Debt, 401(k), or Emergency Fund?

[hermoninny]

We're just starting to grow our mustache back after a couple of bad years, most recently a layoff for my husband.  We knocked out most of our debt before said bad years, but have one car payment ($551/month, $16k total) and one student loan ($134/month, $5k total) and $10k in credit card debt (facepunch). 

I contribute 12% to my 401(k) and am working my way up to maxing it out (1-2% every couple months so we can adjust spending), and we also put $300 in a VUL every month.  My husband has never had a 401(k).  He's currently self-employed.

We depleted our emergency fund during a short sale and subsequent cross-country move three years ago.  We currently have approximately one month of expenses in cash.  I'd like to bring that back up to AT LEAST three months, preferably six. 

Our 2014 tax liability is looking to be astronomical (i.e., double what we've ever owed before, unless I made a grave calculation error) - I think it's due to the switch to full self-employment as well as no longer having a mortgage write-off.  As such, I'm inclined to open a 401(k) for my husband and start putting our extra $$ in there to help reduce our tax liability.   

We're cutting where we can (sold a gas-guzzler with a $462/month car payment and paid cash for a replacement car, cancelled cable, reduced eating out drastically, etc) but our biggest holdback to saving at Mustachian levels is $25k/year in daycare for two kids. 

What do you suggest?  Tackle the debt, open the 401(k), or emergency fund?

 

[Debt Free in Alabama]

D) none of the above.
I would tackle taxes with the details below, sell the car, etc.
A few ideas:
1. Cut more.  Cell phones with Republic Wireless or Airphone yet?  CFL or LED bulbs installed?  Shopped your insurance carriers for home/car with an independent agent?  Taking lunches/cooking 6 days a week?
2. Filing taxes with a home office deduction?  If not, you should, assuming your husband does anything from home.  You can deduct house space used for office.  If his work space is, say, 10% of the square footage of the house, you can deduct 10% of mortgage interest, electric, gas, water, property taxes, insurance, pest control, on and on.

4. Don't invest in the husband's 401k at this point.  Use these tools, and that money, to invest in these "less than one year" payback items listed (home stuff, CPA time, etc) and pay much lower taxes, assuming you make some jack.
5. with the tight predicament you described, I would suggest STOPPING your own 401k contribution and invest that money into these details.  Yes, you'll increase taxes by 15-25% of the amount you now receive in your take home pay.  However, if you stop contributing %500 per month, you'll pay $75-100 of that in tax and have $400 to make these changes (and pay taxes on hubby). 
Your situation sounds like you're cutting it really close, so I would really take this an emergency and make some semi-radical changes to right the ship ASAP.  Get the taxes under control, chop expenses, etc.

As an alternative, you may want to pay off one of the loans IF you will have enough to pay the taxes.
Or, finally, you may want to sell the big car, take the extra cash to closing to pay off the loan, and talk with your credit union about getting a $4,000 loan to buy a $4,000 car that you can drive for 5 years+.
Hopefully that gives you several alternatives that can fit a variety of circumstances.
As a self employed person, cash flow is king, and I have really sacrificed to kill items that cause recuring expenses so that I could profit for decades.  Be careful and don't "over invest" in these ideas, but use them as a road map, as they are all critical for self-employed folks (and most others as well).

[hermoninny]

A few ideas:
1. Cut more.  Cell phones with Republic Wireless or Airphone yet?  CFL or LED bulbs installed?  Shopped your insurance carriers for home/car with an independent agent?  Taking lunches/cooking 6 days a week?

No on the cell phones.  My husband is not on board with switching to a prepaid and/or MVNO and I can't see it happening anytime soon.  The best compromise I've gotten is a switch to Virgin Mobile for about 40% savings off our current Verizon, but the cost of new phones is what's keeping us from pulling the plug right now. 

