How to Increase Savings and Cash Flow at the same Time
RN age 39
Student Loan: $0
Savings balance: $8,500
401(k) balance: 427,000—15% contribution with 6% match
Credit Card debt: $31,500 @ an average of 16% interest—monthly payment $1,500
Client came in with the objective of getting financially organized and getting a better understanding of how she is doing financially. Her main concern was to be able to have enough for retirement and still can live the same lifestyle that she is enjoying today.
Plan that was implemented
Initial assessment of the situation was taken and a discussion around ways to better manage debt was held. The current savings rate of 15% that is being saved is very healthy and with the 6% matching that the company is providing the annual savings rate if quite good and on top of that the 401(k) balance of $427,000 is also very health based on the age of the RN.
Free cash flow of $1100 a month was created
The main thing that is dragging down on even becoming a better saver and getting rid of the unnecessary inefficiencies is the large credit card balance. The balance had happened to trips and unexpected short term expenses. A discussion around how to avoid that in the future was initiated and an agreement was made to create a larger short term emergency/savings account. This could be accomplished by lowering the 401k contribution from 15% to 10% or even to 6% (to still get the match) and use the additional cash flow savings to put towards short term liquidity.
Ultimately a slightly different route was taken with this RN as a 401 (k) loan of $31,500 was initiated and used to pay off all the credit card bills. The loan would create an instant pay back schedule to the 401k but no tax penalty would be assessed and the 16% interest rate on the credit cards would get swapped with a lower 4% on the 401k loan. The new pay back loan payment would be about $400 a month which would create an additional free cash flow of $1100 a month that now could be redirected towards short term savings and to other investments later.
Even though 401(K) loans are not recommended to use freely the loan helped this individual free up cash flow, reduce the interest rate cost and build short term savings that will help minimize the risk of future credit card debt. It also kept the 401k contributions in place.
The process of understanding the long-term effect of your financial decisions are important and by having 16% interest credit cards with outstanding balances creates a financial drag that is difficult to outrun unless some drastic measures are taken. In this case that drastic decision was a 401k loan.
A personal loan could have been an option but due to the credit score that was not feasible.
All scenarios and names mentioned herein are purely fictional and have been created solely for training purposes. Any resemblance to existing situations, persons or fictional characters is coincidental. The information presented should not be used as the basis for any specific investment advice.