How To Break The Paycheck-to-Paycheck Cycle

Topics and your questions answered on the show

• How to break the paycheck-to-paycheck cycle
• How to slow down extra spending
• Co-signing on a rental home
• Are paying mortgage points a good idea
• Using Roth IRA as an emergency fund
• Compound interest for kids
• Withdraw from Roth before age 59 1/2
• Tomorrow’s results today

Read the Transcript

How To Break The Paycheck-to-Paycheck Cycle

[0:00:12] ST: Welcome nation to The Financial Rock star show, I’m your host Scott Alan Turner ready to help you get out of debt, save more money and retire early. In the studio with me is producer Katie who has never met a stranger. On the show today we’ll be answering your questions about money, business and life. If you have a question you would like answered on the show, visit Goaskscott.com.

If you missed the last show, I had a special guest, Philip Taylor or PT as he’s known, shared how you can do more with your money. PT is a popular financial blogger, please check out that show if you missed it. There’s one thing that when, “when” not if but when, when you get to it you’ll have a better marriage, you will treat your friends and family better. Your health will get better, you’ll be happier, your job will get better, you’ll sleep better at night. Everything in your life will improve.

It’s getting away from living paycheck to paycheck. Now, living paycheck to paycheck means, you’re waiting for your next paycheck to come in before you can do things like pay your electricity bill or your mortgage or car payment or even buy groceries. You never seem to get ahead, it’s like purgatory. You’re just waiting and wondering when will it ever end. It’s demoralizing and depressing. Not only that, it’s a very risky place to be.

If you or your spouse loses a job, you can’t pay for your basic necessities. You’re often stuck at your job too because you’ve got to have that paycheck. If you hate your job, you still have to go to work. If your car breaks down, you have no way to pay for it except whipping out a credit card to pay the mechanic. You go deeper into debt, you get further away from breaking the death cycle and you can’t plan for unexpected situations or emergencies.

You certainly can’t save up for a vacation to the beach or going on a ski trip, and forget about saving for retirement. Now, if you want to stop living paycheck to paycheck, the first thing you need to do is get a handle on where your money goes. You might think I was going to say, “Hey, make more money.” Well sometimes it’s not a money problem. Often, it’s an awareness problem. You may have plenty of money coming in to cover your expenses but you don’t know where it’s being spent.

You might be making some lousy spending choices but until you know what you spend your money on, you’ll never know. I want you to pile up all your receipts and your bills for a month and add them up in the categories that makes sense for you. Utilities, credit card debts, your doctor visits, groceries, clothes, haircuts, entertainments. Just see how much you’re spending and decide if we can make some cuts in those categories. Decide in advance of getting your paycheck how much you’re going to spend. If you want to have more money than month, you have to write down how you plan on spending your money before you have the money and then you follow the plan.

Creating a written spending plan doesn’t take that long to do and once you get in the habit of following your plan, you have taken that first step. Sometimes, hey, you can’t cut anymore, I get that. Some people are living close to the bone, then you’ve got some tough choices to make if you’re in that situation. You can go extreme, you can downsize your home, you could rent for a while, you can sell the car to get rid of that car payment, you can sell your TV, you can sell your nightstand, cancel the gym membership, ditch the cable.

Now, these are lifestyle changes and yes, some might seem extreme but they’re also temporary, it might take a couple of years of renting a small apartment or renting a small house. But how does that compare to decades of not being in debt, it’s a small sacrifice if you’ve cut costs, you can’t cut anymore, then you’ve got to figure out how to earn more. Cost-cutting is limited. Your earning potential is unlimited. Working more hours, working a part time job, working from home when the kids are asleep, starting a side hustle, excelling at your current job so you can get a raise or move to a different job. There are a lot of options.

Again, remember, you don’t have to work 80 hours a week forever, we’re just trying to get ahead. But cutting costs or earning more, you now have more money than month. Now you’ve got to take your extra money and prioritize where it’s going to go so you can get ahead. Priority one, you want to build up a small emergency fund, knock out that savings quickly by selling stuff and getting a part time job for a few weeks and you just want to have that little bit of cash because you can’t get out of debt by taking on more debt.

