Recover From a Holiday Binge With a Spending Freeze

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Recover From a Holiday Binge With a Spending Fast

The holiday parties may be over but the financial hangover is just setting in. Holiday sales for 2016 were estimated to top $655 billion, according to the National Retail Federation. If you blew your holiday budget, don’t panic. A January spending freeze may be just what you need to get back on track. If you’ve never done a spending freeze before, here’s what to expect.

See the average budget for someone in your neighborhood.

How Does a Spending Freeze Work?

During a spending freeze, you avoid making nonessential purchases. For example, if you buy fast food two to three times per week or movie tickets once a month, you’d cut those expenses out temporarily. A spending freeze gives you the chance to rein in your spending and evaluate your budget. The money you would’ve spent on fun and entertainment can then go toward paying off the debt you racked up during the holidays.

Getting Started

Recover From a Holiday Binge With a Spending Fast

Before starting your spending freeze, you may need to mentally prepare yourself for what’s to come. Getting rid of bad spending habits can be tricky. But with the right mindset, you may be able to cut costs and achieve some of your financial goals.

The key to making your spending freeze work is being able to separate your needs from your wants. You’ll need to be able to pay for essential costs like rent, mortgage payments and debt payments. But you’ll need to recognize that other expenses – like the cost of a daily latte or a pair of new shoes – can be removed from your budget if necessary.

If you’re having trouble curbing your spending, agreeing to splurge on just one item during the month of January may make sticking with your freeze a bit easier.

Related Article: How to Recover From a Holiday Shopping Spree

Put the Money You’re Saving to Work

Once you begin your spending freeze, you’ll need to figure out what to do with the extra money in your bank account. Paying off your credit card bills should be a top priority since credit card debt tends to have a bigger impact on your credit score than installment debt. Specifically, you may want to focus on paying off your store credit cards since they often carry high interest rates.

Which credit card should you pay off first? You may want to begin by paying off the card with the highest APR since that’ll reduce what you’re paying in interest. Or you could pay off the card with the lowest balance. That may give you the momentum you need to knock out the rest of your credit card debt.

Related Article: How to Stop Spending Money Carelessly

Get a Partner Onboard

Recover From a Holiday Binge With a Spending Fast

Implementing a spending freeze can be difficult if you’ve never done one before. Having someone else along for the ride may help you fight your urge to splurge.

If you’re married, for example, you could ask your spouse to jump on the spending freeze bandwagon with you. Singles can find a friend or family member who’s willing to join in. Just remember that when you’re choosing a partner, it’s best to pick someone who’s going to encourage you to stick with your freeze and make good financial decisions.

Photo credit: ©iStock.com/Pogonici, ©iStock.com/killerb10, ©iStock.com/monkeybusinessimages

The post Recover From a Holiday Binge With a Spending Freeze appeared first on SmartAsset Blog.

Source: smartasset.com

What Is the Self-Employment Tax?

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Working for yourself, either as a part-time side hustle or a full-time endeavor, can be very exciting and financially rewarding. But one downside to self-employment is that you're responsible for following special tax rules. Missing tax deadlines or paying the wrong amount can lead to expensive penalties.

Let's talk about what the self-employment or SE tax is and how it compares to payroll taxes for employees. You’ll learn who must pay the SE tax, how to pay it, and tips to stay compliant when you work for yourself.

What is the self-employment (SE) tax?

In addition to federal and applicable state income taxes, everyone must pay Social Security and Medicare taxes. These two social programs provide you with retirement benefits, disability benefits, survivor benefits, and Medicare health insurance benefits.

Many people don’t realize that when you’re a W-2 employee, your employer must pick up the tab for a portion of your taxes. Thanks to the Federal Insurance Contributions Act (FICA), employers are generally required to withhold Social Security and Medicare taxes from your paycheck and match the tax amounts you owe.

In other words, your employer pays half of your Social Security and Medicare taxes, and you pay the remaining half. Employees pay 100% of federal and state income taxes, which also get withheld from your wages and sent to the government.

When you have your own business, you’re typically responsible for paying the full amount of income taxes, including 100% of your Social Security and Medicare taxes.

