Adjusting Finances in a Pandemic

When confronting the complexities in life, just as in mathematics; always remember to break the problem down to the simplest terms then solve.

When the pandemic initially hit, we were in the midst of focusing our energy on servicing and paying off our remaining student loan debts and mortgage on our primary home. At the time we had put our student loan payments on 5 year payment cycles with relatively low interest rates. Our debt service structure was as follows:

Pre-Pandemic Major Fixed Costs:

• Mortgage: $1,150 (Interest Rate 3.125% 15 yrs)
• Student Loan 1: $550 (Interest Rate: 3.75% 5 yrs)
• Student Loan 2: $698 (Interest Rate: 3.75% 5 yrs)
• Student Loan 3: $278 (Interest Rate: 3.75% 5 yrs) 

Total Major Fixed Costs: $2,676

As the pandemic roared on, we anticipated that many the world governments would have to react to the economic disruption by allowing for loan servicing restructuring, lowering of interest rates, and easing of the monetary policy. As asset prices for stocks and mutual funds had plummeted, we began to reevaluate the amount of money that we were pledging to principal payments within the low cost interest rate environment.

We wanted to take a advantage of the equity risk rate premium which can be summarized as the difference between the expected return on an investment versus the interest rate being charged on the outstanding loan.

Considering that markets had been severely depressed back in March 2020, we were debating on methods of how to  accelerate the purchases of depressed stocks, exchange traded funds (ETFs), and mutual funds. Lowering fixed costs even further became the focus.

As interest rates were cut, we tackled the fixed costs associated with the mortgage, which accounted for $1,150 in fixed costs. We refinanced to a smaller 15 year loan, and eliminated our associated escrow account, the resulting fixed monthly cost was lowered approximately to $425.

As the pandemic roared on we strategically refinanced our student loans approximately three times and ultimately landed with a current allocation after consolidation of Student loans 1 and 3 of approximately: $250 (Interest Rate: 3.11% 15 yrs); and $125 (Interest Rate: 3.49% 20 yrs) per month. Our final post pandemic fixed costs are as follows:

The changes to our fixed costs freed up around $1,500 that we were pledging to principal payments servicing loans at an unweighted average interest rate of approximately 3.59%.

Determined to save as much as possible we moved to evaluating how to get the biggest bang for our savings in conjunction with saving on our taxes. We ultimately learned that leveraging the lower fixed living costs can allow you to contribute hefty amounts to your tax deferred accounts (i.e. Traditional 401k, IRA, and HSA) without significantly impacting your quality of life.   

In the United States, we have a marginal tax system; the more money you make the higher the marginal bracket. Conversely the more money you can defer into tax advantaged accounts, the lower the taxes (especially when you’re in between Marginal tax brackets).

For instance, lets say you’re married filing jointly and you have 3 children and your total income is $150,000 (Placing your firmly in the 22% marginal tax bracket),

Total Federal Income Tax (using 2020 numbers) would have been around $13,124.

Now if the all the tax deferred accounts excluding the Deductible Traditional IRA account were maxed out

Individual 401K: $19,500 (2020 Maximum Contribution)

Spousal 401K: $19,500 (2020 Maximum Contribution)

Family HSA: $7,100 (2020 Maximum Contribution)

Total Federal Income Taxes (using 2020 numbers) would be lowered to approximately $3,100.

This is because deferring the $46,100 in income into tax deferred accounts in combination with the standard deduction of $24,800 lowered the taxable income below the income threshold of $80,250 for the 22% tax bracket which eliminated reduced the tax by around $10,024.

In essence in the example the taxpayer avoided paying around 10k in taxes by deferring around 46k in tax advantaged accounts.

Key Takeaways:

• Examine fixed financial commitments to identify opportunities for the lowering of monthly expenditures
• Periodically reevaluate interest rates charged on loans
• Periodically reassess your taxes
• Save prudently using tax deferred accounts

Save/Stack/Invest/Repeat