Retirement plans can be confusing: How should you save?

Retirement plans (question 5) and deciding whether to invest in retirement or pay down debt (question 2) feature in today's Reader Mailbag.

Photo illustration / Creativ Studio Heinemann / Westend61 / Newscom / File
Question 5 compares retirement options 401(k), 403(b), 457(b), and DCP. Question 2 looks at whether to invest heavily in retirement plans now or to pay off high-interest debt.

What’s inside? Here are the questions answered in today’s reader mailbag, boiled down to five word summaries. Click on the number to jump straight down to the question.
1. Living on less
2. Retirement or debt?
3. Strategic foreclosure
4. Help partner or yourself?
5. Which retirement plan?
6. Paying student loans early
7. Exceptional Microsoft Office deal
8. Estimating costs after dependent leaves
9. Debt payment and marriage
10. Stale checks

In November, I’m going to participate in National Novel Writing Month, which is basically an initiative to encourage writers to buckle down and get a rough draft of a novel of minimum 50,000 words finished before the end of the month. You’re allowed to develop outlines and other such materials earlier, but you’re supposed to write the entire novel within the given month.

I’ve already signed up and you can follow the novel as I write it. I’ve already got some outlines and character notes.

It might be good. It might be awful. I’ll let you know how it’s going when I get started, so you can read it if you’d like.

Q1: Living on less
I am 35, a single mom of one child (7 y/o girl). I live in southern Georgia. I have what I consider to be a great job which I love. I am fortunate enough to get signifacate yearly wage increases. In 2 years with this company I have went from $18,000.00 to $31,000.00. However it never seems to be enough to pay off credit cards etc. I got to the point where I have taken out a title loan on my car to help pay bills. Yes, I’m still paying on the stupid title loan. I have made some poor choices with lack of guidence. I feel like I walk around with this huge rain cloud over me and the bottom is going to fall out at any time. I have no savings, no emegency fund. My question is..Can I live off of only $1000.00 a month? Is it realistic? Do you have/know of any resources or articles to guide me in the right direction? Any guidence would be greatly appreciated.
- Stacy

You can, but you’re helped greatly by your location. You’re living in southern Georgia, which, frankly, has very solid cost-of-living numbers. I don’t know exactly where you live, but I do know that compared to many other areas, your cost for housing and many other items is very strong.

For the short term – and always keep in mind that this is all about the short term – you’re going to have to make some painful cuts. Look for the lowest-cost housing you can, even if it’s tiny. If you live in a smaller Georgia town, look for someone who is renting out a room or two in their home and see if you can live there for a while, perhaps with rent lowered or eliminated in exchange for some household help. Housing is likely one of your biggest costs, so minimize it as much as you can. Ask around – a great place to start is by getting involved at a local church, because at the local level, they do a very good job in terms of social help.

From there, move on to eliminating every dime of your debt that you can. Get an emergency fund of $1,000 or so in the bank, then focus hard on getting rid of that title loan.

You’re going to have a plate full in front of you, but keep in mind you’re living lean now so that you don’t have a scary existence later on. You’re making sacrifices now to build a great foundation for five years down the road.

Q2: Retirement or debt?
I am a 25 year old young professional getting ready to transition into my second job within the next 6 months. I have $4,795.43 in credit card debt and $53,999.83 in student loans (I just consolidated 2 federal loans which will take 2 payments totaling $308.51 down to a payment of roughly $180.00 and then I have an additional loan payment of roughly $180.00

I also contribute 10% to my retirement (Company policy is that I don’t need to contribute any to achieve the company 8% contribution). Finally, I have roughly $3,500 in an Emergency Fund (which even as a single person doesn’t make me comfortable enough). So my question is: should I stop contributing to retirement and direct that money to paying down my credit card and then student loan debt?

I struggle with what to do because I know the more I put into retirement (with the market still down right now) and the earlier I do it the better I will be in the long run.
- Jarrett

Don’t worry about the market timing. You might invest today and the stock market stays level for seven years or drops 20%. You can’t predict the future, so don’t worry about it and be aware that much of your gains will come in the form of dividends, not growing stock price.