But when you have your own business, you’re typically responsible for paying the full amount of income taxes, including 100% of your Social Security and Medicare taxes.

Who must pay the self-employment tax?

All business owners with "pass-through" income must pay the SE tax. That typically includes every business entity except C corporations (or LLCs that elect to get taxed as a corporation).

When you have a C corp or get taxed as a corporation, you work as an employee of your business. You're required to withhold all employment taxes (federal, state, Social Security, and Medicare) from your salary or wages. Other business entities allow income to pass directly to the owner(s), so it gets included in their personal tax returns.

You must pay the SE tax no matter if you call yourself a solopreneur, independent contractor, or freelancer—even if you're already receiving Social Security or Medicare benefits.

You must pay the SE tax no matter if you call yourself a solopreneur, independent contractor, or freelancer—even if you're already receiving Social Security or Medicare benefits.

How much is the self-employment tax?

For 2020, the SE tax rate is 15.3% of earnings from your business. That's a combined Social Security tax rate of 12.4 % and a Medicare tax rate of 2.9%.

For Social Security tax, you pay it on up to a maximum wage base of $137,700. You don't have to pay Social Security tax on any additional income above this threshold. However, this threshold has been increasing and is likely to continue creeping up in future years.

However, for Medicare, there is no wage base. All your income is subject to the 2.9% Medicare tax.

So, if you're self-employed with net income less than $137,700, you'd pay SE tax of 15.3% (12.4% Social Security plus 2.9% Medicare tax), plus ordinary income tax.

Remember that your future Social Security benefits get reduced if you don't claim all of your self-employment income.

What is the additional Medicare tax?

If you have a high income, you must pay an extra tax of 0.9%, known as the additional Medicare tax. This surtax went into effect in 2013 with the passage of the Affordable Care Act (ACA). It applies to wages and self-employment income over these amounts by tax filing status for 2020:

  • Single: $200,000 
  • Married filing jointly: $250,000 
  • Married filing separately: $125,000 
  • Head of household: $200,000 
  • Qualifying widow(er): $200,000

What are estimated taxes?

As I mentioned, when you’re an employee, your employer withholds money for various taxes from your paychecks and sends it to the government on your behalf. This pay-as-you-go system was created to make sure you pay all taxes owed by the end of the year.

You must make quarterly estimated tax payments if you expect to owe at least $1,000 in taxes, including the SE tax.

When you’re self-employed, you also have to keep up with taxes throughout the year. You must make quarterly estimated tax payments if you expect to owe at least $1,000 in taxes, including the SE tax.

Each payment should be one-fourth of the total you expect to owe. Estimated payments are generally due on:

  • April 15 (for the first quarter) 
  • June 15 (for the second quarter) 
  • September 15 (for the third quarter) 
  • January 15 (for the fourth quarter) of the following year

But when the due date falls on a weekend or holiday, it shifts to the next business day. Your state may also require estimated tax payments and may have different deadlines.

How to calculate estimated taxes

Figuring estimated payments can be extremely confusing when you’re self-employed because many entrepreneurs don’t have the faintest idea how much they’ll make from one week to the next, much less how much tax they can expect to pay. Nonetheless, you must make your best guesstimate.

If you earn more than you estimated, you can pay more on any remaining quarterly tax payments. If you earn less, you can reduce them or apply any overpayments to next year’s estimated payments.

If you (or your spouse, if you file taxes jointly) have a W-2 job in addition to self-employment income, you can increase your tax withholding from earnings at your job instead of making estimated payments. To do this, you or your spouse must file an updated Form W-4 with your employer.

The IRS has a Tax Withholding Estimator to help you calculate the right amount to withhold from your pay for your individual or joint taxes.

How to pay estimated taxes

To figure and pay your estimated taxes, use Form 1040-ES, Estimated Tax for Individuals, or Form 1120-W, Estimated Tax for Corporations. These forms contain blank vouchers you can use to mail in your payments, or you can submit funds electronically.

When you have a complicated situation, including having business income, one of your new best friends should be a tax accountant.

