Debt riddled client

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Aug 8, 2007 9:12 am

I'm working with a prospect who is different from many clients. She is younger - in her mid 40's - a three time divorcee and in debt. She has at least 20K in debt and possibly another big expense on the horizon that may or maynot go away. She is recieving about 30K from her ex husbands 401K. She is concerned about socking away money for retirement but I'm convinced she needs to eliminate as much of the high interest debt as possible with the money she's recieving. I told her about the penalty as well as how she will want to withhold taxes now instead of paying later. I know in general it is a bad idea to take money out of non-taxable accounts, but in this case, this seems like the best way to go.


She also mentioned that eliminating this debt will allow her to defer up to $500 a month in savings for her employer sponsored plan.


She has zero home equity, no other savings - this is it. Not your ideal client by any means but since she is a friend of a friend and possibly a nice referall base, I decided to help.


Any ideas besides what I'm recommending? Is using this money from her ex's 401K to eliminate her debt the way to go?

Aug 8, 2007 9:33 am
Aug 8, 2007 9:40 am

I would advise her to get a new husband.

Aug 8, 2007 9:40 am

Your plan may free up $500/ month to save/invest, but only for a little while.  Soon it will be used to service new debt.   Keep her money invested and help her build a pay-off plan. 

Aug 8, 2007 9:43 am

Let me see if I have this right.  A seasoned "financial advisor" is suggesting that not paying down on high cost credit card debt--even by accepting a one time tax penalty--is the way to go?


How much is the penalty for a premature withdrawal from the IRA?


Answer, 10%.


So on $3,000 she's going to suffer a $3,000 penalty.  How long does it take for $30,000 in credit card debt to generate $3,000 in interest, over-limit fees and so forth?


Having to declare the withdrawal in the current year is a moot point because it's a trade off with any $30,000 in generated income.  Actually she'll be better off taking the $30,000 from the IRA than from a second job because she won't have to pay FICA, etc. on the IRA withdrawal.


It is NEVER good advice to stay with an IRA instead of paying off crushing credit card debt.

Aug 8, 2007 9:44 am
companyman:

Your plan may free up $500/ month to save/invest, but only for a little while.  Soon it will be used to service new debt.   Keep her money invested and help her build a pay-off plan. 



Another embarassment.


Pay off her debt and help her build an investment plan to replace the money used to get out of debt. 

Aug 8, 2007 9:51 am

As a Dutch Uncle I'd advise against.


Thrice divorced, and a bailout scheme for consumer debt... This woman needs to feel the pain of paying. Evaporate debt with some future monies and the money will stay gone while the debt will magically reappear. Just like the next husband seems to...


What you suggest is the less expensive course of action, but it's probably not the wiser in the long run.


The other side being that 30grand with 20 years to go equals a 5T retirment party (she'll retire when There's a Tag Tied To her Toe).


Speaking like a Dutch Uncle is often the very best you can do for a client. Granted, she's not going to like it, but look at it this way, if you are managing the 30K (whoopie!) then maybe she'll have something good to tell those referalees that you're hoping she'll send your way. She's not going to credit you for draining her only association with wealth to pay down credit that then reappears.

Aug 8, 2007 9:59 am

This is why financial planning is not math.  Mathematically speaking, assuming that this is high interest debt, she is best off using the retirement money and paying the debt.


Whomit is absolutely correct.  If she doesn't feel the pain of paying the debt, it will reappear.


Before anything else is done, the first thing is that she needs to do is to negotiate with the credit card companies.   If her credit is good, she can find someone to give her money at a much lower rate.  If her credit is completely shot and she's way late on payments, she can probably negotiate a reduced payment. 

Aug 8, 2007 10:16 am

Pay off the debt.

Aug 8, 2007 10:19 am
anonymous:

This is why financial planning is not math.  Mathematically speaking, assuming that this is high interest debt, she is best off using the retirement money and paying the debt.


Whomit is absolutely correct.  If she doesn't feel the pain of paying the debt, it will reappear.