Given that debt load, I wouldn’t cut retirement savings. Instead, I would focus on paying down the higher interest debt first (probably that credit card). Your debt isn’t big enough to be strangling you.

Remember, though, the faster you can get the cards paid off, the better off you are, especially if you don’t touch your retirement savings.

Q3: Strategic foreclosure
My husband and I bought a condo at the peak of the market in Los Angeles for $452,000. It is currently worth about $350K and several units in our building are foreclosing and will drop that price even further. While we can afford the payments, we do not want to live in it forever; it is too small for our growing family. We cannot rent it out for nearly what our monthly mortgage payment is. We have spoken to the bank several times but they will not work with us to refinance because we owe more than what the condo is worth. We could sink a huge amount of our savings into the condo and probably refinance. But then we would lose almost all of our savings and still be stuck with renting the place. We are contemplating foreclosure, trashing our credit and renting for the next 5-7 years before looking to buy another home. What are your thoughts on “strategic foreclosure?” We have two very stable incomes and enough money in savings that we can afford to buy everything else we need, including bigger purchases such as cars, with cash.
- Ansley

Strategic foreclosure is something I go back and forth on. On one hand, you’ve made an agreement with another entity and are obligated to maintain it.

On the other hand, though, I’ve read a number of books about how mortgage companies and large banks behaved during the housing crisis and to describe some of the behavior as unethical almost feels like an understatement. Many groups had a great deal of insider knowledge about the reality of the housing situation and they knew they were issuing negligent loans. They were utterly failing to do any form of due diligence on the loans and were using insider knowledge to pawn off some awful arrangements on potential homeowners.

Given all of that, I completely understand the case for why people would walk away from their mortgages.

Now, does it make financial sense? What is your game plan for after the foreclosure? How does that directly compare to the situation if you chose not to walk away? If I were you, I’d run the numbers on both scenarios in detail, recognizing that your various forms of insurance will probably go up if you do walk away. Make sure to look at scenarios where one or both of you lose a job, too.

I don’t have enough of your financial picture to say which side is better. Good luck.

Q4: Help partner or yourself?
My soon to be fiancé and I recently started living together. We live in a very expensive part of the country in a small apartment. He is currently in grad school. It is an expensive program, and he has some student loans to cover tuition and living expenses. We did Financial Peace University after he had accepted the loans. Neither of us have any consumer debt. We have budgeted so that he is spending way less than the loan money he has been given (about $4000 less each term, so about $12 K less each year of a two year program), and I am spending less than I earn as well. The extra money from his loans is sitting in his bank account, and he will use it to immediately start paying down the loans after graduation. I currently work full-time at a stable job, making about $46K. We currently split the expenses down the middle—me paying for my half with my paycheck, him paying for his half with his loan money. I am currently putting about $1000 into my savings each month. He has about 20K saved in his savings from before grad school, not including the student loan money. I have about $15K in my emergency fund and feel comfortable with that number. My questions: Would it be better for me to pay for all of our joint living expenses for the remainder of his degree, so that he can use less of his loan money, or is it more important that I continue to save that $1000 per month? What would be the best way for us to jointly manage our money and the loans? For whatever reason, it seems like a really confusing decision for us.
- Midge

It comes down to this: are you guys going to be together over the long haul? Is marriage really going to happen?

At some point – and that point varies a lot – you’re going to need to effectively merge your finances on some level, because you’ll be operating as one entity, sharing housing and electricity and water and meals without borders. Any debt that either one of you has will affect you both.

When does this transition occur? That’s very much a matter of your relationship with him. You might feel it’s the right time to do it now. On the other hand, I see nothing wrong with hedging your bets and continuing to save until your wedding, then at that time using a big chunk of your savings to wipe out a lot of his loans at once. This way, if you don’t make it to the wedding, then you still have the money you’ve saved.

