Money Mommy

Stuff your mom should have taught you, but didn't…

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Month: June 2016

Thoughts on Debt and Credit

Debt. Definitely a four-letter word.  And one to be avoided at all costs.  But no, not really.  Debt is simply another tool in your financial tool box.

When you go into debt, you have borrowed money with the intention of paying it back.  (Otherwise, it is simply stealing.)  Credit is a form of debt where you get the benefit of something now, and promise to pay for it in the future.    Credit includes mortgages, car loans, education loans, business loans and certainly credit cards.

The credit industry is very active and certainly very lucrative.  Count how many credit card offers you receive in the mail; notice how often you are asked if you want a store credit card; listen to the television and radio commercials.  In exchange for paying later, you agree to pay interest every month.  The interest can easily be 18% to 30%, or as low as 0%.  Meanwhile, a whole industry has sprung up to convince you that creditors are evil and that you should not have to repay your loans.

Let me just say it: Ridiculous!  If you are old enough and mature enough to get credit; you should be mature enough to handle it.  I’ve got some suggestions for repaying your credit card debts here, but let’s take a look at some of the different types first.

If you are considering  going in to debt, FIRST consider how long you will benefit from your purchase.

Mortgages allow you to buy a house before you can save the money to buy one (or even build your own.)  Typically, mortgages last anywhere from ten to thirty years.   It seems reasonable to go into debt for a lifelong home.  Be sure to calculate the mortgage, utilities and taxes in your budget before you choose your home.  Failure to pay your mortgage would be very serious to your financial health.

Education loans are another common form of debt.  Here you are pledging future earnings for knowledge and training for a future career.  But, be very wary of taking on student debt.  You may be condemning yourself to a lifetime of debt.  I know a young couple who are starting their married life with education debt exceeding a third of a million dollars.  Ouch. Teaching is a very noble profession, but teachers are notoriously low paid.  Take the steps you can to minimize your student debt now – community college; instate and commuter schools; work study programs; apply for scholarships and grants.  Education is so important; choose carefully and wisely.

Car loans have some very low interest rates to entice a buyer.  In our car dependent society, most people see a car as a necessary luxury.  We need them to get to work, grocery shop, school, the list is endless. If you do decide to purchase a car, remember that you are in control.  You choose the make and the model, and ultimately the cost of your vehicle.  I know young people who bought a car so they could go to work.  Now they go to work to pay for their car.  It is an endless cycle.  Choose a vehicle that will fit in your budget, and aim to pay the car loan off within four years. Once you do pay off this loan, continue to place the same amount in a separate account each month.  This will provide you with funds to pay for necessary car repairs or purchase a replacement vehicle in the future.

I saved store and credit cards for last.  This form of debt creeps up very slowly and bites you before you see it coming.  Going through the drive-thru every day for breakfast or out for lunch may only cost you $10.00 a day, but at the end of the month you will have spent over $300 and have nothing to show for it.  Pay a minimal $25 (which the credit card company is quite happy with, since you now owe interest on the remaining $275), and continue the same pattern and you will owe nearly $600 on your credit card. By the fourth month your credit card bill is over $1,000 and you still have nothing to show for your debt.  Add in a few store credit cards for clothing and other “feel-good” purchases, and you are on your way to being seriously in debt.  Remember, you are in control!!  By using your credit card, you have agreed to pay your bill with interest.  The first month you can not pay off your credit card is when you stop using your credit card. If you are not still benefiting from your credit card purchases that you are still paying for months later, then you should not use the credit card to pay for them.  This is the time to use cash for your splurges.  If you don’t have enough cash – you don’t buy it.  Be in control of your own debt.

Like a chain saw, credit is an incredibly powerful too.  It must be handled carefully, or it could destroy your financial house.

 

 

The Roth IRA for College Savings

I’ve given a huge rant on why I don’t think you should use a 529 to save for college. I’ve laid out the scenario of when you still might choose to start a 529 savings account. Now you might be wondering what steps you should take to prepare for future college expenses.  The answer is quite simple: open a Roth IRA.

When you open a 529 account, you do not get any deduction on your federal taxes.  However, as the money grows, you never pay taxes on the growth – provided you use it to pay qualified education expenses.  The mere fact that the growth will not be taxed  is the only advantage that a 529 has.  The ROTH IRA has the exact same attribute, but without many of the restrictions that make the 529 so unappealing.

The IRA was conceived to be a retirement account: Individual Retirement Arrangement.  At age 59 1/2, you can take out funds completely tax and penalty free, as long as your IRA was started at least 5 years ago.  Taking it out early would incur some penalties, but there are notable exceptions. Among the exceptions is using your IRA to pay for college.  You can use your ROTH IRA to pay for college for yourself or your children with NO penalties or tax consequences.  Exactly the same way a 529 works.

However, there are additional benefits to placing college savings in an IRA over the 529 account.

You will still be eligible to receive education credits such as the Lifetime Learning Credit or American Opportunity Credit if funds are taken from your IRA.  If you use funds from a 529 Account for education expenses, these same expenses will not be counted when you calculate the credit.  Remember, the American Opportunity Credit alone is worth $10,000 in tax savings.

By law, money saved in retirement accounts (such as the IRA or a 401K) are not included in the FAFSA calculations to determine federal student aid. On the other hand, money saved in a 529 account counts heavily against the student aid that will be made available.  FAFSA also examines your adjusted gross income, as shown on your 1040, to calculate student aid.  Money taken from a ROTH IRA for education benefits will not be taxed and will not be included in your adjusted gross income.

Because the government wants people to plan for their retirement, they first offered the Saver’s Credit in 2002 as an incentive to the populace to take an active role in their financial security.  Depending on your income, you could save up to $1,000 off your taxes for saving money in an IRA, a 401K or a 403B.  Once again,  the 529 is not eligible for this credit.

Finally, (and this is BIG) you are not limiting your scarce investment resources to pay for just one scenario.  If you do not need the money for college, the money you saved in the ROTH IRA is still available for your own personal retirement. It is your own account in your own name. There will be no penalty when you take it out for retirement.  There will be no taxes when you do take it at retirement.  However, that money had been available to be used exactly the same as if it were in a 529 account if you had needed it.

 

  • Your education tax credits are not limited because you used funds from a 529 account.
  • Your federal student grants and loans have not been decreased because you have funds in a 529 account.
  • You can use funds earmarked for education in your ROTH IRA to receive the Saver’s credit.
  • You can use the funds originally saved for education for anything you want if they were placed in a ROTH IRA (subject to age requirements).
  • You have not limited your options at all.

 

But you have saved.