Updated on 07.20.07

A Perfect Case For Making Things Automatic

Trent Hamm

Angela writes in with the following situation:

I didn’t see any archives where you unexpectedly come into money. My husband is re-enlisting for a big chunk of change (in the end we will get about 37k after taxes). Here is where we are now:
Credit Card 1 – 10k @ 14.25%
Credit Card 2 – 1k @ 16.99%
Debt consolidation loan – 11.5k @ 14%
Truck loan – 12K @ 12%

So you can see that we can pretty much wipe the slate clean there. Here is my real question. Will all that debt just gone, we will have a little over $2,000 a month left over. How do we make sure that we are not just going to blow it? We have four kids to put through college and a neglected retirement fund to look at. But it seems like it is just too much money to really handle. Help!

According to my math, that debt is about $34K, and you’re getting about $37K. With interest rates like those, you’re definitely in the right to pay all of them off as soon as you get the money. Step one is to get that debt completely gone – any time you’re paying out double-digit interest, you’re never going to get ahead.

This leaves you with about $2,000 a month in excess on your monthly budget, which is great. I also understand that, without a plan, you’re going to be prone to spending all of it, which is not great.

What I would do is start automatically putting that money in various places. Set up automatic deductions from the paycheck into a 401(k) and into 529 college savings accounts for each of your kids – $500 a month into the 401(k) and $100 a month into the 529s will eat up $900 of it.

What about the rest? First of all, I’d build up a nice emergency fund to protect yourself from things like a car breakdown – if your car dies and you suddenly have a large bill at the auto repair place, you don’t want to dip into credit to cover it. I would set a goal of having an emergency fund equal to six months’ worth of your monthly budget – with four kids at home, lots of things can happen when you least expect them. This will siphon off that extra $1,100 each month for a while, but when the time comes, you are going to be incredibly happy that you have that money.

What about when the emergency fund is full? Between now and then, spend some time with your husband figuring out what your most important goals are. Do you want a bigger house? A better retirement? Do you want to really fund your children’s education? Some amazing family vacations in the future? Paying cash for automobiles so you never go into debt again? Each of those goals points to different things to be doing with that money. By putting cash into an emergency fund now, you’re not only building security, you’re also giving yourself plenty of time to think about what you really want to do with your money after the emergency fund is completely funded.

My wife and I dream heavily of a country estate, for example, so we’re focusing on paying down all of our debts with some seriously large overpayments right now, then saving rapidly for this home.

The real key, though, is making it automatic – just set up automatic deductions into appropriate accounts. That means that you’ll never touch that $2,000 a month and never be tempted to spend it. Good luck!

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  1. Tim says:

    first thing is that Angela and her husband need to seriously evaluate their financial situation, goals and establish a budget. having that high of interest and debt signifies out of control spending. if not, my guess is that the $34k will be gone, and new charges will be racked up on the credit cards and the remaining $2k gone as well (the $2k will be more than $2k since loan payoff’s are going to be less than what the actual loan currently looks like since it includes the remaining interest). they need to budget, budget, budget. the windfall will only help if they help themselves first. establish your plan before you start paying off everything. that is the problem when people have windfalls, they start doing things without a plan and then in the end have nothing left over and more debt.

    second, since they will be debt free, they are in a much better situation than most Americans. The key is to remain debt free or have controlled debt. Again, the only way to do this is to have a financial plan. clumped all together it seems daunting, but it really isn’t once you break things down. it may be that you cannot pay for college completely and your kids may have to work their way through college. not entirely bad. it also may mean that you have to work a little longer before retirement, but that isn’t bad either.

    third, what is missing is whether or not Angela’s husband is deployed currently. if deployed, they can put the remaining money into the military’s Savings Deposit Program (SDP) earning a guaranteed 10% while he is deployed in a tax exclusion zone. you can direct deposit the $2k into SDP and then set up an allotment to fund up to $10k into SDP. this can be used as your emergency fund account since you can withdraw from it at any time without penalty. if not deployed, then simply put the remaining money in a high yield savings account to establish an emergency fund. without having additional debt to pay off, you can fund your emergency fund pretty quickly. considering the military will move you around and that you have 3 kids and deployment costs (i.e. care packages, new gear etc), I’d build up an emergency fund of around $10k.

