Use 529 to pay off CC debt?

[clijohns]

Hi everybody,

Well, I never thought I would be in this situation but circumstances have led me to this board to seek some advice/ thoughts. I just found out from my wife that we are $67k in CC debt...she hid about $45k of that debt from me the last 3-4 years. I have analyzed our mess for the last 7 days and have been able to pay off $5k of it immediately. I have transferred 3 credit cards over to 0% cards for the next 18 months. So, I feel as if I have a plan to get it paid down...eventually.

My question is this: We have a 529 account for our 1st daughter who is 5 in the amount of $20,800. We made a initial deposit of $20k about 4 years ago (it's only made 4%). Do you think it would be a good idea to use some of the 529 (breaks my heart even thinking about it) to pay down this debt?

Thanks everybody for the help or advice.

[dczech09]

First of all, you appear to have more of a marriage issue than a financial issues. Hiding $45k in CC debt is pretty serious. Where did the other $22k of CC debt come from?

Your daughter's 529 plan only made 4% so far? Change the investments because that is pitiful! I manage my niece and nephews 529 plans and they are clobbering 4%. I have only had them for a couple of years too.

No I would not steal from your daughter to pay off CC debt. When you put that money into the 529 plan, you were essentially giving her a present. Besides, its not like she has enough in the 529 to wipe out the debt completely. Also, if you took out that money to pay off the credit card debt, you would have to pay taxes on the investment returns. You would still have well over $45k in CC debt afterwards.

The only way that I think using that money would be advisable is to avoid a bankruptcy (as you would be forced to liquidate anyway). But I am assuming that you are not looking at bankruptcy and that you can pay off this debt in due time.

Are you on a budget? I am gonna go off on a limb and assume no. If you had a really good budget going, you would not have this debt. You and your wife need to set up a plan, get on a budget, and work to pay off this debt. And marriage counseling too!

[clijohns]

dc,

Thanks for the response. I couldn't agree with you more regarding the "marriage" issue but I will save that one for another board. The other $22k that you mentioned is from debt that I was aware of...$6k does belong to me so I'm not completely innocent.

As far as the 529 only making 4% since inception...the market was not kind to this investment when I first opened the account (it dropped down to $15k during the economic collapse). So, it has bounced back compared to where it was 3 years ago.

I appreciate your candid response regarding whether or not I should use the 529 money to pay down debt.

As far as my budget goes...here are the details:

After monthly expenses (house, bills, kids, etc...), we have roughly $500 left over. I have $14k in an emergency fund.

Card #1: $8,310 Balance; 8.49%; min. payment: $135
Card #2: $18,492 Balance; 11.24%; min. payment: $334
Card #3: $16,917 Balance, 12.99%; min. payment: $321
Card #4: $4,556 Balance; 9.99%; min. payment: $68
Card #5: $6,220 Balance; 0% (not sure how long); min payment: $110
Card #6: $8093 Balance, 14.24%; min payment: min. payment: $169
Card #7: $1200 Balance; 0% (until July '13); min. payment: $50

We have applied for (3) different 0% Balance Transfer Cards this week and were approved for all of them. I have the ability($20k credit limit) to transfer one of the larger balances into one of the 0% cards.

Thoughts?

Thanks again for the response.

[dczech09]

You have a $14k emergency fund, which is great! So you have that going.

With $500 per month left over after each month, its gonna be pretty tough to get the needle moving on this debt. Do you have any expenses that can be cut so you have more money to throw at the debt? Do you have any other debt to worry about like a car loan or mortgage?

You definitely want to get some your CC debt into 0% to avoid interest. Especially those higher rate ones. Going after the 0% balance transfers is very smart too!

Ultimately you have one of two options for paying off the CC debt: high balance or high rate. Since this is credit card that we are talking about, you're probably going to want to go after high rate first.

I would do this...

Card #6: $8093 Balance, 14.24%; min payment: $169 ---> into the zero 0% card
Card #3: $16,917 Balance, 12.99%; min. payment: $321 ---> $11,907 into the zero 0% card, that leaves $5,010 to pay off

So now it looks like this:

Card #7: $1200 Balance; 0% (until July '13); min. payment: $50
Card #3: $5,010 Balance, 12.99%; min payment: about $70 or so
Card #2: $18,492 Balance; 11.24%; min. payment: $334
Card #4: $4,556 Balance; 9.99%; min. payment: $68
Card #1: $8,310 Balance; 8.49%; min. payment: $135
Card #5: $6,220 Balance; 0% (not sure how long); min payment: $110
New Card: $20,000 Balance; 0% (untile whenever); min payment: about $800 or so

Pay the minimums on time for all of the cards. Then with whatever money you have left over after taking care of the household stuff, pay off the debts in this order listed.

Kill that $1,200 card as quick as possible. It may be at 0%, but you knock out a card and free-up $50 per month. After that, go after the high interest rates first. This will optimize your pay-off strategy.

If you can, sell some stuff, lower household expenses, or work more hours.

I hope this helps.

[disneysteve]

Are you on a budget?

