I am 28 years old and have just paid off all my debts. But after reading your column, I realized that I did something stupid.
I use all my savings to pay the entire balance. Now all my accounts—current savings, emergency, long-term—are zero. I have no debts, but no assets. I plan to save 20% of each salary according to my budget. Am I in serious trouble, or is it just a temporary bubble that I can get rid of with some self-discipline?
I cannot assure you that tomorrow will not bring disaster. Maybe your car broke down that day, your cat needs to go to the vet urgently, and you were unemployed on the same day. So yes, if the world implodes tomorrow, you will be in serious trouble. But if you can stick to your plan and spend the next year or so without major disasters, I think you will be fine.
Before you beat yourself too hard, I don’t think what you did was stupid. My definition of stupid is to spend all your savings on vacation or buy some toys that you can’t afford. You use your life savings to pay off debts. In the long run, you will be in a better position. But in the next few months, you put yourself in a dangerous situation.
This is your plan of action: if you have paid off any credit cards, keep the account open even if you have sworn to pay off the debt. You want to use this credit line for any worst-case scenario that you may encounter while rebuilding your savings.In addition, keeping your old credit accounts open and using them occasionally can help you maintain a good Credit score.
If your employer matches contributions to 401(k) Or other retirement accounts, the contribution is just enough to get the game. In addition, every penny will go into your savings account until you have established three-month emergency savings. If you are budgeting your take-home salary, your 401(k) contribution will not even count towards that 20%, because the money is taken out before you see it.
Once you have established your three months Emergency fund, Pat yourself on the back. But wait! You are not finished yet. Your ultimate goal is to accumulate savings for six months. But once you have three months of value, you have more leeway in how to use the 20%. For example, you can invest 10% of your savings every month, plus 10% Ross Irish Republican Army.
If you search any retirement accounts to pay off debts, you need to budget for the tax consequences. The Internal Revenue Service charges you a 10% penalty and treats early retirement distributions as taxable income, but you can get Ross contributions at any time without penalty. If you do withdraw early, I actually recommend that you focus on the three-month emergency fund before the budget tax.Very easy to set up IRS payment plan When you owe taxes.
If you encounter an emergency before rebuilding your savings, there are no simple answers how to deal with it. However, if you need to use a credit card to pay for unexpected expenses, I suggest you pay only the minimum expenses until you have accumulated three months of savings.
You said you plan to save 20%. Is it possible to squeeze out more from this salary? The benefit is twofold: by forcing yourself to save more money, you make your life less, thereby reducing the minimum savings you need.
Suppose you earn $3,000 per month after taxes. You live on 80% or $2,400, and save the remaining 20%. You need an emergency fund of $7,200. If you save $600 a month, it will take 12 months to build one.
But suppose you can live on 75% and save another 25%. You only need to cut $150 from your budget every month. You can reduce the minimum emergency fund requirement to $6,750. Save $750 per month and you can get there in just 9 months. This may be more feasible than you think, because you are no longer paying debts.
If it is impossible to save more than 20% of the current salary, please consider taking it sideline. It does not need to be long-term. Just deposit some extra cash in a few months to help you quickly recover your savings. You can take any measures to shorten the time when there is no emergency fund. This is a huge victory.
In rare cases, your financial situation is truly doomed to failure at 28. If you can develop the habit of life-long debt-free life (except perhaps for a mortgage one day), stick to your budget and save at least 20%, you will be in good shape.
Robin Hartill is Penny Hoarder’s certified financial planner and senior author.Send your tough money questions to [email protected].