This article is original content written by Manchester, CT Financial Advisor Thomas Scanlon, CFP®, CPA
Don’t you just love it when a Major League athlete signs a huge contract with a new team and says, “It’s not about the money.”
Just to be clear:
It’s always about the money!
Don’t get me wrong I don’t think your life should revolve exclusively around money. Obsessing about money is a quick way to get sent to the funny farm. Having said that, I’m sure you realize it sure helps to have some money.
You should however have an understanding of what money can and can’t do for you. Money can’t buy you happiness. How many times have you heard that? More than a few I suspect. There are plenty of celebrities that have tons of money that just don’t seem very happy.
You will certainly need money now to pay your bills and you will need money in the future for your retirement. How do you balance these two?
Live beneath your means
I know, I know, it’s easier said than done.
Your neighbor has a brand new, fire engine red convertible Beemer in his driveway. You want one too.
Your coworker just returned from a ten day trip across Europe. You’re wondering why you haven’t done this.
Your ten year old daughter wants a smart phone because, well, just because.
And on it goes.
There are countless ways to spend money. And tons of companies are looking to help you spend with them. Their advertisements are everywhere.
“No payments for twelve months.”
“Zero percent interest.”
Several preapproved credit cards show up in your mailbox every day.
Living beneath your means is a process where you are spending less than you are making. This means having money to save on a monthly basis. The first thing to do is to set up an appropriate amount into your cash reserve fund. The commonly quoted amount to have is six months of living expenses. This might be difficult for many folks. Have at least three months of living expenses set aside, hopefully more. You will need your cash reserve fund someday. You don’t know when and for what but you will need it.
Then the first place to save is by enrolling in your employer’s 401(k) plan. Contribute at least an amount to get the employer match. Consider contributing the maximum annual amount of $19,500 in 2020 ($26,000 for taxpayers over age 50) if the investment options are decent and the fees are competitive.
After this take a hard look at the Roth IRA. Individuals are allowed to contribute up to $6,000 annually ($7,000 if over age 50) assuming you have earned income from working. Higher income earners are not eligible to contribute to a Roth IRA however. For a married couple filing a joint return they can contribute to the Roth IRA if their income modified adjusted gross income is below $196,000 in 2020t least five years and you don’t take distributions until after age 59 1/2 then all of the distributions are tax-free. Repeat, tax-free. This is huge. You can have decades of tax-free growth.
Another benefit to the Roth IRA is that your contributions come out first and they are not taxed. For example, you contribute $6,000 a year to your Roth IRA. If you contribute this annually for ten years your total contributions are $60,000. Something comes up and you need some money. You could take the funds from your Roth IRA (not that I am encouraging you to) and not pay any income tax when you withdraw your contributions.
The final benefit to the Roth IRA is that it is not subject to the Required Minimum Distribution (“RMD”) rules. These rules require taxpayers with IRA’s and 401(k)’s to begin taking distributions when they turn 72. The IRS has a chart that essentially makes you take out distributions over your life expectancy.
If you have children you will want to save for their college education. The College Savings 529 Plan is the most popular vehicle for this. Funds are invested and if qualifying distributions are made, they are tax-free. While there is no federal income tax benefit with contributing to a 529 plan, there is a State of Connecticut benefit. Connecticut residents that contribute to the Connecticut 529 plan get a deduction on their Connecticut Income Tax Return. If a Connecticut Resident contributes to the Connecticut Higher Education Trust (“CHET”) they can deduct up to $10,000 on their Connecticut Tax Return if they are married filing jointly. Single filers can deduct up to $5,000.
So the question becomes:
What does it cost you a year to live?
You don’t know what this number is? Go run the calculations. I’ll wait here. Don’t forget to include your expenses you typically pay once a year. Car insurance, homeowners insurance, personal umbrella insurance and perhaps real estate taxes would be some examples. Take your total expenses for the year and divide by 12. This is your monthly ‘nut.’
That was the easy part. Now it gets a little more challenging. How do you get this number down? Certainly you can look at the deductibles on your cars, home and umbrella policies. Increasing the deductibles could save you some dollars. Just be cautious. If you need to file an insurance claim, that increase in the deductible is coming out of your pocket.
