Not everyone agrees whether you should focus on paying off debt before saving for retirement. On the one hand, if it will take you many years, or even decades, to eliminate every last penny of debt, it may be too late to save enough for retirement before you plan to stop working. On the other hand, diverting money to retirement savings while you have too much debt outstanding may prevent you from reducing your debt load, or worse.
When you are in extreme debt, there is no good answer to this question. The reality of an extreme amount of debt is that it will almost certainly take an extended period of time to pay off. So to date, I have been contributing about 5% of my full-time salary towards my company's pension plan, with the company chipping in another 5%. The problem is, I don't think this is working.
Yes, I am slowly accumulating retirement savings, but at what cost? Despite making a number of significant changes to our spending habits, we continue to run out of rope when it comes to finding ways to make ends meet. Last month, I even had to dip into my newly created emergency fund, cutting it in half to avoid running out of cash.
All of this has me questioning my current strategy of continuing to save for retirement right now. Yes, the company matching of my 5% contribution seems like a shame to give up, but extreme times call for extreme measures. Perhaps diverting this 5% of my income towards debt repayment will start the ball rolling in the right direction.
But of course, simply diverting retirement savings towards debt repayment is not enough. I realize it is critical to have a plan to continue to decrease spending and increase earnings to the point where there is enough leeway to restart retirement savings. And given the amount of debt we have to repay, we cannot wait until it is all paid off to reach that point. I also realize that every year that goes by without continuing our retirement savings will have a significant impact on the overall amount we will be able to save before we may want to retire.
I will not be able to make thing change until January, since contribution rates can only be changed annually. Therefore, in the mean time, I have decided to withdraw about $4,000 from my retirement savings, to keep us going until then. Short sighted? Perhaps. But at this point, I feel this is a better option to falling behind on our bills, which we have so far managed to avoid. I think that as long as we use this only as a means to buy us the time to get our spending and income to where it needs to be, the sacrifice will have been justified.
Whether that actually happens, time will tell. Stay tuned.
Monday, October 26, 2009
Thursday, October 15, 2009
Carnival of Personal Finance
I am happy to report that Extreme Debt Story was included in the Carnival of Personal Finance last week, for the article Emergency Fund Malfunction. Please visit last week's Carnival here, to find the other great articles it featured.
Monday, October 5, 2009
Emergency Fund Malfunction
Every good personal finance expert will tell you that the first thing you need to do when trying to get out of debt is build a basic emergency fund, typically $1,000. So, a few months ago, I went and created a new ING Direct sub-account called "Emergency", and set it to automatically transfer $100 every other week from my checking account, to align with when my pay comes in. As of last week, I was up to $800--almost done with the initial emergency fund goal.
But then, something went terribly wrong.
Despite the fact that I believe we have gone to great lengths to get our spending under control, including making many cutbacks in many areas, our expenses are still not significantly lower than our income. In some months, we pretty much broke even. In other months, we still spent more than our income. The reason for this is that prior to the cutbacks, we must have been spending so much more than our income, growing and growing our debt load, that even with significant expense trimming, we're still not in a great position.
This month, a few unexpected expenses came up, and a week and a half from my next pay day, I found myself in a position where I could not pay a couple of bills without withdrawing cash from my credit card. So between the option of doing that, and withdrawing from my emergency fund, I chose the emergency fund. How much did I take from it? Half. Yes, the bill is now paid, but I am back to just $400 in the emergency fund.
Talk about an emergency fund malfunction!
Was this the right thing to do? When you're piled under so much debt and fighting just to survive, there are very few "right" options. Ultimately, the right thing to do is to cut spending further, and raise income as well, to the point where all expenses can be covered without looking for other options. But when you are in extreme debt, it takes longer to make enough changes to spend less than you make, unless you are willing to do something drastic like sell your home, which I am not willing to do, at least not unless I have absolutely no other choice.
When you are in extreme debt, cutting your spending may take several rounds of changes, and even then, there is only so much you can cut. On the flip side, adding income sources also takes time. Whether you are starting an on-line business, or getting a part-time job, the new income flows are not instantaneous.
Until your spending is well enough under your income to account for budgeting flaws, you are left with few options when that bill is staring you in the face. Sacrificing your emergency fund is like throwing your life vest overboard when you have no idea if a storm is approaching. Here's to hoping for clear sailing ahead.
But then, something went terribly wrong.
Despite the fact that I believe we have gone to great lengths to get our spending under control, including making many cutbacks in many areas, our expenses are still not significantly lower than our income. In some months, we pretty much broke even. In other months, we still spent more than our income. The reason for this is that prior to the cutbacks, we must have been spending so much more than our income, growing and growing our debt load, that even with significant expense trimming, we're still not in a great position.
This month, a few unexpected expenses came up, and a week and a half from my next pay day, I found myself in a position where I could not pay a couple of bills without withdrawing cash from my credit card. So between the option of doing that, and withdrawing from my emergency fund, I chose the emergency fund. How much did I take from it? Half. Yes, the bill is now paid, but I am back to just $400 in the emergency fund.
Talk about an emergency fund malfunction!
Was this the right thing to do? When you're piled under so much debt and fighting just to survive, there are very few "right" options. Ultimately, the right thing to do is to cut spending further, and raise income as well, to the point where all expenses can be covered without looking for other options. But when you are in extreme debt, it takes longer to make enough changes to spend less than you make, unless you are willing to do something drastic like sell your home, which I am not willing to do, at least not unless I have absolutely no other choice.
When you are in extreme debt, cutting your spending may take several rounds of changes, and even then, there is only so much you can cut. On the flip side, adding income sources also takes time. Whether you are starting an on-line business, or getting a part-time job, the new income flows are not instantaneous.
Until your spending is well enough under your income to account for budgeting flaws, you are left with few options when that bill is staring you in the face. Sacrificing your emergency fund is like throwing your life vest overboard when you have no idea if a storm is approaching. Here's to hoping for clear sailing ahead.
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