Most people, they’ve never had $1,000 set aside in their life for an unexpected expense. Then when something goes wrong, you get stressed out and we have to charge it to the credit card. That’s the last thing you want if you’re already trying to get out of debt. If a “what if” situation happens, you’ll be able to pay for it in cash. Now with your spending plan in place, you can start attacking your debts one at a time with the extra money you’ve carved out, either from your cost-cutting or earning more.

Follow that plan each month and you focus in paying off the credit cards, paying off the car, paying off the student loans, the medical bills the 401(k) loan. One at a time, methodically with laser focus. It’s a simple plan but it’s not always easy, I get that. But it does work and it will work for you if you stick to it. Above anything else I’ve shared here is you have to have a burning desire to get out of living paycheck to paycheck. If you want freedom but you haven’t started to get it yet then you don’t want it bad enough. You’ve got to be relentless in your pursuits.

Now, on to your questions Dana writes.

[0:06:20] D: “I make a budget on paper and sometimes use every dollar but actually making it work is another thing. I don’t have the preferred tool where my bank accounts are used because I’m cheap to auto import the transactions, maybe that would help? We make really good money so there’s hugely a surplus but we have two in college and are cash flowing that and it’s hitting us pretty hard. We want to pay off our house by the end of next year but I need to slow down on my extra spending. We have $41,500 left on our mortgage.

[0:06:51] ST: First Dana, nice work on getting the house paid down, that is awesome to look forward to in only a short time do you get that paid off. Now certainly having a tool that makes it easy will help you but you have to commit to keeping it updated. You don’t want to spend the extra money on every dollar plus, you can check out Mint — mint.com. That allows you it import all your bank accounts and credit card statements for free. The budget tools aren’t as easy to use as every dollar, Mint that is. You’ll be clicking around three times as much but it does beat using paper.

Now what I would think would be a greater benefit to you is going to the envelope system. Once you decide on a budget, determine how much you want to spend in each of your budgeted categories. Just withdraw cash at the beginning of the month for those categories you typically overspend on. Whether that is eating out for you or groceries or clothing or personal shopping. Whatever categories you feel you want to improve on and cut your spending.

So you may take $500 for entertainment and $500 for groceries, $100 for clothing, $100 for personal shopping. Take that cash, stick it in the envelope on the first of each month, when you go out each day, just grab some cash out of the envelope if you plan on making a purchase for that category. You’re picking up take out on the way home from work, grab $50 from the entertainment envelope. If the envelope is empty, guess what? You’re cooking tonight. I keep a sticky note on the door of our garage that says, “Bring cash,” as a reminder to me and my wife when we head out the door.

Maybe the first month or two, you do this, you run out of cash before the month is up, that is normal. But because of how we feel about cash and treat it differently, we become more conscientious — ahh that is the toughest word for me to say. We become more aware of our spending each month. Always get conscious and conscientious, confused. Someday I’m actually going to spend the five minutes on a dictionary looking up the difference between those two.

Become more aware each month. Month two or three, you’re more likely to have a surplus at the end of the month, you just have to try it but trust me, your spending habits will change for the better. Please let me know when that house is paid off so that I can celebrate with you, that is going to be an awesome day and it’s coming. If you moved to the cash budget, that day will arrive sooner. Thanks for the question Dana.

Manny’s brother in law wants him to cosign a rental home so they can start getting into real estate. He writes.

[0:09:25] M: “I have an emergency fund and could afford a situation if we didn’t have tenants for a while but how do I tell him I don’t want to be a landlord with him?

[0:09:33] ST: He can’t afford the mortgage by himself Manny, and he wants you to not afford it with him. Bad idea. Co-signing on a loan doesn’t help him or you build a real estate empire. What’s more important than money is your relationship and when you start adding a financial component to a relationship, the relationship quickly breaks down. If the roof needs replacing, how is it going to be paid for? When the toilet breaks on the weekend and the toilet is going to break on the weekend, who is going to go fix it? You want to replace the carpets? He doesn’t, he likes these tenants, you don’t. There’s more to it than a signature.

