Category: Financial Planning
Just like the athletes training for the Summer Olympics, we must challenge our own financial fitness and prioritize to ensure we are successful in achieving personal goals. When you have excess cash, how do you resolve the competing needs?
When you have several financial goals that you'd like to accomplish and have limited resources, it can be tough to determine how best to prioritize the allocation of cash. While each family’s situation is different, the following should be considered a general guideline:
Emergency Fund. First and foremost, you should have enough cash in an interest bearing savings account for unexpected cash needs or emergencies. This "emergency fund" should have a balance equal to three to six months of your living expenses.
Retirement Savings. Once your emergency fund is in tact, you should save to your employer-sponsored retirement account (401k, 403b, etc.). The maximum amount that you can contribute to an employer retirement account this year is $17,000; or $22,500 if you’re age 50 or older.
-Your contributions are made with pre-tax dollars. This lowers your taxable income and reduces your tax.
-Earnings on these dollars grow tax-deferred.
-Some employers also contribute a matching amount if you contribute (additional free savings!).
If you have calculated the amount you need to secure your retirement and additional savings above your employer plan are required, you should make contributions to an IRA. The maximum contribution amount this year is $5,000, or $6,000 if you are age 50 or older. Married couples are both eligible to contribute to their personal IRA as long as one of the spouses has earned income.
If you have outstanding debt, paying it down should be your next priority. However, there is good debt and not-so-good debt, so prioritizing your repayment is key. Generally, you will want to reduce the debt that has the highest interest rate first.
Credit Card Debt. Credit card debt should be repaid the most aggressively. Typically interest rates are higher than other loans and the interest is not tax-deductible.
Auto Loans. Loans on vehicles should be next. Although interest rates have been lower in recent years, this interest is not tax deductible.
Home Equity Line of Credit. As long as your savings is in tact, you may want to reduce/eliminate any outstanding balance on a home equity line of credit. Today's interest rates are favorable, the interest is tax deductible, and your home is collateral for the debt; however, this debt is reducing the equity in your home.
Mortgage. It is not imperative that you pay off your home mortgage; interest rates on mortgages are very low today and it is nice to have flexibility with additional savings while mortgage rates are cheap. If you want to eliminate your mortgage, this should be done after other debts are paid off and your savings is systematic.
Student Loans. The pay off of student loans may be last in line when it comes to repayment for the following reasons:
-Up to $2,500 of the interest paid can be tax deductible (subject to limitations).
-Rates are not as low as mortgage rates today, but they are still reasonable.
-Student loans are forgiven at death, where as all other debt is not.
Saving for College
If you have children, the thought of paying for their college education can be daunting. The earlier you start saving, the better. However, it is important that you take care of your personal financial security first. Once you have established an emergency fund, are maximizing retirement contributions, and have eliminated credit card debt; then you can be comfortable allocating excess cash to a 529 college savings fund. Here’s why a 529 is a great vehicle to use for college savings:
-Contributions to a 529 plan grow tax-free if used for qualifying post-high school education expenses.
-Indiana offers a state tax credit to Indiana residents who contribute to the Indiana CollegeChoice 529 College Savings Plan. The tax credit is equal to 20 percent of the amount of your contribution, up to a maximum credit of $1,000 per year.
-If your child does not attend college, you can change the beneficiary of his/her plan to another child/individual, or take the funds back out for your personal use. The account earnings that are withdrawn for a non-qualifying expense will be subject to income taxes and a 10 percent penalty tax.
Because most of us don’t have unlimited resources, we need to be intentional with our actions. Your financial fitness depends on your decision-making. "Go for the gold" by using your cash to get a solid financial foundation, lower debt costs, and a secure retirement.
This article was contributed by Kathy Hower, CFP, a Wealth Advisor at Bedel Financial Consulting, Inc.
Elaine E. Bedel, CFP, is president of Bedel Financial Consulting, Inc., a wealth management firm providing fee-only financial planning and investment management services for individuals, consulting services for corporate retirement plans, and investment advisory for institutions and endowments. She is the author of "Advice You Never Asked For…But wished you had!" available on Amazon.com. For more information, visit their website at www.BedelFinancial.com or email to email@example.com.
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