Help & Advice
Save Money or Repay Debt?
So you have a little extra cash on hand at the end of the month—should you use it to pay down credit card debt, or add it to your savings account? The answer depends on a lot of factors unique to your personal financial situation. To make the right choice about what to do with extra money, take these following questions into consideration:
Do you have enough money set aside in case of emergency? Most financial experts recommend that you keep an "emergency fund" large enough to cover three to six months of living expenses. Your emergency fund should be kept in a savings or a money market account that you can access without penalty, but won't be tempted to touch unless you absolutely need the money.
What's the interest rate? Get out your statements from savings and investment accounts, as well as your credit card bills. What are the interest rates? Interest rates have plummeted over the past several years, so that many savings accounts and money market accounts are earning next to nothing. On the other hand, you may be paying interest on credit card debt as high as 20 percent. You should pay down debt with extra money, unless you can find an investment vehicle that offers a higher interest rate.
- Savings: If you put $100 in a savings account earning 1 percent interest, you'll have $101 in a year. But you'll owe taxes on that extra $1, so your real rate of return is actually less.
- Debt Reduction: If you pay off $100 of debt on a credit card that charges 18 percent interest, you'll save $18 and owe $100 less.
Why not do a little of both? If you're not sure whether to pay off debt or add to savings, why not do both? Use half your extra money to pay down the debt with the highest interest rate, and invest the other half. When it comes to your money, it doesn't have to be all or nothing.
Retirement
Everyone knows saving for retirement is a smart investment, but how much money do you really need? The answer is different for everyone, because everyone has different plans on how to spend retirement:
Do you plan to earn income? Some people are counting down the days until their 65th birthday, when they can to walk out of the office, discard their work clothes, and begin enjoying a life of leisure. Others expect to keep working, because of a recreational or part-time job. If you don't plan to work, you'll need other sources of income to pay the bills.
What lifestyle do you envision for yourself? Traveling the world costs a lot more than tending to a vegetable garden. If you have expensive plans ahead of you, you'll need to save a lot more to make them happen.
How long will your retirement last? When the retirement age was set to 65, most people didn't expect to live past 70. Due to medical advances, life expectancy has risen over the past few years, which means you could be living off retirement savings for 35 years or more.
How Much Annual Income You'll Need
Experts disagree about the best way to estimate retirement income needs. For a long time, financial planners said 70 percent of your pre-retirement income would be sufficient. Now many experts say you need 80 to 100 percent of your pre-retirement income, depending on your lifestyle and health status.
If you're planning to retire in a few years, you can probably estimate how much you'll be earning the year before you retire. If retirement is more than 10 years away, it may be harder to anticipate your pre-retirement income. There are calculators on the internet that will do the math for you, or you can multiply your current salary by one plus your average annual raise. Repeat that calculation once for every year until you retire. This calculation will estimate the amount of income you will be earning the year you retire.
For example, say you earn $35,000 today. You usually get a 3 percent raise and you plan to retire in 24 years. Multiply $35,000 by 1.03, and then multiply the result by 1.03 twenty-four times. You end up with $73,282, which is the estimate of your earnings for the year you retire.
Maximize Your Retirement Savings
Most people save for retirement in tax-advantaged accounts, such as a 401(k) or a traditional or Roth IRA. Some contributions are tax deductible, so they offer present-day tax benefits. There are tax benefits over time as well, since investments grow tax-deferred. If you're self-employed, you may be funding a SEP-IRA, Keough, or SIMPLE plan that offers similar benefits. You may also be entitled to pension benefits from a current or previous employer.
Since there are annual limits on the amount you can contribute to tax-advantaged accounts, you should establish taxable accounts to add to your retirement savings. You won't get any tax deductions for your contributions and you'll pay taxes on any income or realized capital gains each year, but you'll be adding to your retirement nest egg.
Estate Planning
Whether your estate includes a mansion and a private jet, or a three-bedroom house and some mutual funds, you need to think about what will happen to those assets after your death. If you don't specify your wishes, you're telling the government they can do whatever they want with your hard-earned wealth.
Even if you plan to live another 50 years, you should take the time now to make some decisions about your estate, for these reasons:
- If you don't state your wishes, a court can decide how your assets are distributed after your death.
- Proper estate planning can minimize the taxes your estate pays, leaving more for your heirs.
- You can avoid costly, time-consuming probate and emotional battles over your estate.
Many people think an estate refers to only land and property. Obviously your house is an important part of your estate, but for many people, it's not the largest part. Your estate includes everything you own and everything you owe:
- Business assets and ownership stakes
- Investments (stocks, bonds, mutual funds, and bank accounts)
- Savings (retirement and college savings plans)
- Valuable antiques, art, jewelry, and collectibles
- Personal property (furniture and clothing)
- Real estate
- Life insurance death benefits payable to your heirs
- Debts, including unpaid loans and other liabilities
Estate planning also involves planning for the unexpected, such as temporary incapacity. You need to decide who will take control of your assets if you're ever unable to manage your own affairs due to illness or injury. You can decide now, or let a court decide for you later.
Writing a Will
If you die without writing a will, or intestate, a court will decide how your assets will be distributed according to the laws of your state. A will lets you state exactly how your assets should be distrbuted and who you want to oversee the process, your executor. You can be as specific or as general as you like, and changes can always be made later.
If you have minor chidren, an important part of a will is deciding what will happen to them. You need to choose someone to raise them and someone to manage their financial affairs, if it's not the same person.
Keep Up With Your Estate Plan
Once you've gone through the process of planning your estate—writing a will, executing powers of attorney, creating trusts, and re-titling property—plan to review the entire package at least once every few years. The decisions you make today may not be suitable to fit your lifestyle in the future.
Any major life event should involve a review of your estate plan, including marriage, divorce, the birth or adoption of a child, starting or selling a business, and buying or inheriting property. If you move to another state or country, you'll need to have an attorney review your plan to make sure it conforms to local law.
