Developing Strategies To Remain Debt Free - Strategy 1 In The Series

Aug 18 2008

Posted by NCN as Debt Free |

Finally, YOU DID IT!

You worked hard, you sacrificed, you made extra payments, and now, you are, officially, 100%, DEBT FREE!

Excited, you do a little dance, complete with running-man style knee lifts and a little old school moon-walking.

Life is good. No. Life is GREAT!

For the next few weeks, you feel like a King. Who’s the man? You’re the man! Who’s debt free? You’re debt free! Who rocks? You rock?

Then…

You realize that you have a NEW goal - an even BIGGER goal.

You want to remain debt free.

On February 26, 2006, I made my final debt reduction payment. I was, for the first time in my adult life, free from the burden of debt.

Debt free, I celebrated with my friends, my family and my blog readers. Life was good. No. Life was great!

A few weeks later, after the euphoria subsided (it never quite goes away…), I realized the need to develop some strategies that would help me remain debt free.

Developing Strategies To Remain Debt Free

Strategy 1 - Finding The Balance Between Investing For The Future and Saving For The Present

If you want to remain debt free, you need cash. But, if you want to plan for your retirement, you need contributions. I have worked hard to find the right balance between investing (for retirement and kids’ college) and saving (for future purchases like newer cars, new furniture, and other major items). Income is limited, and must be allocated wisely.

At every turn, there are decisions to make. If I contribute to my 403(b) (a pre-tax retirement account), my income taxes are reduced. But, I won’t have access to that money (without penalties) until I’m ready to retire. If I put more money into my savings account, I’ll have easy access, but I’ll pay income tax (and tax on any earned interest).

If I maximize my Roth IRA (an after-tax retirement account) contributions, I’ll be setting the groundwork for a great retirement. But, there are some restrictions associated with accessing the money in my Roth, should I need it. Conversely, if I keep the money in a checking account, and don’t make my Roth contributions, I lose a year’s worth of retirement funding.

I created a life priorities list, to help me decide which accounts get funded first, second, third, and so forth.

1. I want minimize my taxes.

2. I want a nice retirement.

3. I want to pay cash for major purchases.

4. I want a really nice retirement.

5. I want to help my kids pay for college.

6. I want to pay cash for a home.

Using this priorities list, I’ve then created my prioritized funding list.

1. Each year, I will fully-fund my 403(b) (and other pre-tax retirement plans).

2. I will maintain (or build) and emergency fund (in my savings account) equal to 12 months worth of household expenses.

3. I will save - in my savings account - for future car, furniture, and appliance purchases.

4. I will fully-fund my Roth IRA.

5. I will fully-fund Education Savings Accounts for each of my kids.

6. I will save - in my savings account - for a future home purchase.

As you can see, I’ve tried to find balance between the future and the present. There are some expenses, like newer automobiles or newer appliances, that are inevitable, even if I don’t know precisely when they will be incurred. As a person living debt free, I need to plan for those expenses now, instead of waiting to worry about them when the engine blows or the dryer dies. But, if I focus too much on the ‘what ifs’ associated with current needs, I’ll fail to adequately fund my retirement accounts.

Finding balance can be difficult. It requires asking, and answering, some challenging questions.

Am I willing to be as intense about saving money as I was about reducing my debt?

Am I willing to give up some retirement contribution opportunities, so that I can maintain adequate (as defined by me) cash reserves?

Am I willing to pay higher taxes, this year, so that I can have access to my money?

What percentage of my money should be dedicated to savings?

What percentage should be dedicated to investing?

Over the next few weeks, I’ll explore these questions, and many more. I hope you’ll stay tuned, and I really value your feedback. (When leaving a comment, please be patient. For some reason, comments take a few minutes to show up. It’s a problem I’m aware of, and I’m working to correct it.)

If you are interested in keeping up with this series, consider subscribing to No Credit Needed. This series is very important to me and I’ll be taking the time to adequately prepare for and develop each post.

Side note: For those looking forward to the next installment in the Bills-In-A-Box series, stay tuned. It will be up Thursday! (Hint: I have a new video camera.)

One final note: For the purpose of this series, debt free means debt free including OR excluding a first-mortgage. I live in a house provided by my employer as part of my compensation. So, I’m saving for a future home purchase. Should I need to move, I would face another decision - to rent or to buy (with a mortgage). At some point in the future, I’ll write a bit more about this topic. Suffice to say, buying a home with cash is a big time goal - and one for which I’m shooting!

12 Responses

imelda

August 18th, 2008 at 10:41 am
1

Hi NCN

I have been debt free for a while now but its been hard at times. We wanted to replace our carpet for sooo long but wanted to pay cash. At one point I almost opened a CC to pay for it then pay it off in 3 months but we decided to break the job up in chucks and pay cash.

Thank you thank you thank you for your inspiration!