Before anything else is done, the first thing is that she needs to do is to negotiate with the credit card companies.   If her credit is good, she can find someone to give her money at a much lower rate.  If her credit is completely shot and she's way late on payments, she can probably negotiate a reduced payment. 



The stupidity is awesome.


The lady withdraws from the IRA, does away with the debt and starts an investment that debits her checking account for an amount equal to, or greater, than her credit card payments would have been.


"Financial advisors" are not psychologists--you have no insight into what makes this woman tick and assuming that she will replace paid off debt with new debt indicates that that is what you would do.


Are you all such whores that you cannot accept that investments come AFTER elimination of debt--especially high interest debt--and AFTER proper life insurance and AFTER owning a home and AFTER establishing a year's worth of living expenses in an insured bank account?

Aug 8, 2007 10:25 am

[quote=Devil'sAdvocate

The stupidity is awesome.


The lady withdraws from the IRA, does away with the debt and starts an investment that debits her checking account for an amount equal to, or greater, than her credit card payments would have been.


"Financial advisors" are not psychologists--you have no insight into what makes this woman tick and assuming that she will replace paid off debt with new debt indicates that that is what you would do.


Are you all such whores that you cannot accept that investments come AFTER elimination of debt--especially high interest debt--and AFTER proper life insurance and AFTER owning a home and AFTER establishing a year's worth of living expenses in an insured bank account?[/quote]


I think your "awesome advice" has already been posted by others...............

Aug 8, 2007 10:36 am

Wow, got a couple of Suzie O's in the crowd, huh?   Do you also suggest investments before learning about a prospect's risk tolerance, goals, and expectations?


Get off your high horse and think about it for a minute.  The fact that she has the debt MIGHT suggest that she doesn't approach money with the same discipline that you do.  So although mathematically it makes more sense to take the hit and pay off the debt all at once, is it POSSIBLE, that just MAYBE when you take into consideration that this individual has never bothered to save anything and has run up debt that it MIGHT be beneficial to leave what little nestegg she has alone and help her build a plan to eliminate the debt?  Is it POSSIBLE that this would help to teach her the value/cost of borrowed money? 


Just a thought to consider if you can take a break from your superiority complex to consider that money isn't just math, it's also emotion?

Aug 8, 2007 10:37 am

Putsy,


You are not a psychologist.  You have no insight into what makes this woman tick.  Why would you assume that this debt would not be replaced with new debt?


No decision on the best course of action can be made until after she attempts to negotiate with the credit card company.


New investments should certainly come after the elimination of high interest debt.   Whether investments should be liquidated really depends on the individual and whether the paying of the debt will cause her to accumulate new debt.


New investments should certainly come after proper insurance (all types) and savings.  Whether they should come before or after owning a house really depends on the individual.


Aug 8, 2007 10:45 am
anonymous:

Whether they should come before or after owning a house really depends on the individual.



It would be fun to hear your argument in favor of not owning a home.

Aug 8, 2007 10:48 am
Devil'sAdvocate:
anonymous:

Whether they should come before or after owning a house really depends on the individual.



It would be fun to hear your argument in favor of not owning a home.



RK, why don't you have the guts to respond to the thread about you?

Aug 8, 2007 11:01 am
Devil'sAdvocate:

Are you all such whores that you cannot accept that investments come AFTER elimination of debt--especially high interest debt--and AFTER proper life insurance and AFTER owning a home and AFTER establishing a year's worth of living expenses in an insured bank account?



And then there's Walgreen's...


Face a fact DA, for the vast vast vast majority of Americans Investments come before all of those other things and have done so for quite some time.


Are you saying that people with debt should not make any contributions into their 401ks until their mortgage is paid off? A mortgage is debt in some cases high interest debt.


Do you really think that all the people who contribute to their 401k at your company are without credit card debt? (Wouldn't be a bad plan, btw for there to be a "Pretax debt reduction" program to be offered by one of the candidates. As a way to bail out the poor financial services industry and the sub prime lenders who agree to pay the tax to the gov't, resulting in a lowered rate of earnings to the lender, but they stay in business and the homeowner stays in the house.... Hey, I'm gonna fire this e-mail off to Hilary!)