You don’t know how long that house will sit vacant and you guys are going to have to foot the mortgage bill. Does he have the money to do that? No? Well, are you going to pay it all? Nope. I am avoiding that mess, I’m going to stay out of that situation all together. You need to sit down with him and tell him the truth, you don’t want to be a cosigner on a loan with anyone, family or not. Don’t send him a text or an email, that’s impersonal. The downside outweighs the upside. Too much could go wrong and flame out the relationship, it’s not worth the money.

Explain that as clearly and succinctly as you can. You value him as a brother in law, that’s more important. It’s going to be a weird conversation, it is, because people don’t like to tell other people no when they ask for help. Don’t put it off, don’t hymn and haw. If he gets mad at you, someday he’ll get over it, if he doesn’t, the relationship wasn’t that good to begin with. Chances are, he’s going to get over it, if the relationship is solid and he’s dude, he’ll probably not get emotional because he’s a dude. He’ll use about five or six on the average 10,000 words a man speaks on today and say, “Okay, I understand and move on.”

Now I had to tell someone once, I wasn’t going to lend them some money and why and they understood, that was that. They’re still my friend, it was weird, I didn’t like having to tell them no but it was the right thing to do. Not because I couldn’t afford it but because I valued the friendship more. It does make it harder when you have the money but we are not helping people in that situation. Though it seems like we are getting them out of a bind or whatever reason, we don’t like saying no, people don’t like hearing no but you’ve got to say no to co-signing loans and lending out money. It’s going to be bad for the relationship. Thanks for the question Manny.

Kaylie is going to refinance from a 30 year loan to a 15 year loan.

[0:12:11] K: “We’ve paid off $25,000 in credit card debt and our car loan. Our last big debt is the mortgage. If we pay points, we can reduce our monthly payment even more and pay off the mortgage a little sooner, is it a good idea to pay points?”

[0:12:26] ST: $25,000 in credit card debt, no car loan, that’s pretty awesome. Nice work on that, way to get started on that. Now, if you can afford to pay a bit more and go from a 15 year to a 30 year loan, that’s a pretty smart move, you can save a lot of money on that in interest over time.

Now what points are they’re prepaid interest, you pay points that represents 1% of the total amount of the money borrowed. We’ve got two types of points, you have borrowed points, was there a profit paid to the lender and these other type of points are discount points, they are fee paid in advance to lower the interest rate over the life of the loan. Now you’ve got to ask yourself, what’s the breakeven point? What points if you’re going to pay them down?

For me I would say, don’t waste your time in the calculations. You’re paying money to lower in interest rate by a fraction of a percent and when you figuring this stuff out, general rule is, the longer you plan to have a mortgage, the more it makes sense for you to pay the points now because you’ll have a long time to benefit from the lower rate. But what we’ve got to consider, average person in the home about five and a half years. It’s not a long time. Because it’s not a long time, it’s never enough time to make your money back. Average time to recoup your points if you pay them is about seven years.

If you’re going to be in the home five and a half years, it’s going to take you seven years to make the money back, that doesn’t make sense at all. Some of you are thinking, “Alright, what if I’m going to be in my home 10 years or 50 years or what if this is my lifetime home? This is the last home we’re ever going to have.” What I do know is, most people, we don’t know for sure how long we’re going to be in the same place or in the same mortgage or in there for the life of the mortgage. We don’t know those things, it’s just going to educate a guess, most time we’d guess wrong.

Another factor you got to figure in is the opportunity cost. If you don’t use that money for points, what else could you be doing with it? Can you invest it? Even if you expect to be in your house for a long time, there might be more pressing needs over the years. Now, if you listen to me, take my advice, you’re going to be out of your mortgage faster anyways. Take the mortgage rate with no points, with no origination fees, your payments are going to be slightly higher but you don’t’ have to come up with that extra cash, that big check going in with closing and you’re going to have that extra money to do with what you want.

Sum it all up, mortgage points, don’t do it, that’s all. If you have a money related question you would like answered, please visit Goaskscott.com and get in touch with me. That website has my email address, Twitter, you can also leave me a voice mail. Please contact me, I am here to help you.