You are doing sooo well with you blogs and readership! I’m so proud of you and so glad you are helping sooo many people.
luxuryoption

August 19th, 2008 at 12:55 am
2

Thanks for this upcoming series!!!. I’m debt-free since April 2008. and look forward to your advice.
Evelyn Guzman

August 19th, 2008 at 8:36 am
3

I love this first strategy; I hope I don’t miss the next installment. You have such good ideas. If they are implemented, everyone will be debt free. I have a question though. Why buy a home with cash when you can make the interest tax deductible? Thank you for all the information.

Evelyn Guzman
Debt Challenger
Joshua Watson

August 19th, 2008 at 10:45 am
4

You bring up a great point. 93% of people fall back into debt within 12 months of becoming debt free. By realizing this, we can take steps to prevent the same patterns from repeating. Your post has a lot of good ideas.
Moneymonk

August 20th, 2008 at 12:35 pm
5

I always said that becoming debt free is easier than REMAINING debt free
DivaJean

August 21st, 2008 at 11:26 am
6

I am rarely “in debt.” Credit cards are used rarely- and when they are, they are paid off when the bill comes. I can’t think of when I last used credit for anything– maybe last year for a hotel overnight stay—or a few items at Xmas time shopping. Oh- and ebay/paypal– maybe three months ago. So you see how rare it is! Remaining debt free is easy if you don’t buy much.

I owe about $46K on my $110K home and as a family, we are trying to get that paid off early. We have a 15 year loan and are on year 5. We think we’ll be able to swing getting it paid off within the next 5 years if all goes well and the creeks don’t rise (my mom’s expression). Once that happens- I’ll have about 5 years to get ready for kidlets and college. Not that we aren’t already saving- but with the mortgage out of the way, it will be infinately easier.

My family of 6 lives on my modest income alone- hubby stays home with the kidlets and devotes her time to shopping smart, keeping the house in order, growing our veggies in the garden and when school is in- doing the bigger home projects so we don’t have to pay others for the work. We put 15% of my income in an untouchable, its-the-3rd-rail, save for retirement 401K with 5% of my income matched by my employer (so basically 20%). 3 out of 4 kids warrant a monthly stipend from the state (we adopted from fostering). This is divided by 4 and goes into their college savings plans–except a few hundred dollars/year for scouting, day camp, music lessons thru the school, or other learning experiences we all agree on.

I think we have our goals and money management well laid out- even though we don’t work a “budget” per se. We are so tight on the pennies, Lincoln cries.
Scott @ The Passive Dad

August 21st, 2008 at 12:43 pm
7

Wonderful that you have documented your goals and prioritized them. As for #1 minimizing taxes, do you have a personal business or can you write off your blog as a business? Since you have advertising income and expenses like office, electricity, and internet, can you write these off? This should help reduce your tax rate.
Aaron

August 21st, 2008 at 1:21 pm
8

I would make #1 fully fund 403(b) up to the match, then make fully funding the Roth #2. Shouldn’t the question be will your tax rate be higher or lower when you retire? We currently live in a time with historically low tax rates. It’s likely taxes will be raised to pay for entitlement programs for the retiring baby boomers. Therefore I’d rather pay taxes now then later.
Jane

August 22nd, 2008 at 10:20 am
9

Debt free always, that’s the best way to not only to gain financial stability but also to get a piece of mind. It’s not easy though when we are bombarded with commercial after commercial about products that we don’t really need.
Mike Sweeney

August 22nd, 2008 at 7:01 pm
10

Great post and 1st strategy.
Mark L

August 22nd, 2008 at 10:25 pm
11

Aaron,

The decision on Roth vs. Traditional IRA can be tricky, but you are correct to point out that it is when you want your tax burden. With the Roth plans (which now include both IRAs and some 401(k) plans) you pay taxes now. With the traditional plans (most 401(k)s and 403(b)s), you pay them later.

Many people will - in retirement - live on less annual income than they do now. They have no kids, no house payment, no insurance, etc. So, a 100K income earner might only need 70k in retirement to have the same standard of living. In that case, the traditional plan works better since the tax burden is lower.

However, if you are really savvy and expect to have a lot of investments, and a lot of wealth, then you may find that you will have a higher income in retirement - and that you want to enjoy it. That makes the Roth plans better since you’ve already paid taxes.

Personally, I’m doing a hybrid. I am fully funding (10K) the Roth IRA plans, and putting another 7k in the traditional 401(k). The reason I’m putting more in the Roth now is that I’ve been heavily invested in the traditional for many years, but just started with the Roth.

The other reason to like the Roth over the 401(k) specifically, is the options. WIth a personal Roth account, you get all the market as potential investments. In the 401(k), you just have the company choices.

So, to go back to the list, I would redo it slightly:

1) Fund tax-favored company retirement plan to maximum match (typically 3-5%)
2) Fully fund personal IRA account (Roth preferred, but Traditional okay)
3) Assuming you haven’t gotten to 15-20% of your income in retirement yet, fund tax-favored company plan to that level.
chris

September 10th, 2008 at 11:20 am
12

I find a great motivator to remain debt free is too think about how short lived any feeling from purchasing something lasts, compared the the pain of paying it off. I therefore find it a better long term feeling to save and pay in cash.