Then go through your other expenses. Some payments are fixed. Mortgage payments, car loans and student loans are generally fixed monthly payments. With that said, it might be appropriate to refinance your mortgage and / or student loans to a lower interest rate. If you are considering this, you want to jump on it. The Federal Reserve Board just raised interest rates in early December 2015 for the first time in nearly a decade. There have been seven rate hikes since then and the rate is at 2.5% in December, 2018. Although it may take some time, the trend of interest rates is clearly up. You may want to consider refinancing now if you are considering it. People with a variable rate mortgage should consider refinancing and getting a fixed rate mortgage. If you expect to remain in your home for the foreseeable future, this might be appropriate for you.
The world has moved to credit cards, bill pay and Apple Pay. While these are convenient and secure (we’re told) they are almost too easy. See what you like online? Place your order; they already have your credit card on file. It will be here in three days. Oh, and the shipping is free. The credit card bill won’t come in for another three weeks. We’ll deal with paying for it then. Yikes!
I know it sounds old school but many folks should use their credit cards less. It sounds archaic but consider paying cash for many of the items you buy. This means you will only be buying items you have the cash to pay for them.
We all have habits. Some habits serve us well. Some habits not so much. Saving is a good habit. Gambling is a not so good habit. Working out is a good habit. Late night pizza runs although fun, might not be the best habit.
It appears to me that many of our money habits are acquired in our youth. My father tied my allowance to my school grades. This was real bad for me. I had to go work to make money as my little allowance wasn’t going to cut it. I was fortunate. I learned the value of hard work at an early age. We have instilled this with our children also.
How do you change your habits? Good question. Our experience is that small, incremental changes made over time are the ones that stick. And that’s what it is all about, isn’t it? Gradually change the habits that aren’t working for you into ones that are and stay on this path. For example, if you are only putting 5% of your paycheck into your 401(k) plan at work, increase it to 6%. You may not even notice the difference. Then in six months to a year, increase your contribution to 7%. This is the gradual and incremental change that you can stick with over time.
How to Get Money
Generally getting an education never hurts. The key word here of course is generally. An education can be formal or informal. A formal education after high school costs money. If you didn’t have enough money to pay the school you could take out a loan. Just keep in mind the lender is expecting to be paid back. Apparently a lot of students needed loans as the amount of student loan debt now is staggering, exceeding $1.4 trillion. The average loan balance of is about $33,000 each. On paper, these loans are expected to be repaid. It appears however that with many students defaulting the government might be looking for a bail out. This is a very bad idea.
Too many students borrowed too much money and don’t have jobs to support their debt level. This is more than unfortunate. Students and their parents should be cautious when financing a college education. According to the College Board, the average tuition and room and board for the 2018-2019 year to attend a public four-year out-of-state school is $36,480.(1) And that’s only for one year and only for one child. That’s quite an investment to make. Going to a school you can afford and having a major that should result in a job are crucial. Here are the 3 Ways My Daughter Financially Contributes to her College Education.
The good news is you are like the Major League athlete mentioned above. Oh, sorry, you likely won’t be signing that multimillion dollar contract that he signed. You are like him in the context that you are a free agent, just like he is. This means you can play for whatever team (company) you want to play for that wants you. That’s pretty cool. Back in the day your parents or grandparents would go to work for one employer and spend their entire career there. Those days are long gone. Employees now move around a lot.
We can’t discuss money without mentioning giving. If you have been fortunate enough you should give. If you live in the United States you have already won the lottery and have been fortunate. Giving could be either money or time or both to your favorite charity. Notice I didn’t say give back. I said give. Giving back infers or implies you took something. I don’t know about you but I never took anything. Correction, I have always tried to take advantage of any potential opportunities that have come my way. So I stand corrected. Giving though shows your appreciation and gratitude. Don’t forget, Givers Gain!
The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Thomas F. Scanlon, CPA, CFP® and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice.
Investors should carefully consider the investment objectives, risks, charges and expenses associated with 529 plans before investing. This and other information about 529 plans is available in the issuer’s official statement and should be read carefully before investing. Investors should consult a tax advisor about any state tax consequences of an investment in a 529 plan.