Kara McGuire: Money matters on your mind

Special to the Star Tribune
September 29, 2005

I'm usually the one asking questions. But not today. Here are questions from 20-somethings that deal with the ever-so-popular topics of debt and housing. If you have a question, send it to kara@startribune.com.
Roll it over

Hillary Drake is like many 24-year-olds. Having been out of school and in entry-level jobs for a couple of years, she's not sure what's next. She recently left an administrative assistant position and hopes to start a part-time MBA program in the fall. Her question: What to do with the $4,000 in her 401(k) with her former employer? It's just shy of the amount she'd need for the company to keep the money for her. Where can she transfer this money for retirement that won't mean paying taxes or penalties?

First of all, kudos for not taking the $4,000 and buying a plasma TV, said certified financial planner Nate Wenner. Forty-five percent of Americans cash out of 401(k)s with former employers, according to HR consulting firm Hewitt Associates. That said, being "forced out" of a retirement plan if you have less than $5,000 is not a bad thing if the expenses are high or the fund options stink. (Note that come 2006, the law changes, so companies must give you the option to stay as long as you have $1,000.)

Wenner recommends opening a rollover IRA through a mutual fund company known for low expenses (TIAA-CREF, Vanguard, Fidelity and T. Rowe Price come to mind). Make sure to ask whether there are any maintenance fees, because those small sums add up quickly and take a bite out of returns.

The safest way to transfer the money is to do what's called a direct rollover. That's when your old retirement plan sends a check to the new account instead of sending a check to you. That way, you can be sure not to trigger any IRS red flags. And it will save you the price of your time and a stamp.

Drat that debt

Elizabeth lives in St. Paul. She loves her job in public relations and says she makes a pretty good salary. But she can't seem to make a dent in her $5,000 worth of credit card debt and her $3,000 student loan. The idea of never getting out of the red is causing bloodshot eyes from lack of sleep. Is her debt load higher than the average 24-year-old's?

Eighteen- to 24-year-olds have an average $2,985 in credit card debt, according to last year's Demos USA study, "Generation Broke." The average plastic debt for 25- to 34-year-olds is $4,088. So, yes, Elizabeth's credit card debt is higher than the average.

As for student loans, Minnesota's class of 2004 owed an average of $20,300, according to the National Postsecondary Student Aid Study, so she's nearing the student-debt finish line compared with many other 20-somethings.

But instead of letting statistics give her consolation or a kick in the pants, Elizabeth needs to think about how the debt is affecting her life. Next time she's up at 2 a.m., she should take the opportunity to figure out where her pretty good salary goes and whether there's any way she can increase her credit card payments.

Other options to consider: Shopping for a card with a lower interest rate and transferring the balance (read all the fine print again and again), and slowing down her student-loan payments (because presumably the interest rate on her student loan is lower than what Visa or Mastercard charges).

A cure for renting?

Latoyia of Minneapolis is sick of renting. The 25-year-old would like to take money from her 401(k) to use as a down payment and wants to know whether borrowing from a retirement account ever makes sense.

No one likes to focus on the glass half-empty, but if Latoyia borrows from her retirement plan and switches jobs or is laid off, she'd have to pay the entire amount back or be slapped with a 10 percent penalty plus income tax on the dough-turned-down payment. That unexpected financial blow on top of a new mortgage and home maintenance responsibilities could turn Latoyia's dream of home ownership into a monetary nightmare.

Echo Huang, a financial adviser with LPL Financial Services, never recommends borrowing from a 401(k). Not only is there the risk of having to pay the money back right away, but there's also the financial loss.

When you borrow from your 401(k), you pay back the loan with after-tax money. Huang crunched these numbers: If Latoyia borrows $15,000 of pre-tax money and pays about 32 percent in taxes (assuming a 25 percent federal tax bracket plus state tax), she'll need to come up with roughly $25,000 to pay back the loan.

Not to mention that borrowing money from your retirement plan means there's less money growing for your golden years. Chances are you'd be in no position to pay back the loan quickly. "The time you missed in the market is very valuable," reminded Huang.

Some might argue that the time you miss in the housing market is very valuable too, but buying a home should not be just about the money. You have to be ready for the responsibility, and that means having the discipline to save. Examining your budget for leaks and reducing retirement plan contributions (being sure to keep any company match) for quick saving are better strategies than borrowing the down payment from your 401(k).

Student loan hangover

Nancy is a Georgetown law student who found my column on the Web. She'll have $120,000 in loans when she's through and would like to know how having that much student-loan debt will affect her ability to borrow for a home. It's the only debt she has, her credit's super and she expects to net a fat paycheck when she graduates.

Kristin Wilson, senior loan officer at Summit Mortgage, said the short answer is that it can affect her. But that doesn't help anyone, does it? So Wilson made some assumptions, using her experience with a well-paid lawyer client who has just about as much student debt. His payment is $700 per month.

Say that Nancy's is the same, and that she makes $110,000 a year. That means she could buy a $250,000 home and still have her housing debt take up only 21 percent of her gross income, well within the benchmark of spending no more than 30 percent on housing costs.

The way Wilson looks at it, "the student loan is like a loan for the Beamer she doesn't have." So Nancy, if you end up moving to wintry Minnesota, take good care of your current car.

Trying to figure out whether you can afford to stay home with your tot? If so, email kara@startribune.com.