As far as my budget goes...here are the details:

After monthly expenses (house, bills, kids, etc...), we have roughly $500 left over.

That isn't details. That's a broad overview. Other than the credit cards, post your actual budget. Where is every dollar going each month (and how much do you earn)?

You also haven't mentioned where that 67K went. What was that money spent on? How much of it was spent on tangible items that could be sold, or maybe even returned, to raise cash to repay the debt?

It is great that you have a 14K emergency fund. Now you have an emergency. We need to see your income and budget numbers to give exact advice but just with what you've given so far, I'd say to write a check and pay off card #6 tomorrow at the very least. That still leaves a 6K EF which is probably fine for a while.

[clijohns]

dc,

Thanks for the help! I agree that I need to go ahead get the $1200 card out of the way. I may pull from the EF to go ahead pay this off. We do have a mortgage but we do not have any car loans.

Steve,

I appreciate the help. Majority of the credit card debt was spent on "stuff"...no particular reason to any of the charges. It was mainly a result of her inability to manage the check-book properly and me not being involved in the day-to-day finances (BIG mistake...I know). This went on for years. I agree with you on the EF and that we now have an emergency. However, I wouldn't feel comfortable using all of our EF to pay down debt b/c we have the ability to make minimums and pay extra on some cards. However, I would be okay with using some of it, if necessary. I have included my budget below:

Income Monthly (minimum): $8000 (includes $167 reimbursement from Verizon) I also get bonuses sometimes each month that range from $100 to $600 after taxes depending on how well we do.

Day-Care $1,105
ADT $33
U-verse $220
Gym $60
Verizon $181.85 (We are reimbursed for $167 of this through wife's work..she works from home)
Gas $45
Car Insurance $68
Trash $25
Water $75
Mortgage $2,700
Georgia Power $260
Gymnastics $70
Chubb $30
Groceries $340
Credit cards $1,306
Dog Food $90
Gas (Cars) $250
Savings $200 ($50 per week)
Kid's School lunch $20
Run Around $125ea $250
Housekeepers $130

Total Expenses: $7,459

This budget is fairly new for us (as you can tell with our situation). I added the "Run Around" expense of $125 each per month. I know this may be counter-intuitive but we have kids and this will give us the ability to use that for them if we are out (ex..Apple Picking, Pumpkins, etc...). I don't want them to be penalized for this mess. Sorry.

I really appreciate your willingness to help and I've already started putting some of the suggestions into play that you guys have given.

[bjl584]

To your initial question, should you use the 529 to pay off the CC debt? I would say yes. College is the last thing that you should be saving for. Is there a penalty for withdrawing a 529 early? That may be the only thing that would change my mind. But, everything that I have read and/or heard from financial experts is to take care of your own finances first, then worry about college costs for the kids. That can always be taken care of by loans, scholarships, military service, pay as you go by working, or a combination of all of those things.

I would also use part of the EF to pay down some of the CC debt immediately.

Looking at your budget, there are tons of areas that can be trimmed. Housekeeping for instance can go.

[disneysteve]

At this point, I would not raid the 529.
There is a fair amount of fat in your budget, plenty of room to cut spending. I would do that first.

67K is a heck of a lot of "stuff". There must be something amongst all of that stuff that could be sold - take clothing to consignment stores, have a yard sale, put stuff on craigslist and/or ebay, books on half.com, etc. Recoup as much of that money as you can by getting rid of all of the stuff you didn't need to buy in the first place. Even at 20 cents on the dollar, that could bring in 12K or so.

It's a bit ironic that you say you don't want to penalize the kids but at the same time, you want to wipe out their college savings. Twenty years from now, do you think they'd be more upset by not having gone apple-picking or by not having been able to afford college?

One problem that jumps out from your budget is that your mortgage is too high for your income. You are at 33.75%. Rule of thumb is not to exceed 28% which would be $2,240, almost $500 less than what you are actually paying. Not much you can easily do about that one, though, unless you are in a position to refinance (or willing to move).

Overall, you have a great income. Get the spending under control and attack that debt. Will the kids be deprived? Maybe temporarily, but the end result will have been worth it. Go to a bare bones budget for a year or two and you can probably pay off the bulk of this debt.

[jpg7n16]

Is there a penalty for withdrawing a 529 early? That may be the only thing that would change my mind.

Think of non-college 529 withdrawals kinda like Roth early distributions. You are taxed and 10% penalty on earnings only.

The only difference is, Roth withdrawals come out contributions 1st. 529 withdrawals come out proportionately.

To your initial question, should you use the 529 to pay off the CC debt? I would say yes. College is the last thing that you should be saving for.

I would say this depends more on how close you are to college, and how much earnings are included in the balance.

Given that per the OP, school is 13-17 years away, and earnings are only $800, I would cash it out as well. The roughly $300 tax is nothing compared to the interest you will save long term. (At those rates you'll save $2k+ in interest the 1st year alone) And as the CC debt is charging more than you can expect to make, you'd be better off financially paying it off.

The mistakes that cost you the college fund have already been made. Now it's just a matter of doing what's best for the family as a whole.

