking down this interesting case!

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