Q5: Which retirement plan?
I work for the University of California and I have to say, the benefits are none too shabby. Aside from the medical benefits, I’m already taking advantage of the 401k contributions, (and I’ve set up a separate Roth IRA with Vanguard) but I just discovered that there are a bunch more retirement account options that I’ve never heard of. 403b, 457B, DCP? I’m lost, and the material I’ve found online is a little over my head. What are these plans, and how do I know if they’re right for me?

Maybe I’m getting a little bit ahead of myself…I’m 24 and I have a good chunk of debt from student loans. I’ve set myself on a course to pay off the entire $23k by the time I’m 30, while still allowing for contributions to my 401k and Roth IRA plans in between. Since I only make $30k per year and I’m nowhere near maxing out my 401k and Roth IRA contributions, would opening more retirement accounts even be a wise decision, or should I just focus on what I’ve got right now?
- Lauren

The number of retirement options can be confusing. I’ll try to simplify your options as concisely as I can.

A 403(b) is pretty much identical to a 401(k). A 457(b) is almost the same as the other two, except you can make early withdrawals without the 10% penalty, but you’re also not able to open up a Roth IRA. A DCP is a deferred compensation plan, where you agree to have some of your salary paid to you at a later date by your employer (usually with cost-of-living increases added in).

I wouldn’t really worry too much about the tons of options available to you. Just keep putting money into your 401(k) and Roth IRA as you have been. The only reason you might want to consider changing your 401(k) plan is if you discover that the specific investment choices are better with the 403(b) or 457 offerings. I would skip out on deferred compensation unless you’re making a lot of money and can afford to basically say “pay me 50% of my salary now and 50% in 15 years.” That’s a good deal for some but not so good for a younger person with a starting salary.

Q6: Paying student loans early
I’ve done some searching about my situation and I came across a problem you figured out about a guy with who had three loans to be paid off with three different interest rates. I tried to translate it to my loan situation but I couldn’t figure it out. Which leads me to emailing you and it would mean a lot of you could help me figure this problem out. Here goes:
Loan #1: $16,732.17 Interest Rate: 5.0 Minimum Payment: $122.67 Paid off in: 16yrs,11mths
Loan #2: $62,573.15 Interest Rate: 3.25 Minimum Payment: $302.18 Paid off in: 25yrs,5mths

I’ve been paying $500.00 towards Loan #2 and $122.67 towards Loan #1. With that being said this is what my Loan #2 looks like.
Loan #2: $62.573.15 Interest Rate: 3.25 Monthly Payment: $500 Paid off in: 12yrs,10mths

My question is what would be the most beneficial to my current situation as far as dividing up the extra $197.82 I put towards loan #2? Do I put the extra month towards the smaller loan amount or continue paying as I am? Also, how do I calculate what my outstanding principle will be years into my loan after making minimum or putting extra towards the payments?
- Bob

I would put that entire $197.82 – let’s just round it to $200 – towards loan #1 and make minimum payments on loan #2.

There are two reasons for this. One, the first loan has a higher interest rate, which means that for every dollar in that loan, it’s directly costing you more to leave it unpaid. Second, the first loan has a lower balance, which means that with extra payments, you’ll eliminate the loan faster than you would eliminate the second one with an identical extra payment.

If you can knock out the higher interest loan faster than you can a lower interest loan, always knock out the high interest loan first. You win in terms of both cash flow and overall interest paid.

Q7: Exceptional Microsoft Office deal

Did you ever hear of this offer? My wife’s company sent this around indicating we could purchase the complete MS Office suite to use at home for only $9.95.

Is this a scam?
- Jeff

It’s not a scam at all, just some smart business by Microsoft.

For some companies that buy Microsoft Office for their business, Microsoft throws in a sweetener – deeply discounted copies of Office for the employees of those companies for personal use. I know of at least two people who are in similar situations.