I think we have CFL's.  I don't think CA has sold anything else in quite a while.  The electricity in our house does not like CFL's though.  We burn through bulbs super fast.  Half the lights in our house are burned out at any given time.  With my husband working at home, unfortunately the A/C and/or heat is running all day.  He says he keeps it at 75 during the day, but he turns it down to 71 every night and I cannot, for the life of me, get him to dress more weather-appropriate and turn the A/C up and/or the heater down.  It drives me INSANE.  Especially because I'm generally covered up with a sweatshirt and blanket in the summer and wearing shorts/tank tops to bed in the winter. 

I just adjusted our car insurance yesterday and we're now saving $160 a year.  :)

We rent, and our renter's insurance is minimal ($300/year).

My husband works, and therefore eats, at home.  We're working on switching the kids off of their expensive toddler food and onto regular-people food.  We have an extremely picky 3-yr-old!  We probably eat the equivalent of 5.5 days a week at home.  We walk to McDonald's on the weekends for the kids to play in the playplace and spend $10 on breakfast.  We used to spend ~$100 a weekend eating out, and we're probably down to $25.  We also do 1-2 lunches a month at my work so we can have some kid-free time.  That's ~$20 each visit.  So, we're down from $700-$800 per month eating out to under $200 this month for the first time in probably ever.  Definitely more work to be done, but we're getting there!

2. Filing a home office?  You can deduct house space used for office.  If it's, say, 10%, you can deduct 10% of mortgage interest, electric, gas, water, property taxes, insurance, pest control, on and on.

We have never filed a home office due to the increased tax audit liability.  It has never made sense to us, but it might be worthwhile to look into now. 

3. I would suggest you husband set up as an LLC filing as an S-Corp.  That terminology is important to follow all the way (ie, the S-corp part) to save massive taxes.  Talk to a CPA and if he doesn't get excited about the thought of helping you save taxes with that phrase, get another CPA.  I'm serious.

We've avoided the LLC route due to the increased expense and filings.  His sole proprietorship is set up in TN, and their LLC filings are CRAZY.  I have another LLC that's winding down that I'm responsible for all tax and business filings and it's impossible to keep up.  Every time I turn around, there's some filing I missed and I'm getting threatening letters.  Whoever said TN was one of the best states to do business in is CRAZY.  (/rant off)  I'm actually a CPA, but I don't specialize in taxes so even though I understand most of the mumbo-jumbo and have always filed our taxes, I don't know all the workarounds.

4. Don't invest in the husband's 401k at this point.  Use these tools, and that money, to invest in these "less than one year" payback items listed (home stuff, CPA time, etc) and pay much lower taxes, assuming you make some jack.  If his income isn't $60K or so, it's probably not worth it to do the LLC filing as an S-Corp.

His gross *should* be over 60k if his current trajectory continues.  The months of unemployment at the beginning of 2014 might keep that from happening, but only time will tell.

5. with the tight predicament you described, I would suggest STOPPING your own 401k contribution and invest that money into these details.  Yes, you'll increase taxes by 15-25% of the amount you now receive in your take home pay.  However, if you stop contributing %500 per month, you'll pay $75-100 of that in tax and have $400 to make these changes (and pay taxes on hubby). 

Hmmm...something to think about.  Increasing our taxes at this point really scares me.  We're already looking at a $30k bill (7.65% of self-employment taxes are killing us) and this is pretty much our only buffer at this point. 

Thanks for the suggestions!  I'll talk them over with the husband and see where we come out...it's funny how when we were first married he was the more Mustachian one, and now I want to cut everything and he wants luxuries and expensive hobbies.

[Debt Free in Alabama]

Don't give up.  There may be $10,000 in tax savings/household savings there on your article when you dig in with taxes and cars.  How would that help?
I'm incorporated in Delaware, it's easy as cake, although AL does require a business privilege tax, it's only $100 a year, filed one time.  I have to have a registered agent in Delaware, and that's $100 per year. Or, you could just start it in your home state (CA?) and be your own registered agent.
As you know, this is basically a cash flow question, an ROI question.  What expenses that you invest in (CPA, spending money to pay off the car, etc) will pay off in time to NOT cause you to miss paying your taxes?
You can do this.

