To cope with a lower income, short-term savings take priority

By Michelle Singletary
Washington Post Staff Writer
Wednesday, November 3, 2010; 8:27 PM

In an economy that is still as rocky as the Grand Canyon, many people remain perplexed about what they should do if they find themselves without a job or on the verge of losing one soon.

While politicians argue over the best way to fix the economy, their constituents are desperately trying to deal with the reality of lower incomes. Personal incomes decreased 0.1 percent in September, a decline largely due to a drop in unemployment insurance benefits.

"This administration recognizes that high unemployment remains an impediment to stronger growth in personal income, and we remain committed to doing all we can to ensure that more Americans can find good-paying jobs that provide a sense of security and hope for the future," said Rebecca Blank, the Commerce Department's undersecretary for economic affairs.

Got that? Are you reassured?

Well, until people feel safer about their jobs, many have two basic questions: Should they still invest? Should they aggressively pay down debt or save the money?

During a recent online discussion, here's what one reader asked on behalf of her married 32-year-old sister who is about to either lose her job in 10 months or be reduced to a part-time position. The sister's husband, who is 28, has a job that's not in immediate danger, but he is in a field that has suffered layoffs. They have some savings ($20,000 in retirement funds) and some debt.

She asked: "Right now, they make substantial savings contributions each month, some to 401(k) and some to a credit union account. They also pay extra on the debt each month. They're doing the obvious things to prepare for possible unemployment - paring their budget to increase savings, looking for more secure jobs, etc. Should they reduce the 401(k) contributions (neither gets a match) to increase available savings should the worst happen? Similarly, should they drop their debt payments to the minimum?"

The concerned sister is worried that a one- or two-year pause in the couple's savings could set them back considerably in accumulating what's needed for their retirement.

Another reader, asking on behalf of a friend, had a similar question. In this case, a friend is getting married. The woman's parents are paying for the wedding. The groom-to-be is unemployed.

This reader wanted to know: "It's expected that most people will give her cash as gifts. I suggested using the funds to pay down her debt, about $4,000 in credit card debt and $12,000 in student loans, but she wants to use it as starting-off money to help pay for expenses. I don't think this is the best idea, so I was planning on giving her a savings bond that she wouldn't be able to cash for a year, thinking she might be singing a different tune then. Where and what type of bond should I get?"

I want to address the latter situation first.

I know this person means well, but she's wrong in trying to manipulate how her friend spends her wedding-gift money. Forget the bond, because the soon-to-be bride is right to want to take care of the necessary expenses first rather than attacking the debt. I would suggest that the couple make the minimum payments on the credit card debt and the student loans until they are in a better financial position. I know this goes against what I typically tell people to do, which is to aggressively pay down debt. But that advice is best when one's household income is enough to cover all the necessary expenses.

I do have one caveat. If the household expenses can be managed on one salary, then using the wedding-gift money to get rid of the debt would help with the couple's monthly budget and take some stress off them.

As for the first couple, who are facing a possible layoff or reduction in income, the advice is much the same.

The couple should reduce or even temporarily stop the 401(k) contributions to boost their short-term savings. If they tie up their money in a 401(k), and then they find they need that money, they'll pay a 10 percent penalty on top of taxes to pull it out. They should also continue to make the minimum payments on their debt. When you're unemployed or underemployed, you need to hoard cash to pay for the essentials - food, housing, utilities and transportation costs.

I know it's been drummed in our heads that investing is paramount. And it is. But when money is tight, you have to hold on to your cash.

Readers can write to Michelle Singletary c/o The Washington Post, 1150 15th St., N.W., Washington, D.C. 20071. Her e-mail address is Comments and questions are welcome, but due to the volume of mail, personal responses may not be possible.

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