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This past week I received a couple of phone calls from clients who were facing some desicions. One of the clients had noticed his cash flow was getting tight and asked if I had any suggestions. The obvious answer is to cut expenses and/or increase income. However, there are many other alternatives that may help. In this post I'd like to share this experience with you.
This client has been paying extra principal on his house and was considering reducing it. He was also thinking about cutting back on his 401(k) contributions. I didn't like either of these choices. Here's what I did instead.
We had completed our annual financial plan update back in March. I asked for an updated budget, a copy of his check stub, a copy of his 2011 income tax return (1040 and schedule A), and an update on all his current debts (balance, interest rate, amount of payments, etc.). I first calculated the client’s projected annual shortfall by comparing his updated budget to the budget from March. This is the shortfall we needed to cover.
I noticed the client had received a federal tax refund for last year. I suggested he first adjust his W-4 to withhold less tax so as to get his tax refund as close to zero as possible. Then I recommended he roll all of his non-mortgage debt into a home equity line of credit (HELOC) at prime plus 0.50%, or 3.75%. Both of these actions totaled about $800 more than the shortfall the client needed to cover. But in January, his 401(k) contribution is scheduled to increase by 1.0%, or about that same $800. Therefore, after all steps, the shortfall would be zero.
However, the 401(k) contribution is pre-tax so the after-tax effect will be less. Moreover, the interest on the HELOC would be tax deductible whereas the current interest is not. This would provide additional tax savings. They were glad they asked.
As it happens, I had been contacted by a prospective client a few days prior. I then asked the aforementioned client if I could give his name and phone number to the prospective client as a reference and he wholeheartedly agreed.
I have another story with a different client to share, but we'll have to discuss that later.
Thanks for reading and have a great week!