[MDM]

I contribute 12% to my 401(k) and am working my way up to maxing it out (1-2% every couple months so we can adjust spending), and we also put $300 in a VUL every month.  My husband has never had a 401(k).  He's currently self-employed.

We depleted our emergency fund during a short sale and subsequent cross-country move three years ago.  We currently have approximately one month of expenses in cash.  I'd like to bring that back up to AT LEAST three months, preferably six. 

Our 2014 tax liability is looking to be astronomical (i.e., double what we've ever owed before, unless I made a grave calculation error) - I think it's due to the switch to full self-employment as well as no longer having a mortgage write-off.  As such, I'm inclined to open a 401(k) for my husband and start putting our extra $$ in there to help reduce our tax liability.   

What do you suggest?  Tackle the debt, open the 401(k), or emergency fund?

All the bolded items above.  Excellent ideas on your part.

DFiA's tax suggestions also appear worth pursuing.  Don't let "fear of an audit" prevent you from adopting perfectly legal strategies to reduce your taxes.

Speaking of taxes: are you withholding enough (or paying enough estimated taxes) to avoid penalties/interest in April 2015?  Bad enough you have to pay; even worse if you have to pay extra.

Can't speak to the debt payments without knowing the interest rates.  Easy suggestions would be "prepay if >6%; pay minimum if <2%".  When you get into the  ~4% range it becomes as much about psychology (like debt? hate debt?) as finance.

In general: you should have (if you don't already) a spreadsheet or other software that allows you to play "what if?" with all these options.

ETA: Almost forgot - why VUL?  Not usually a recommended thing for someone in a low tax bracket.  E.g. see http://en.wikipedia.org/wiki/Variable_universal_life_insurance

[hermoninny]

Taxes - yes.  I save 25% of each contract for taxes.  This is the first year we'll need to make estimated payments.  We've almost always gotten a refund from my withholdings or owed a small enough amount to not have penalties.

Debt - car is at 2.9% and student loan is 2.25%.  Credit card is high- don't know the exact rate though.  I hate debt, so it's worth it to me to pay it all off and free up the money during the month. 

I'm the spreadsheet queen.  :). I definitely play with the scenarios all the time!  It's actually how I realized our tax predicament this year - I started playing with the numbers and got a big surprise!  I thought we'd have a lot left in our tax savings account based on prior years' effective tax rate and instead found out I was barely saving enough.

VUL - sigh.  The more I research, the more I realize I was swindled a bit.  A friend was getting her license 10 years ago and I bought it from her when I was trying to figure out how to invest the small amount of money I got when my dad died.  My husband bought one a  couple years later.  We just didn't know any better.  I'm researching how to get out of it.  We have about $25k in then between the two of us, and it looks like our surrender values are about $21k.  Not sure when we can cancel and pull all our money out, but I'm calling first thing tomorrow to find out.  I'm also planning to lower the payments to the minimum needed to keep the life insurance open and use the rest to add to the monthly debt payoff. 


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[Debt Free in Alabama]

I just saw the part about $30k in taxes, and the life insurance.
My thoughts are that if you owe $30k, SOMEBODY made some money!  That's a good thing.  If hubby made $100k, the self employment tax (both halves) is $15,300, throw in Federal and Medicare, state taxes, that sounds like $100k+ was earned?
Life insurance (*heavy sigh*).  Dave Ramsey calls VUL "the title pawn of the middle class," as it's the worst product possible that middle class folks like us can get involved with.  I would get 10-12X your husband's earnings in term life from an independent agent, then cancel the VUL, biting the bullet the whole time and losing the money (then spreading the word to everyone you can, for the rest of your life, about that terrible product).