It works pretty much as that page describes. If you have a valid email address for the company and the correct passcode, you can log in to download the deeply discounted copy of Office you’re entitled to as a work perk.

In other words, it’s a great offer, but it’s heavily restricted as to who can use it. Yet another reason why it’s worthwhile to check out your benefits at work.

Q8: Estimating costs after dependent leaves
My daughter is in her first year of college. She is attending out-of-state because she and my husband were convinced that none of the in-state schools that accepted her would meet her educational needs. She has a car which she needs for work because she can’t get a job on campus because they are all need-based and her parents have too much income. From what we can tell, she does get some discount on her car insurance because she is on our policy, but she is also penalized because her father has a fairly new and expensive car. She is also on our health insurance policy. We are trying to find out if it makes financial sense for her to live off campus so she can declare herself independent from us and next year qualify for need-based scholarships and jobs, but we can’t get a straight answer on any of the numbers in order to determine what course she should follow. Are there any sources you know of which would enable us to estimate her costs if she were no longer our dependent?
- Lisa

The best source you have is your college’s financial aid office. This is pretty much the reason why such offices exist – to help people get such affairs in order.

The office will have a much greater insight than I do as to her eligibility for jobs and additional scholarships and grants when she’s independent versus dependent.

My speculation is that there will be a benefit overall for her financially, but it might not be as big as you think and it might be subsumed by the tax benefits you get with her as a dependent.

Q9: Debt payment and marriage
My boyfriend and I are both 23 and we’re trying to pay off our debts in the hopes that in a year or two we can get married. We feel we want to enter into such a large commitment without any extra stress. I have about $1300 in credit card debt and he has about $10,000 in auto loan debt (that he is aggressively paying off). Neither of us has an emergency fund since all of our extra money goes towards these debts. I only make about $700 a month and with the combination of paying my bills and paying $200 towards my credit card, I don’t have much left over (and what I do have left goes to my credit card). What more do you think we could do to aid our path to a debt-free life together? Should we both begin an emergency fund now, along with both of us making aggressive payments towards our debts?
- Rhiannon

I think you’re doing the best thing you guys can possibly do to make sure your relationship off on a financially firm foundation.

If you have no emergency fund at all, I would encourage you to save up $1,000 for such a fund, perhaps a shared one for the both of you. This will help create a buffer against the unforeseen and allows you to be independent of the whims of the credit card industry when you need that money for an emergency.

Aside from that, you’re doing great. I strongly commend you for getting things started in such a sensible fashion.

Q10: Stale checks
We have stumbled across a financial issue that is tough for us to answer both legally and ethically. We were contacted by our previous landlord today who said that he found a check yesterday (9/27/10) from us, dated October 2009, that he forgot to deposit. We switched banks this summer, so even if the bank would have cashed it, that account is now closed. It’s only for parking ($50), but still, not something that we are eager to pay since we are paying down our debt snowball, and really have a use for every dollar.

As a little background info, the couple we rented from were constantly clueless when it came to finances – they had to ask us what our security deposit had been when we moved out, as they didn’t remember. They returned everything to us, and then later asked for our check copies to prove what we had paid them. We are a little tired of having to deal with them because of their own financial mismanagement, especially considering that we were extremely good tenants, usually paying the rent weeks in advance of when it was due, and leaving the apartment in excellent condition.

Are we now obligated to issue them a new check, or is it their loss for being irresponsible?
- Shannon

I don’t think you are obligated to do so.

According to the Uniform Commercial Code, a check is outdated after six months and a bank does not have to accept it. I think the same thing would reasonably apply here – the bank probably wouldn’t accept that old check, and that’s their negligence, not yours.

I would politely tell them that you issued them payment when they needed it, the check is now stale and invalid as per the banking policy stated above, and that you’re currently in a strapped financial position. That should be the end of the subject.

Got any questions? Email them to me or leave them in the comments and I’ll attempt to answer them in a future mailbag. However, I do receive hundreds of questions per week, so I may not necessarily be able to answer yours.

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