Get Financial Affairs in Order.
New Financial Planning Resolutions!
Now that we midway through 2007 in the dogs days of summer, you may be ready to settle in and get your financial affairs in order.
What is the best system of ordering? People often make mistakes in their financial priorities. Most of us need to save more and get rid of debt, but some tasks are more pressing than others. For instance, parents frequently save for their children’s college education when they should be saving more for their own retirement first.
You can divide planning into long-term and short term goals. Here’s what many Certified Financial Planners (CFP™) recommend as the most effective order in which to prioritize your financial goals:
Debt. The absolute first priority is to pay off high-cost, nondeductible consumer debt. Obviously, paying off a credit card that’s charging 18% interest is like earning a risk-free, tax-free 18% rate of return.
There are a couple of different strategies for getting rid of debt. Some people like to first pay off the credit card with the lowest balance, to see faster results. The most cost-effective method, however, is to pay off the card with the highest interest rate first. Bear in mind those balance transfers may not be -0%- any more if you had them longer than the 6 month teaser.
And, meanwhile, be sure to save at least something for retirement and emergency spending -- while paying off debt -- so you’ll get in the habit of saving.
Cash savings. Once the credit-card debt is gone, experts advise emergency fund saving- enough cash to live on for three to six months, and to keep it easily available in a money-market account for emergencies. Someone with more financial flexibility, who could use a credit card if the car breaks down, could set aside less cash. But you should save as much as possible if a job loss or other major event could be on the horizon. You could save and hold this in a separate Bank or credit union savings account or even short term CD’s if the rate is tempting. But, make sure it’s not in the daily household checking account.
Retirement savings. Once you have a cash cushion, you should contribute to your 401(k) or 403(b) retirement account a work. Invest at least to the amount of the company match, because that’s free money.
Most people get their raise in January, making this a good time to increase your 401(k) contribution before the money even hits your checking account. Ideally, people should be saving at least 15% of their salary. While most investors don’t reach the maximum, an investor could contribute $15,500 into a 401(k) plan, which is for people in the private sector, or a 403(b) plan, for those in academia or nonprofits. People 50 and older can contribute an extra $5,000 annually to these accounts.
Depending on your tax situation, and especially if your employer doesn’t offer a pension, you should also contribute to an individual retirement account. "Whatever you’re going to do, automate it," says Mr. Ritter, who teaches financial planning at Johns Hopkins University. "If you automate, you don’t have to think about it every month."
College savings. It’s not what parents want to hear, but saving for retirement must come before saving for college for your children. That’s because there are many ways to pay for college. A student could borrow, get scholarships or attend a less-expensive community college or state university. But no one is going to lend you money or give you a scholarship for retirement.
If you are saving 15% of your salary in a 401(k), by all means put some money away for your children’s education. The most effective way to save is to contribute after-tax income into a state-sponsored 529 college-savings plan. Money in these accounts grows tax-free and can be withdrawn free of federal tax on investment earnings as long as it is used to pay for higher education. More than 30 states also provide a tax deduction for contributions and other benefits.
Prepaying your mortgage. Many people find it tempting to prepay their mortgage. According to new research, though, you’re probably better off putting that extra money into your 401(k), at least up to the maximum matched by your company. Prepaying is a good idea, if you’re close to retirement or already saving enough for retirement. Consider prepaying, if you are in the later years of a mortgage where your interest is no longer enough to justify itemizing your tax deduction.
Buying insurance. If you haven’t evaluated your insurance coverage in a while, do it now. Home values have soared in recent years. Make sure that your homeowner and auto policies are up-to-date and that the deductibles make sense.
Do you have enough life insurance? As a general rule of thumb, a full-time worker with a family should have life insurance equal to six to 10 time’s salary. In recent years, the cost of life insurance has dropped significantly, especially term life.
Additionally, people need to consider whether to buy long-term-care insurance, which can help pay for time spent in nursing or assisted-living care.
Estate planning. No matter the size of your estate, it is important to update your will to ensure that your wishes are carried out. That means you also should have a durable power of attorney and a health-care power of attorney, which authorizes someone to make medical decisions if you can’t make them yourself.
Planning ahead also saves time and money for your heirs. Make sure the beneficiary designations and titling on your bank, brokerage and retirement accounts are up to date, because it’s not unusual for someone to accidentally leave something to an ex-spouse.
The need for this article was inspired by a recent WSJ article.
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