Are you further saying that home ownership (as opposed to rent) is an absolute? So nobody should invest if they live in NYC and rent an apartment? Huh? what do you know? That'll put a crimp in the liquidity in some markets! It would loosen up some of those rent controlled apartments though, you know, the ones that cost less than what the ownership of a $150,000 home in the country would.


And then there is that nagging question of the one year's expenses... What if that same client has two years of expenses in their 401K in gics or the like? Does that count? Why not?


What if they have three years of expenses in equity in their home and an open home equity line at prime? Do they still need to have the cash at the bank?


In the real world we recognize what is and we separate it from what ought to be. Present the woman with the pros and cons of both sides and let her decide (as if we have any ability to do otherwise, when ChrisHansen goes to the client with his advice, the lady'll either accept it or go to a different advisor until she gets the advice she wanted in the first place). In a Walgreen's world it would be better for her to pay off the debt and then "go forth and sin no more" but in the real world she should kep the cash someplace where nobody can come after it (in an IRA) just in case the rest of her world goes to hell in a handbasket.


Why would you take her "year's worth of expenses" and blow it all on the paying down of old debt?

Aug 8, 2007 11:10 am
Aug 8, 2007 11:15 am
Devil'sAdvocate:
anonymous:

Whether they should come before or after owning a house really depends on the individual.



It would be fun to hear your argument in favor of not owning a home.



Uhhh how about they're military and they move every two years? Owning a home would be a terrible risk for the family given the vagrities of markets and the 6% sucking sound everytime they did a transaction (12% every two years for the sell/buy). Not to mention that they'd constantly be paying interest only on the mortgage.


Then there is the economics of metropolitan living versus individual home ownership. To own in a desirable location requires a massive outlay of cash. Cash that could be invested elsewhere earning returns that help pay the rent, therefore leaving monies for growth investments.


Are you now going to tell me that Real Estate has outperformed the s&p500 over the years? I could swear I saw somewhere else that you were arguing against the cost of fees on investments. What do you think taxes are? How about lawn care? Utilities? Up keep? etc etc etc?

Aug 8, 2007 11:23 am
Whomitmayconcer:

Uhhh how about they're military and they move every two years? Owning a home would be a terrible risk for the family given the vagrities of markets and the 6% sucking sound everytime they did a transaction (12% every two years for the sell/buy). Not to mention that they'd constantly be paying interest only on the mortgage.


Then there is the economics of metropolitan living versus individual home ownership. To own in a desirable location requires a massive outlay of cash. Cash that could be invested elsewhere earning returns that help pay the rent, therefore leaving monies for growth investments.


Are you now going to tell me that Real Estate has outperformed the s&p500 over the years? I could swear I saw somewhere else that you were arguing against the cost of fees on investments. What do you think taxes are? How about lawn care? Utilities? Up keep? etc etc etc?



How many investors are in the military?


I think you'll find that among the officer corps--the most likely investors--many will buy homes at their new assignment.  I understand the risk of having to sell if you're transferred in a down cycle but they're warriiors, risk takers, and many of them will take the risk.


Where do you come up with the idea that the buyer pays a commission on a real estate transaction?



If you're using your mutual fund income to help pay the rent, how much growth are you getting?


Isn't "massive" relative?  Are you of the opinion that homeownership is beyond the reach of the "average guy" because of the downpayment?



Do you really believe that a renter does not pay to maintain their rental unit?

Aug 8, 2007 11:42 am

It would be fun to hear your argument in favor of not owning a home.


Client's townhouse is too small.  They aren't sure where they want to move.  They sell their townhouse for a handsome profit.  They happen to find a large house that is on the market for $600,000.  Owner agrees to rent instead of sell and is only charging $1,500/month. 


I don't know about you, but if I liked a $600,000 house and I could get it for $1500/month, I'd rent over buying it any day of the week.  Add in that they'll be moving within 2 years and prices are falling, renting is a complete no brainer.