Cut expenses if income drops; don’t raid retirement account
Dear Liz: I was laid off in November 2009. For the first year, I took the unemployment and tried to find a job without success. So, in late 2010, I started my own business, contracting mainly for employers for whom I used to work. Unfortunately, I am making about a third of what I used to make, and even after cutting expenses, there are months that I can’t pay my bills. I have taken two withdrawals from my self-directed IRA this year. Is that the smartest thing to do? Or should I even out my cash flow by writing myself loans from my home equity line of credit?
Answer: You need to accept your new reality, rather than papering it over with ill-advised loans or raids on your retirement accounts.
That means reducing your expenses dramatically to reflect your new, lower income. If your housing expenses eat up more than a third of your current pay, for example, you need to consider your alternatives. You have equity in your home, which should make a sale easier. If you want to hang on to the house, consider getting roommates or even renting out the house while you live elsewhere (if the rent will cover your home’s monthly expenses).
You may have loan payments or other debts taken on when you had more income that you can no longer afford. If that’s the case, discuss your situation with both a legitimate credit counselor (one affiliated with the National Foundation for Credit Counseling at https://www.nfcc.org) and a bankruptcy attorney (find referrals from the National Assn. of Consumer Bankruptcy Attorneys at https://www.nacba.org).
Your home equity should be reserved for emergencies, not used to finance a lifestyle you can no longer afford. And your retirement funds should be left alone for retirement.
Never use retirement funds to pay down credit card debt
Dear Liz: I had to retire because of illness at 44. I have $30,000 in credit card debt. Should I use the $24,000 in my 401(k) to pay off the majority of that debt? The payments are $1,000 a month. My wife and I can afford the payments, as we have a combined gross income of $120,000. But we hate to think we’ll be paying forever and, worse yet, what we’ll pay in interest over time. A home equity loan is out of the question since we only have about $50,000. What should we do?
Answer: Don’t use retirement funds to pay off credit cards. Period.
If it pains you to think about the interest you’re paying, good. That may keep you from running up more debt.
But you’ll pay a lot more in the long run by raiding your retirement fund. First, you’ll lose one-third or more of your savings ($8,000 or more) to taxes and penalties. Then you’ll lose all the future, tax-deferred returns your 401(k) could have earned. You can figure that the $24,000 will easily cost you more than $100,000 in lost future retirement income.
A better approach is to cut your expenses so you can put more money toward paying off your debt. An extra $500 a month could shave a year or more off the time you’re in debt and save you a considerable amount in interest.
Closing credit card accounts may affect credit scores
Dear Liz: When our daughter turned 18, I was able to get her a credit card with a $750 limit by opening the account myself, with her named as an authorized user. I did not plan to use the credit card myself and did not. We were then able to order her a credit card with her name on it. She used the card for five years, paying the balance each month. When she graduated from college, the same credit card company offered her a rewards card with a $3,000 limit in her name only, leaving me off the account. This was just as I planned it. Now she wants to close the account with the $750 limit that was opened five years ago. Will this hurt anyone’s credit scores? Neither one of us plans to ever use this account again.
Answer: Closing accounts can’t help your credit scores and may hurt them. But if both of you have good scores (FICOs of 740 or above) and other open credit accounts, then canceling this account shouldn’t have disastrous effects on your scores.
Liz Weston is the author of “The 10 Commandments of Money: Survive and Thrive in the New Economy.” Questions for possible inclusion in her column may be sent to 3940 Laurel Canyon, No. 238, Studio City, CA 91604 or via asklizweston.com. Distributed by No More Red Inc.