[rmendpara]

We're just starting to grow our mustache back after a couple of bad years, most recently a layoff for my husband.  We knocked out most of our debt before said bad years, but have one car payment ($551/month, $16k total) and one student loan ($134/month, $5k total) and $10k in credit card debt (facepunch). 

I contribute 12% to my 401(k) and am working my way up to maxing it out (1-2% every couple months so we can adjust spending), and we also put $300 in a VUL every month.  My husband has never had a 401(k).  He's currently self-employed.

We depleted our emergency fund during a short sale and subsequent cross-country move three years ago.  We currently have approximately one month of expenses in cash.  I'd like to bring that back up to AT LEAST three months, preferably six. 

Our 2014 tax liability is looking to be astronomical (i.e., double what we've ever owed before, unless I made a grave calculation error) - I think it's due to the switch to full self-employment as well as no longer having a mortgage write-off.  As such, I'm inclined to open a 401(k) for my husband and start putting our extra $$ in there to help reduce our tax liability.   

We're cutting where we can (sold a gas-guzzler with a $462/month car payment and paid cash for a replacement car, cancelled cable, reduced eating out drastically, etc) but our biggest holdback to saving at Mustachian levels is $25k/year in daycare for two kids. 

What do you suggest?  Tackle the debt, open the 401(k), or emergency fund?

Math 101: Why are you investing (beyond getting a company match, if any) at all if you have credit card debt? You probably will not earn more than 10% on your investments, while your credit cards are likely costing you 15%+? Even if you have a special low rate on the credit card, it is a terrible habit to run a balance there.

Here's what I would do:

Owing the IRS is not a bad thing (hear me out) as the rates they charge are usually very low. Ideally, you should be paying taxes when you are supposed to pay,
1) Get to 3 months expenses in e-fund. Without this, any small issue will knock you back 5 steps.
2) Contribute to 401k only enough to get company match. (this is a 100% return on what you invest)
3) Pay off the credit card debt (is this really even a question?)
4) Increase your 401k contribution in proportion to an increase in payment toward student loans
5) worry about this once you've done #1-#4 and maxed out $17.5k in your 401k contributions and a Roth/Trad IRA for both of you

Quit worrying about saving money on taxes (for now, focus on paying what you owe). You have debt. That is a bigger problem.

[hermoninny]

I just saw the part about $30k in taxes, and the life insurance.
My thoughts are that if you owe $30k, SOMEBODY made some money!  That's a good thing.  If hubby made $100k, the self employment tax (both halves) is $15,300, throw in Federal and Medicare, state taxes, that sounds like $100k+ was earned?

Yes, we're very blessed with the amount of money we make!  But we also live in Los Angeles, so rent and daycare alone are about my entire take-home pay.   My husband lost his job last summer, but immediately found work freelance making about the same as his full-time gig.  But then he was laid off from that when the movie was done, so we had 2-3 months where his earnings were 1/4 - 2/3 what he was making before.  Thankfully, through someone I work with whose son is also in our daughter's daycare class, he made some amazing contacts and things are looking way up for the rest of the year.  But, still a bit unknown because it's a fickle, fickle industry!  Most of his work is currently being sent overseas to countries whose governments are subsidizing the film industry and he's scrambling to figure out how to use his skills in a different way, especially one that might move us away from the HCOL of LA in the future. 

Don't let "fear of an audit" prevent you from adopting perfectly legal strategies to reduce your taxes.

I feel the need to note that my fear of tax audits isn't completely unfounded.  My mom was self-employed when I was a kid.  My parents were audited when I was about 13, and I remember sitting at the kitchen table for weeks looking through all her mileage records to put together the documentation the IRS wanted.  I don't remember what the result was, but I do know that between that audit and the sale of my childhood home when I was 15 (less than a year before the capital gain laws were changed), my parents owed the IRS money that they could never seem to come up with.  Interest and penalties abounded.  My dad got the IRS bill in the divorce agreement, and he attempted to settle.  When he died about a year later, they went after my mom for the amount he didn't pay in the settlement and she ended up having to pay it out of his life insurance money.  So....my fear of the IRS runs very deep! 