[BREAK]

[0:15:28] ST: Got on some very popular financial websites not long ago, a couple article topics caught my attention. They were two different websites, two different articles but they’re both about where you should put money for your emergency funds, where should we store it? I thought, “Alright, I’ll check this out.” Read through them and I was blown away, flabbergasted, five dollar words. Five dollar word, flabbergasted. I was blown away that both of these articles said that you should be using your Roth IRA as an emergency fund.

Now Roth’s are used for making money in investing. Roth’s, 401(k) 403(b), 457 plans, these are investment vehicles therefore retirement. They are not for emergencies, they are not for cars. Both articles, they gave all the pros of why you could use a Roth for your emergency fund because you can earn 10% interest, right? You put your money in there and it’s going to grow as supposed to being in a brick and mortar earning 0% or where I recommend on my savings account where you can earn a measly 1% but it’s greater than zero.

Yeah, you can earn 10% on your investments in a Roth if you put them there. But neither of these articles mentioned the cons about why this is a terrible idea. Number one, it’s going to take you four or five days to get your money out. Any type of an investment place you’ve got to sell your investments even to the cash money mutual fund, you’ve got to unload it there, you got to transfer it to your bank. If you get the phone call and say, “Hey, bro, I’m in trouble, I need a thousand bucks tomorrow or I’m getting kicked out of my apartment.” I am telling you, western union, they don’t accept Roth IRA’s, you can’t go there and link up to your account and get that money to somebody when they need it in a short period of time.

So that’s con number one, your money is not quickly accessible. But the bigger one and neither of these articles mentioned it, not a single time. They didn’t mention the stock market goes down. If you have $5,000 in a Roth in 2008 and you wanted that to be your emergency fund, in 2009, that emergency fund was worth $2,500 because the stock market dropped by 50% over 18 months. If you have $1,000, $5,000, $50,000 in your emergency fund, you put that in cash because it will continue be worth $1,000, $5,000, $50,000. You don’t want to put it in a Roth, you don’t want to treat your 401(k) as an emergency fund, 403(b), 457 plans. Any of those. Those are for investing. They go up and they go down, you don’t want to lose your value of your emergency funds.

Now, back to your questions. Peter is up next. Peter has a daughter aged 13 and a son aged 16.

[0:18:27] P: “We haven’t been very good with our finances our entire lives. We’re six months away from getting all of our credit cards and cards paid off for the first time in our 18 years of marriage. One of my goals is to make sure our kids don’t repeat our mistakes. If you could suggest one lesson about money to teach them, what would it be?”

[0:18:46] ST: 18 years of debt, wow. How much interest is that? That is a lot of interest and that is the new normal right now for many people, which is unfortunate. One of the reasons I do this show but you’re six months away from getting out of debt, fantastic, congratulations on that. 18 years and now finally getting out of debt for the first time, what a great, great feeling. This is one thing that just many people need to know because we’ve all got, most of us have children.

Just one. Okay, I don’t know if I can do just one thing that I would teach them. The first one would probably be don’t go into consumer debt. With your car loans, car loans are the worst, credit cards are bad too. For me, the car loans or the student loans, it was the trifecta. Car loans, credit cards, student loans, they’re all kind of bad news. Student loans, some people consider those a good debt, we’re not going to dwell on that. Anyway, your kids, they’re too young for a house, we’re going to forget about that, please don’t tip you’d want to teach them for that.

But I think number one, yes I know. I would yield to a man who is slightly smarter than I, a man who has no parallels in his wisdom, Homer J. Simpson. Here’s what Homer had to say. No, I’m just teasing — Albert Einstein. Albert Einstein, when talking about compound interest, he said it was the eighth wonder of the world. Sit down with your kids, you can bust out a white board and show them the math so that they could see the examples, there’s online calculators to do this, you can write it down real quick.

