Financial Literacy

Mint Money Audit: Expecting a Windfall …To Save or Pay?

 

“I’m expecting a $100,000 work commission. Should I save or pay off debt?”

Sure, a tax refund is nice. But what about a six-figure cash infusion? Oh, the many, many ways we could advance our financial lives!

For 37-year-old Michelle from Hoboken, NJ, that lucky day is soon to arrive. After two years working on various real estate development projects at her firm, she’ll be receiving a sales commission totaling $100,000.

Michelle wants to do the responsible thing and use the money to pay off her $52,000 in student loans. After taxes, the $70,000 or so that’s left from the commission check can help to erase all of it, which is what Michelle prefers to do. “I got myself through college, so as a badge of honor I want to get rid of these loans,” she tells me. Her goal is to be debt-free by the time she reaches 40 years of age.

But a closer look at her Mint profile reveals this may not be the best way to immediately put this lump sum to use.

A little more about Michelle’s finances:

  • Annual income: $90,000
  • Rainy Day Savings: $24,000. Transfers about $500 per moth towards savings.
  • Retirement Savings: $30,000. Includes a 401(k), Roth and Traditional IRAs. Transfer 10% of income to a 401(k)
  • Monthly Expenses: $3,000 including her father’s hospice nurse contribution, utilities, student loan payment and car and gas payments.
  • Rent: $0 per month. Michelle currently lives with her dad, as his primary care taker. She does pay the home’s real estate taxes, which stand at $1,800 to $2,000 per quarter.
  • Student Loans: $52,000 in federal loans consolidated at 2.65% rate.
  • Credit Card Debt: $3,000 on a 0% rate credit card.
  • Credit Score: 704

Michelle’s Financial Strengths: She has strong rainy day savings, which could afford her about a six to seven-month savings cushion. Her expenses are low relative to income. Her student loans, while topping $50,000, have a very low interest rate, which keeps payments at around $400 per month.

Financial Weakness: The big weakness is retirement savings. At 37-years of age, Michelle would ideally have more saved for her future. She admittedly set herself back a few years when she cashed out her 401(k). “I had to start from scratch five years ago,” she says. She’s currently saving 10% of her income for retirement, which normally would be sufficient had she been staying the course since your early years and hadn’t cashed our her retirement savings.

Recommendations:

Allocate $45,000 Towards Retirement

While paying off her loans would provide Michelle with financial relief (and pride), I’m more stuck on the fact that her retirement savings amounts to just $30,000. “I would like to have more faith in my retirement plans and be a better more informed investor,” she admits.

While our plans and needs in retirement vary, a good rule of thumb for everyone is to have about twice your income saved by age 35 and three times your salary by age 40.

At age 37, Michelle would be well off playing some savings catch-up. According to a retirement calculator at Fidelty, at her current 10% annual rate of saving and with only $30,000 in the bank, she wouldn’t be able to retire until her late 70’s.

But, according to that same calculator, if she allocated $45,000 of her windfall towards retirement now and continued to save 15% to 17% of her annual income each year, she’d be able to more comfortably retire by 67 years old.

While she can’t place the whole $45,000 into her 401(k) this year or IRA (this year’s 401(k) limit is $18,000 and $5,500 for IRAs), she can allocate the $45,000 in the following ways:

  • $18,000 in her 401(k)
  • $5,500 in her IRA
  • $21,500 in a brokerage account investing in low-fee index funds and ETFs. Sites like Betterment, Wealthfront and Ellevest offer online investment platforms with low-cost diversified portfolios.

After 2017, once she’s built up her retirement assets, it’s important that Michelle aims to max out her 401(k) or at least invests about 15% to 17% of her income. If there’s any more money left over, she could choose to invest in a traditional IRA (however she may not be eligible to deduct the contribution due to her income) or invest in the brokerage account.

Knock Down Her Debt

With the remaining $25,000, Michelle can erase her credit card debt ($3,000) and reduce her student loan principal to $22,000.

By placing a lump sum of $22,000 towards the principal of her student loan, her monthly student loan payments will likely fall to around $200 per month. By continuing to pay that minimum and adding another $500-$600 to the loan’s principal each month, she could be debt-free by the end of 2019, by the time she reaches 40 years old.

Talk to Siblings About Selling Father’s Home

Michelle has placed a great deal of time and money into her dad’s home (also her childhood home), paying for the real estate taxes and utilities. The home currently appraises at $425,000 but she believes, based on her real estate expertise, that with some upgrades she could sell the property for $600,000 in a couple years. She and her three siblings are all technically the beneficiaries of this home. But only Michelle is currently contributing to the upkeep and financial costs related to it.

I suggest Michelle have a conversation with all of her siblings about the fate of this home and what seems fair to all of them very soon. Some questions worth asking:

  • Do the siblings plan to contribute to the renovations? If not, then I don’t think it makes sense to Michelle to pay for them, only to receive 25% of the home’s profits.
  • Can Michelle negotiate a bigger percentage of the home’s sale, given that she’s contributed to its upkeep, taxes and utilities?
  • Can she buy out some of her siblings?

The sooner she and her siblings can resolve this, with the help of a real estate attorney, the better. My advice is not to let too much more time go by.

 

Have a question for Farnoosh? You can submit your questions via Twitter @Farnoosh, Facebook or email at farnoosh@farnoosh.tv (please note “Mint Blog” in the subject line).

Farnoosh Torabi is America’s leading personal finance authority hooked on helping Americans live their richest, happiest lives. From her early days reporting for Money Magazine to now hosting a primetime series on CNBC and writing monthly for O, The Oprah Magazine, she’s become our favorite go-to money expert and friend.