For much more information about running a small business successfully, check out my newest book, Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers. Part four, Understanding Business Taxes, covers everything you need to know to comply and stay out of trouble.

From personal experience, I can tell you that when you have a complicated situation, including having business income, one of your new best friends should be a tax accountant. Find one who listens well and seems to understand the kind of work you're doing.

A good accountant will help you calculate your estimated quarterly taxes, claim tax deductions, and save you money by helping you take advantage of every tax benefit that's allowed when you're self-employed. In Money-Smart Solopreneur, I recommend various software, online services, and apps to help you track expenses, deductions, and tax deadlines that will keep your business running smoothly.

Source: quickanddirtytips.com

Am I On Track to Retire?

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The only way to retire with financial security is by saving for retirement ASAP.  Although setting aside retirement savings is a solid start in the right direction, making sure you’re saving enough toward your retirement goal is just as important.

Once you’ve decided how much you’ll contribute to your retirement fund, you’ll be closer to knowing if your savings are on track. Here’s how to get started.

Compound Earnings Catapults Your Retirement Fund

Building your retirement savings isn’t something you can do on a whim, work on for a few years, and then abandon. You need to set up a plan — and the earlier in life, the better — then commit to it for decades.

Why? Because compound earnings over time is what gets you to your retirement goal faster. 

When you invest into your retirement, your funds earn interest. That interest is reinvested to earn more interest. This is the concept behind “compound interest”. To successfully plan for retirement, putting your contributions on auto-pilot is essential to maximize your compounded earnings.

This starts with opening the right to retirement plan, or even a combination of plans. From there, you can set up payroll deductions or automatic transfers from your bank account to fund whatever retirement plan you’ve chosen.

Choosing the Right Retirement Plan

You can start saving for retirement by participating in a workplace retirement plan, if your employer offers one. This will typically be a 401(k), 403(b), 457 or Thrift Savings Plan (TSP).

Under current tax contribution laws, you can contribute up to $19,500 per year to any of those plans, or $26,000 if you’re 50 or older. Some employers also offer a matching contribution that grows your savings fund more quickly.

A limitation of an employer-sponsored plan is that you’re often on your own to manage it. There might also be limited investment options, including some that have high investment fees. A good workaround for this problem is to sign up with a 401(k)-specific robo-advisor, like Blooom. 

It’s a service that creates and manages a portfolio within your employer-sponsored plan, including replacing high-fee funds with those that charge lower fees. And it provides this service for a low, flat monthly fee. Your employer doesn’t need to be involved in the process — just add Blooom to your existing plan.

If You Don’t Have an Employer-Sponsored Retirement Plan

If you don’t have access to an employer-sponsored plan, you have a few options depending on your situation. Here are other types of retirement plans to consider: 

  • Traditional IRA or Roth IRA. It can either include brokerage firms if you prefer self-directed investing, or robo-advisors if you’d rather have your investments managed for you. IRA contribution limits for either type of retirement plan let you contribute up to $6,000 per year, or $7,000 if you’re 50 or older. Here are a few places to open an IRA account.
  • SEP-IRA. If you’re self-employed and a high-income earner, a SEP-IRA is the best way to build up a large retirement portfolio in less time.  Rather than an annual contribution limit of $6,000 for traditional and Roth IRAs, the limit for a SEP-IRA is a whopping $57,000.
  • Solo 401(k). A Solo 401(k) is also designed for self-employed workers (though it can also include a spouse who participates in the business). It has the same employee contribution limit as a standard 401(k) at $19,500 per year, or $26,000 if you are 50 or older. But a solo 401(k) lets you make an additional employer contribution to the plan up to $57,000 (or $63,500 if you are 59 or older). Employer contributions are also capped no more than 25% of your total compensation from your business.

General Retirement Find Milestone Guidelines

The number of variables involved in retirement makes it impossible to come up with a specific savings goal to aim for in your situation. But like any plan, you’ll need to have milestones to let you know if you’re on track to retire or not.

Although there are different methods of calculating retirement milestones, the Fidelity Retirement Widget offers the best ballpark figure. The widget is incredibly user-friendly, produces easy to understand results, and is absolutely free to use.