$1,000 invested at age 15 become $117,000 at age 65 if you do nothing else. Put $1,000 in it to stop. $1,000 invested at age 25 becomes $45,000 at age 65. That’s a big drop huh? $72,000 less for the same investment, that is sick, that is the power of compound interest. How many of you right now wish you had put a thousand dollars away when you’re 15? The hands are probably going up. There’s a compound interest calculator, I use quite frequently on investor.gov. You could sit down with your kids and walk through some examples there and they will see the value of money and the power of compound interest and the wisdom of Homer J. Simpson — Albert Einstein.

Our next question comes from a voice mail. Let’s have a listen.

[0:21:26] D: “Hi Scott, I’m 41 and I have been maximizing my Roth IRA, 401(k) contributions to the max and by the age of 55 I should have just over a million dollars in present value today money dollar. My question is, since the age to withdraw funds out of your Roth account is 59 and a half. I want to retire by 55, is there a way to pull your contributions out of your Roth account without paying the 10% penalty? I know it’s not really advertised but I thought I heard that you could pull off the contributions since they were after tax.

If not, I guess my other option would be to set aside a brokerage account where I invest in a taxable way and sort of try and forecast how much I need to take me from 55 to 59 and a half when I could start withdrawing from the Roth accounts. I just wanted to get your take on that and what do you think about a million in today’s dollars at 55? Should be pretty good I’m planning on a mortgage paid off or close to paid off by that age. Thanks.”

[0:22:38] ST: Nice work on the investment savings, sounds like eyou’ve been stocking away some serious cash. Now the Roth IRA, yes, you can withdraw money before age 59 and a half without penalty in taxes but there’s some rules to do so. Let’s say you have a Roth IRA balance of $40,000 and $30,000 of the balance was your contributions. The remaining $10,000 came from your investments going up. You would be able to pull out $30,000 in contributions that you made tax free and penalty free.

Now, withdrawing your regular contributions is always tax free and always penalty free in a Roth if you’re under age 59 and a half or if you had the account for less than five years. It’s only the earnings that are taxable and subject to the 10% early withdrawal penalty before age 59 and a half. But what people run in to is they don’t know how much they’ve contributed over time. If you don’t track your contributions, you won’t know what amount is taxable and what amount isn’t. You can compound the problem by moving accounts around between different brokers, rolling over regular IRA’s to Roth IRA’s or just not keeping track.

Especially if you’ve been doing this for five, 10, 15, 20 years. The easy thing to do is just keep a spreadsheet recording how much you’ve contributed each year. And keep all your deposit receipts for when you do, make a contribution then when the time comes, you just add up the values and the spreadsheet and see how much you put in and how much your account has grown. There is no need to open up a separate investment account unless you’re going to need to pull out money to live on and those four and a half years until you hit age 59 and a half.

Now with some rough math, if you plan on living on 30,000 a year, you would need to have added a $135,000 in contributions to your Roth to be able to pull out that money without penalty. Now you asked, “Is a million dollars enough to retire on?” It depends. It depends on so many factors that there’s not a one size fits all answer. There are 30 year old couples who were aggressive in saving and have accumulated one million dollars in the 20’s and they’re now early retirees. Now they’re going to make it till age 65? 70, 80? I don’t know? I don’t know, but they’re trying it out.

General rule of thumb is, it gets tossed around is called 4% rule. If 4% rule states, you can safely withdraw 4% of your retirement money each year and have good odds of having enough money to last you 30 years in retirement. It’s a very, very basic calculation and it should only be used to start a conversation. I would never bet my retirement or yours or anyone else’s in such a simple equation.

Recent research is showing the 4% rule is not all that reliable. One study revealed, I got it in front of me, “Using historical interest rate average a retiree drawing down savings for a 30 year retirement using the 4% rule had only a 6% chance of running out. Using the interest rate level is from January 2013 when the research was published, the authors found their retiree savings would grow so slowly that the chance of failure rose to 57%” in that study.

It used to be, 4% was pretty reliable, nowadays, research has shown, not so much. In your case, if you have a million dollars, you could withdraw $40,000 each year to live on. The first question is, can you live on $40,000 a year given your current standard of living? For me, the answer is absolutely not because we have to pay $15,000 a year for health insurance and that’s a single expense, that is brutal, you have to consider health care in your equation, utility bills, car upkeep, food, clothing, property taxes, you get the idea.