But, I also think it's time to put on my big girl panties and talk to a CPA and figure out our best move going forward for tax planning purposes. 

Life insurance (*heavy sigh*).  Dave Ramsey calls VUL "the title pawn of the middle class," as it's the worst product possible that middle class folks like us can get involved with.  I would get 10-12X your husband's earnings in term life from an independent agent, then cancel the VUL, biting the bullet the whole time and losing the money (then spreading the word to everyone you can, for the rest of your life, about that terrible product).

I just got off the phone with our VUL company.  I'm extremely thankful that my news is much better than what my mom's VUL company told her.  She was *completely* conned into buying her VUL - she specifically stated she did not want life insurance, they told her it wasn't and now she's stuck for a while.  But our company seems to be a bit more honest, and it looks like we can cancel my policy with minimal cash loss.  My husband stands to lose almost $3k in his, so I'll have to do the math on it.  If we pull everything, we'd be able to pay off all of our debt and then use the freed-up monthly income to open his 401(k). 

[hermoninny]

Math 101: Why are you investing (beyond getting a company match, if any) at all if you have credit card debt? You probably will not earn more than 10% on your investments, while your credit cards are likely costing you 15%+? Even if you have a special low rate on the credit card, it is a terrible habit to run a balance there.

Here's what I would do:

1) Get to 3 months expenses in e-fund. Without this, any small issue will knock you back 5 steps.
2) Contribute to 401k only enough to get company match. (this is a 100% return on what you invest)
3) Pay off the credit card debt (is this really even a question?)
4) Increase your 401k contribution in proportion to an increase in payment toward student loans
5) worry about this once you've done #1-#4 and maxed out $17.5k in your 401k contributions and a Roth/Trad IRA for both of you

Quit worrying about saving money on taxes. You have debt. That is a bigger problem.

Very true about the credit card debt and saving!  It's actually extremely recent debt - we got hit with a ton of unexpected expenses right when my husband was laid off in March.  We're waiting on a couple of checks, and then we'll actually have the credit card debt knocked in half. 

Thanks!

[Debt Free in Alabama]

One last note then I'm done....
I've read about this and seen the math.....I encourage you to look at this long and hard to see if you can at least breakeven....
Since it is you that says "the childcare and rent consume your whole paycheck," what if you stopped working?
I believe that you'd save MORE than the $900 in rent by going seriously Mustachian:
1. Not driving (perhap go to one car permanently?
2. No work clothese needed
3. No taxes also consuming your check.
4. More able to focus on raising kids, for free, and focus on "home economics" of eating/shopping/making sure you are saving the money in 100 areas.
5. Do something part time, from home, like baby sit 2-3 other children for neighbors and charge THEM a bit that makes up for not going to work.
Just a thought.  May not be for you, may be it is.  My wife follows this plan in our house and it works, based on the small opportunity cost of what she was earning ($30,000 annually)
You can figure this out. 
Be bold, think on paper, make it work.

[MDM]

If we pull everything, we'd be able to pay off all of our debt and then use the freed-up monthly income to open his 401(k).

Great plan! 

Your screen name is well chosen, as all your inclinations seem spot on.  The more you can put away in 401ks (after erasing the high interest debt) the better.  Keep up the good work!