    when your debt is paid off, then your husband should start to contribute into TSP. if deployed to tax exclusion zone, he can contribute up to $45k. if not deployed to tax exclusion zone, he has the $15500 limit. also, fund Roth IRAs for both since he obviously makes enough money to be eligible to do so.

    if deployed, you guys need to save the extra money that he gets rather than spending it. just because he is deployed doesn’t mean you have to spend more because you have more money available. Your TSP contributions will remain tax free if he is a tax exclusion zone. Normally, TSP is tax deferred, but tax free money remains tax free money. this is why you should look to max out as much of the $45k into TSP you can within your budget and goals when he is in a tax exclusion zone. Also, if your husband was deployed the past few years in tax exclusion zone, you can contribute to back Roth IRAs for those years.

    i wouldn’t invest in 529 or ESP until after you have maxed your TSP and Roth IRA contributions, but that is dependent upon what your goals are for you paying their college education. It would also depend on how old you are and when your kids are going to be going to college.

    you should also take a look at getting insurance through USAA since you are probably eligible for membership.

    these are just a couple of things, but Angela would have to list more things in order to provide information on budgeting. bottom line, evaluate your spending habits. establish short, mid, and long term goals. create a budget to meet those goals. then allocate money to your budget.

  2. MVP says:

    I’d advise creating and following a budget, after paying off the debt. List the family’s priorities (they may include saving for retirement, college, a used car, vacation, Christmas gifts – whatever’s on the family’s list of needs) then incorporating those priorities into the budget. The first couple of months may require some tweaking till they get the right fit for them, but after that, it’s almost autopilot. And I’d definitely include a large emergency fund because they have a single breadwinner (I think) and several kids to care for. And get rid of the credit cards YESTERDAY. Seriously, they need to stop using them altogether and learn to use cash or debit for everything, particularly since their spending clearly has been out of control if they haven’t paid off the balance each month. Or they’ll surely end up in the same place again.

  3. Brip Blap says:

    I agree with Tim about investing in their children’s education. I think paying off debt and building up an emergency fund are key, because of the dangerous nature of her husband’s profession. I have heard it countless times, but it’s true that it’s fairly easy to get a student loan, but nobody will give you an oh-I-can’t-pay-the-electric-bill loan. Other than the credit card companies and various other shady characters, but then you’re right back in the same hole again.

    Automatic savings are such an easy solution – I wish more people would follow this advice. I always found it hard to save until I automated my savings, and then it became almost trivial. Save first, pay for stuff second!

  4. ammb says:

    all good ideas. however, if not already w/USAA, check into them. my husband & I used their free financial advisers to make certain we covered all the basics and all our goals to make sure we’ll get there in good time & good shape.

  5. Dean says:

    I am assuming that her husband is not currently deployed since she is figuring for taxes in her estimate. While deployed the money would be tax-free. Although, she might want to look into this a little bit further. Even though taxes will be paid now, it may be possible to have them all refunded at the end of the tax season. They should talk to their accountant or anyone knowledgeable in military pay to find out the details on how to make sure they get their money back. This will not happen automatically so you’ll need to be looking for it. Good luck!

  6. Rob in Madrid says:

    It sounds like you’ve been there before Tim! Simply paying off debt with a windfall won’t change anything as the old spending habits remain. Often people who take consolidation loans in a few years end up in worse shape because they spend the extra money (that one I know from hard expereince). I would suggest spending time here and at other PF blogs to find the tricks of the trade to living frugally.

  7. Johanna B says:

    Since no one else has said this I will. To Angela’s husband, “Thank-you for serving your country.”

  8. Tim says:

    USAA does not provide free financial planning unless you have $500,000 or more in investment assets to be eligible for USAA personal asset management accounts making you eligible for the USAA Select program which allows for a free consultation with a certified financial planner.

    now usaa does have some neat tools and does give general free financial advice. this is much different than having a financial planner look at your entire portfolio. for that, they do charge a fee. it is a start and angela’s husband is probably eligible for membership.

    Dean, yes i presumed that he re-enlisted outside a tax exclusion zone; however, if he is returning, there are some definite benefits that they should be aware of to set up their savings plan.

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