Then you have to figure out what you’re going to do in retirement, travel, might get a new car someday, there are big ticket items that need to be factored in. At some point, you’ll need to replace your automobile unless you rely exclusively on public transportation. Next, how long do you plan on living? When doing a retirement projection, we need to consider the health and the longevity of our parents and grandparents. Plus, people are living longer. Do you expect to live to 80, 85, 90, an extra five years makes a huge difference. Are you going to work part time on your retirement?

Extra pocket money from some occasional work can extend your retirement savings. For many people, myself included, earlier retirement means working because you want to, not because you have to. Even if you work because you want to, you’re making an income. Also, you have to factor in the social insecurity benefits, how much are you going to have when you start collecting them? If you wait until age 70, you’ll collect more benefits, that’s another piece of the puzzle that’ll help preserve your nest egg a little bit.

Your best bet, sit down with a fee only certified financial planner, pay them for a few hours at a time, plug in all your numbers and give you a much more accurate assessment of your desire to retire early. It is well worth the investment. Take out the guesswork, see if these can run an analysis and come up with a probability of you running out of your money or money outlasting you.

Check out the Garret Planning Network, I’ll include the link in the show notes, you can search for a fee only, CFP’s in your area that charge by the hour. It’s worth the investment to consult with a financial adviser before making any big decisions about an IRA withdrawal. Thanks Dimitri for the question.

[0:28:25] ST: Okay, quick break, back in 30 seconds. I’ll be answering more of your questions, you’re listening to Scott Alan Turner.

[BREAK]

[0:28:31] ST: Hey Rock Star Nation, Scott Alan Turner here. Now folks, for those of you that are my long time listeners, you know I’m not one of those guys in the radio who promotes every product that shows up on their desk. You’ll never hear me trying to get you to buy Twinkies — delicious! Or recommending you buy Microsoft Windows — blue screen of death. No, I have a name to uphold to you, the Rock Star Nation.

If I were to recommend something to you, I would tell you about Himalayan cats. No other cat requires much brushing as a Himalayan. You can spend hours of peaceful time brushing your Himalayan cat. With all the extra fur you collect, you can stuff your own pillow saving you money from that expensive down pillow you’ve been considering. Win/win. If you can figure out how to spell Himalayan, type it in to Google, tell them Scott Alan Turner sent you.

[CONTINUED]

[0:29:27] ST: Welcome back Nation. Everything you think or do is an outcome set in motion. It’s going to affect your life. Listening here right now will have an outcome for you, the money you spend today will have an outcome. The money you save today will have an outcome. Not listening to me will also have an outcome for you. Not spending money today will also have an outcome. Not saving money today is going to have an outcome. You might think the effect is negligible or small and you might be right.

Buying a 99 cent pack of gum isn’t a big deal but it is a deal. It does have an effect on your life. The thousands of decisions will make each day and our job and our business, our relationships, eating habits, finances, they compound over time. They compound just like compound interest compounds. Eating half a dozen Krispy Kreme donuts today won’t kill you right? But eating half a dozen of Krispy Kreme donuts every day for the next 10 years probably might.

Now I love those donuts, you haven’t experience at Crispy Kreme donuts? You need to add that to your bucket list. I just said, it’s not a doughnut, it’s an experience but I digress. Everything you do or don’t do has a result, make sure at what you’re doing today is compounding the results you want tomorrow. Those are the words. Shout out to Eric F. in the Philippines for subscribing to the podcast, thank you Eric. Send me a screenshot of your iTunes or stitcher showing you as a subscriber to the show so I can personally thank you on the show. Get your name on here.

Next time on the show I’m going to give you some simple tips to improve your credit score as well as answer more of your questions, that’s it for this episode. I’m your host, Scott Alan Turner, rock star Katie is my producer. Special bumper music today provided by The Hyenas. Thanks guys for the audio tracks. Find out more about them and all the links mentioned in the show in the show notes on Scottalanturner.com. Today’s episode is powered by Ben and Jerry’s Ice Cream. Keeps my motor running. Thanks for listening.