The plan: Take a systematic approach

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Leah Kelly
Profile:Leah Kelly
The problem:
Leah and Lamar wish to relieve themselves of debt.
The plan:
They can systematically pay it off and begin building wealth.

Get life insurance
Before anything else, the Kellys need life insurance. How much do they need? Either parent could support the children on one salary if the house and other debts were paid off. So they should start with enough to cover the mortgage and debt, a total of roughly $200,000. The survivor will also need to have enough to pay for college when the children turn 18. We estimate costs will be approximately $50,000 in today’s dollars for each child at a state university in Georgia.

Should an unfortunate event occur, the education-related funds should be placed in a 529 plan, where it is reasonable to expect an average annualized return of 7 percent. Lamar will have the added expense of day care for the kids until they are old enough for school: $55,000. They will need $10,000 for burial expenses. In addition, they should add a cushion of $25,000 each for unexpected expenses. For instance, if one of them died when the cars were six years old, the other would need a new car in the foreseeable future.

They will need $400,000 of term coverage on Leah’s life and $350,000 on Lamar’s life. Monthly premiums for policies with that coverage will run only $11 each.

The plan in 3 steps
Beef up savings
Begin by saving $1,000 in a savings account.
Next build up an emergency fund with three months of living expense.
Then start 401(k) plan contributions.
Invest 401(k) proceeds in target-date retirement funds.
Brush up on the retirement plans available for self-employed people.
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Buy disability insurance
If one of them were to stop working due to an injury or illness, the Kellys would have to go further into debt just to survive. Lamar should ask at work if his employer provides disability insurance. Leah should shop online and get multiple quotes for disability insurance. To keep costs down, they should apply for policies that pay only if they cannot work at any job rather than the jobs they have now. Also, the policies should have an elimination period (time between the injury and when payments start) of 90 days.

Open a savings account
Leah and Lamar’s next step is to save $1,000 in an account they can conveniently retrieve. There will undoubtedly be expenses that arise for the house or cars; these should be paid in cash so they don’t have to rack up more debt. This should be accessible so they can use it when they need it; it should be in a bank savings account, not in a CD.

Tackle credit cards
The Kellys should pay the full balance of the credit cards with the lowest balances first. For example, they have a card with a balance of only $355; this can be paid off in one month.

The other five cards have a total balance of more than $12,800; they should be consolidated to get a lower monthly payment and lower rate. The Kellys should try to consolidate them with a card that has zero percent APR for a year. If they’re unable to do that, they can consolidate them with a card they already have with a 9.25 percent APR; it is 10 percentage points lower than the other cards. Having only one bill to pay rather than six will also make their lives a little easier to manage.

After they transfer the balances to one card, they should allocate the $250 used to pay minimums now plus their free cash, $550, toward that card. At 9.25 percent, paying $800 a month, it should take them approximately 18 months to pay the balance. Naturally, the time frame will be further reduced if they use a card with a zero percent APR. If Lamar finds a job closer to home, that would free up another $500 or so that can be applied toward the credit cards.

  The problem