It determines how much money you should have at each age, based on your answers to three questions:

  • What is your current age?
  • What age do you expect to retire?
  • What do you think your lifestyle will be in retirement? (You can choose below average, average, and above average.)

The last question about your lifestyle in retirement is admittedly vague, but an educated guess is enough.

Plugging in a starting age of 25, with an expected age of retirement of 67, and an average lifestyle in retirement, Fidelity provided the following retirement milestones in five-year increments:

Each bar represents a multiple of your current annual income at a specific age. For example, at age 30, your total retirement savings should roughly equal your annual income. At 35, you should’ve saved double your income, and so on until age 67 when you retire. 

At that point your retirement savings should be 10 times the amount of your annual income just before retiring. (It will be 12X your income at 67 if you expect an above average lifestyle, but just 8X if you expect to live a below-average lifestyle.)

How Accurate Are These Retirement Savings Milestones?

There’s no guaranteed method to project your exact future earnings or how much your retirement fund will compound over time. The best we can do is a ballpark estimate, especially if you’re only in your 20s or 30s.

But let’s work a loose example to demonstrate the validity of the Fidelity estimate.

Let’s say you reach 67, your final salary is $100,000, and you’ve accumulated 10 times that income in your combined retirement savings (i.e. $1 million).

It’s not reasonable to assume a $1 million portfolio will consistently generate 10% annual returns, fully replacing your $100,000 pre-retirement income.

General Rule of Thumb for Retirement Savings

Generally, you can plan on replacing 80% of your pre-retirement income. That means $80,000 per year of income in retirement. The reduction assumes you won’t have work-related expenses, like commuting, or making additional retirement contributions. It also assumes a lower annual tax bite. After all, once you retire, you’ll no longer be paying FICA taxes.

If you have a $1 million retirement portfolio, you can withdraw 4% per year without draining your portfolio to zero. This is what’s frequently referred to as the safe withdrawal rate.

Withdrawals of 4% will come to $40,000 on a $1 million portfolio. That will represent 50% of the $80,000 in needed retirement income.

Presumably, the rest will come from a combination of Social Security and any available pension income. You can use the Social Security Quick Calculator to determine what your benefits will be at retirement.

Using a Retirement Calculator to Track Your Goals

With your estimated Social Security benefits in mind, a retirement calculator can help you understand the remaining gap between your savings and how much you need for retirement. 

For example, let’s say you’re 25-years-old, earning $50,000 annually, and your employer offers a 401(k) plan. For each of the remaining examples, we’ll assume your employer doesn’t match contributions, and assume a 7% annual rate of return on investments reflecting a mix of stocks and bonds in your plan.

If you want your 401(k) plan balance to match your salary by age 30, you’ll need to contribute

17% of your income — or about $8,500 per year — to your plan. With a 7% annual rate of return, that’ll give you a balance of $50,717.

If you expect to be earning $75,000 per year by the time you’re 35, you’ll need to have $150,000 in your plan by the time you reach that age.

Assuming your income averages $62,500 per year between the ages of 30 and 35, you’ll need to contribute 21% of your income, or $13,125 per year, to reach the $150,000 threshold in your plan. 

The Magic of Saving for Retirement Early

Looking long-term, at retirement at age 67, let’s assume your income will grow to $100,000 between age 35 and 67. In this scenario, your average annual income is $87,500. Since you expect to earn $100,000 just before retiring, you should have $1 million sitting in your 401(k) plan.

What will it take to reach that goal?

Absolutely nothing!

One of the biggest and best secrets of retirement planning is the earlier in life you begin saving, the less you’ll need to save later on in life. And sometimes that’s nothing.

In this case, since you already have $150,000 in your plan at age 35, simply by investing the money at an average annual return of 7% for 32 years your plan will grow to $1.3 million. That’s without making even a single dollar of additional contribution.

And for what it’s worth, if you simply made the maximum 401(k) contribution of $19,500 each year between 35 and 67, your plan would have more than $3.4 million by the time you reach retirement.