[hermoninny]

One last note then I'm done....
I've read about this and seen the math.....I encourage you to look at this long and hard to see if you can at least breakeven....
Since it is you that says "the childcare and rent consume your whole paycheck," what if you stopped working?
I believe that you'd save MORE than the $900 in rent by going seriously Mustachian:
1. Not driving (perhap go to one car permanently?
2. No work clothese needed
3. No taxes also consuming your check.
4. More able to focus on raising kids, for free, and focus on "home economics" of eating/shopping/making sure you are saving the money in 100 areas.
5. Do something part time, from home, like baby sit 2-3 other children for neighbors and charge THEM a bit that makes up for not going to work.
Just a thought.  May not be for you, may be it is.  My wife follows this plan in our house and it works, based on the small opportunity cost of what she was earning ($30,000 annually)
You can figure this out. 
Be bold, think on paper, make it work.

It's definitely a consideration now more than it was in the past.  When we first moved back to CA, I stayed at home with our then-infant son for about eight months.  The math didn't make sense then, because my husband wasn't making enough money to cover our non-mustachian lifestyle at the time.  As we reduce our expenses, it's something that we can definitely put back on our radar. 

A couple of immediate thoughts, both pro and con.  I'm not nay-saying your suggestion in any way...this just helps me think things through.  :)   

1. I actually make more money than my husband, especially if you factor in self-employment taxes.  With the new gig he has going right now, it's actually a possibility for his income to surpass mine for the first time since we've been married.  But that's never even been in the realm of possibility before - I've always made about 25-50% more than him. 

2. For the first time since I graduated college (2002), I actually really like my job.  I love my company, what I do, and who I work with and for.   This is a BIG thing for me, as I've had some really unfortunate work experiences.  To the point where I had to take medical leave because I was having debilitating panic attacks, not sleeping because of worry-induced insomnia, and I was crying all the time.  I still feel the effects even though I quit that job four years ago - I still get minor panic attacks and have occasional insomnia (this week has actually been pretty bad).  To quit this job, at this point in time, after coming through all that is something that would take a lot of consideration.   I told my husband that if we ever leave LA, I'm done working and will focus on my side business.

3. I have a side business that's mostly dormant right now, but has potential to make a decent income if I could devote 100% of my time to it.  It would never replace what I do 9-5, but I enjoy it and will get out of it what I put into it.  It's actually what I plan to do if we ever reach FIRE.  I learned when I was home with my son that I'm not capable of sitting still.  With the kids being so young (3 and 18 months), I can't devote a lot of time to it, as it requires some fairly intensive outdoor labor that doesn't allow me to focus enough attention on the kids unless someone is helping me.  The equation changes as they get older and definitely when they get to be school age, so my quitting in the near future to pursue this business is definitely on the table. 

4. My husband's job and industry is currently very volatile.  To rely the majority of our well-being on his income, at this point in time, is a little too risky for my blood.  He's looking into other avenues to use his skill set that are less risky, but this is currently where we are.  I absolutely wish I could hurry him along and/or change his mindset as to what he should be looking for out of a career.  But he is who he is, and his ambition is a big part of what I love about him so I'm kind of along for the ride right now. 

5. We actually really want another baby, but can't afford the daycare costs.  So it's another "pro" to cutting our living to the point of me being able to stay home.  But it also delays my ability to pursue my business fully for another few years.


I really appreciate all your thoughts on my situation!  I'm definitely internalizing them, discussing them with my husband, and figuring out how to use them to move us along.  Wheels are already in motion.  :)

[hermoninny]

Feeling slightly more in control again.

Filled out an application for term life insurance.  The woman I talked to was astounded at how low the rate quote was. I took it as good news.  Requested the paperwork to surrender the VUL.  Reworked the budget to include reduced insurance costs and zero debt payments, and ran the numbers for how long till we're back to three months' expenses in our emergency fund.  We should be able to open the Solor 401(k) in about six months.  We'll still get killed in taxes this year, most likely, but at least we can plan better for next year. 

Also - talked to a friend who is coming into town on Saturday.  We usually go out to eat when they're in town (sometimes up to 30 miles away) but we're doing a BBQ at our house instead.  The only thing it will cost us is a bag of hamburger buns and a bottle of BBQ sauce, because we already have all the food in the pantry/freezer. 

Feels good!