Maybe the emotional hit of cashing out your daughter's college savings will help you guys avoid debt going forward. And hopefully discourage any hidden debts going forward too.



Steps I would take:
- Cash it out and pay off CC debt starting with the highest interest rate 1st.
- Transfer remaining balances to a 0% interest offer
- Work with these guys to get your budget sorted out

I mean, how would you feel if you cashed out her college savings, and then built back up the debt again? What effect would that have on your ability to send her to college?

[clijohns]

Thanks for the response everybody. You guys have given a lot of great advice. I agree on multiple fronts with regards trimming some of the fat from our budget, using some of the savings account, etc...

JPG- I appreciate the insight on the 529 plan. Could you explain to me what you mean by the withdrawal being taxed proportionately? The 529 plan becomes more of a moral issue for me the more I think about it and I just want to do the right thing for my family.

Thanks again!

[kv968]

I noticed you have $200/month going towards savings. Is that for retirement, the EF or just plain savings?

Also, what does your retirement account look like? Is there one? Are you still funding it?

[jpg7n16]

JPG- I appreciate the insight on the 529 plan. Could you explain to me what you mean by the withdrawal being taxed proportionately?

Sure.

Say your 529 plan was a Roth IRA. If you withdrew only half the balance ($10,400) - having put in $20k, your entire w/d would be tax free. Roth comes out of contributions 1st, then earnings.

But a 529 is proportionate. If you withdrew half the balance, it would not be tax free. You would evaluate that the total balance is $20,800, and you put in $20k, so you have gains of $800. If you withdrew 1/2, you would be considered as withdrawing $10k principal and $400 of gains. (note on the Roth, it would be $10,400 all principal).

For easier math, think if you had a $10k balance which had $2k earnings and $8k contributions. Earnings are 20% of the balance, therefore any withdraw will be 20% earnings.

See for specifics:

Publication 970 (2011), Tax Benefits for Education

The 529 plan becomes more of a moral issue for me the more I think about it and I just want to do the right thing for my family.

How is this a moral decision? You are dealing with how to put your family in the best financial position - I agree.

However I do not see how it could be considered "immoral" to withdraw a college savings account. It is an account you have for savings.

What moral issue are you struggling with here?


If you could go back in time to before you made the 529 contribution, and you knew then about the amount of debt that was out there, would you still put $20k into college savings? Or use it to improve your household financial position?

[dczech09]

If you could go back in time to before you made the 529 contribution, and you knew then about the amount of debt that was out there, would you still put $20k into college savings? Or use it to improve your household financial position?

Excellent point jpg. However my argument is that when money is put over to the 529, it should be done so as a gift and should not be taken unless for emergencies.

Just like when I contribute to my Roth IRA, I consider that money "untouchable" unless I need to avoid something like the mob coming after me.

Same thing with 529 plan money- "untouchable" unless there is a dire situation and the money is absolutely needed.

For the OP, I do not think it is dire. They are addressing the situation BEFORE it has become an emergency, so there is time to remedy the situation in other ways.

So in this situation, I would view the 529 plan money as being a gift for the daughter and it being a bad idea to raid that money.

Again, if it were absolutely necessary, then I would do it. But its not absolutely necessary right now.

[jpg7n16]

Excellent point jpg. However my argument is that when money is put over to the 529, it should be done so as a gift and should not be taken unless for emergencies.

Just like when I contribute to my Roth IRA, I consider that money "untouchable" unless I need to avoid something like the mob coming after me.

Same thing with 529 plan money- "untouchable" unless there is a dire situation and the money is absolutely needed.

I understand where you're coming from, but have a much different view of the purpose of a 529 plan.

Retirement savings is a necessity. College savings for your children is a luxury.


I do not feel that people with $60k in CC debt are in any sort of financial position to gift away $20k. Even to their own children.


So although I understand the principle of the $20k was a gift to their daughter, when you learn more about the overall picture, the best thing they can give their daughter is a secure future for the family.


I paid my own way through college and turned out fine (for the most part ). And if you could go back to when I was little, my parents had CC debt. Give my parents $20k extra and ask me whether I would prefer they give me the money for my college, or use that money to get out of debt and closer on track to retirement -- and I'd pick telling them to pay off the debt in a heartbeat.

Don't forget that kids worry about their parents, and it stresses us out too when our parents are struggling financially.

So if OP were my dad, and I was their 5 year old kid, I would ask him to please use that $20k to pay off the debt and also ask him to get on track for retirement before worrying about my college expenses.

Hence my advice.


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Also, if OP stated that the $20k was a gift to his 5 year old daughter so that she could tour Europe when she graduates high school, would that change your mind? It's still a gift. Or does it influence your decision that the purpose is college?

So are you truly against using the $20k because it was a gift? Or what is the real reason?

[dczech09]

Perhaps "gift" was not my real objection. It has more to do with it being for college. I'm just of the school of thought that when you put money into a shelter like that, you should almost forget that it is there until you need for the end goal, or to avoid an emergency.

But I do see your point.

Just like a lot of financial situations, there is really no one "right" answer. A lot has to do with perception.