The most fundamental rule of retirement savings planning is: save early and often!

Planning for Early Retirement

If you’re 25 years old and you want to retire at 50, decide how much income you’ll need to live on by the time you reach 50. Since you won’t have the benefit of Social Security or a pension, you’ll rely entirely on your retirement savings.

Let’s say you’ll need $40,000 per year to live in retirement. In this case, you’ll need to have $1 million in your retirement portfolio based on the 4% safe withdrawal rate.

How Much to Save for an Early Retirement

To get from $0 to $1 million in your retirement plan between 25 and 50, you’ll need to make the maximum 401(k) contribution allowed at $19,500 each year for 25 years. Assuming your investment produces a 7% return, you’ll have $1,181,209 by the time you reach 50. That’ll be a little bit higher than your $1 million retirement goal.

It’ll be difficult to carve out the full $19,500 on a $50,000 income you’re earning at age 25, but it gets easier as the years pass and your income increases. You might even decide to lower your contributions in your 20s, and work up to the maximum by the time you’re 30.

Just be aware that the foundational strategy of reaching early retirement is based on saving a seemingly ridiculous percentage of your income. Although others are saving 10% or maybe 15% of their income each year, you’ll need to think more in terms of 30%, 40%, or 50% savings. It all depends on how early you want to retire.

What to Do if You’re Not on Track to Retire

Unfortunately, this describes the majority of Americans. But it doesn’t need to be you, even if you’re not currently on track to retire.

Let’s say you’re 45 years old and earning $100,000, and you currently have $100,000 in total retirement savings. That means that at age 45 your retirement fund is where Fidelity recommends it should’ve been at age 30.

Don’t give up hope.

If you make the maximum contribution of $19,500 per year between ages 45 and 50, then increase it to the maximum of $26,000 per year from ages 50 to 65, you’ll have just over $1.3 million in your plan by the time you reach 65.

You won’t benefit from compound earnings that you would’ve seen had you started saving aggressively in your 20s, but your situation is far from hopeless.

The main takeaway is that you can get on track to retire at just about any age. But you have to be willing to commit to saving as much as you can and on a completely consistent basis.

The post Am I On Track to Retire? appeared first on Good Financial Cents®.

Source: goodfinancialcents.com

Should I Take Money Out of My 401(k) Now?

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Is taking money from your 401(k) plan a good idea? Generally speaking, the common advice for raiding your 401(k) is to only take this step if you absolutely have to. After all, your retirement funds are meant to grow and flourish until you reach retirement age and actually need them. If you take money from your 401(k) and don’t replace it, you could be putting your future self at a financial disadvantage.

Still, we all know that times are hard right now, and that there are situations where removing money from a 401(k) plan seems inevitable. In that case, you should know all your options when it comes to withdrawing from a 401(k) plan early or taking out a 401(k) loan.

401(k) Withdrawal Options if You’ve Been Impacted by COVID-19

First off, you should know that you have some new options when it comes to taking money from your 401(k) if you have been negatively impacted by coronavirus. Generally speaking, these new options that arose from the CARES Act include the chance to withdraw money from your 401(k) without the normal 10% penalty, but you also get the chance to take out a 401(k) loan in a larger amount than usual. 

Here are the specifics:

401(k) Withdrawal

The CARES Act will allow you to withdraw money from your 401(k) plan before the age of 59 ½ without the normal 10% penalty for doing so. Note that these same rules apply to other tax-deferred accounts like a traditional IRA or a 403(b). 

To qualify for this early penalty-free withdrawal, you do have to meet some specific criteria. For example, you, a spouse, or a dependent must have been diagnosed with a CDC-approved COVID-19 test. As an alternative, you can qualify if you have “experienced adverse financial consequences as a result of certain COVID-19-related conditions, such as a delayed start date for a job, rescinded job offer, quarantine, lay off, furlough, reduction in pay or hours or self-employment income, the closing or reduction of your business, an inability to work due to lack of childcare, or other factors identified by the Department of Treasury,” notes the Consumer Financial Protection Bureau (CFPB). 

Due to this temporary change, you can withdraw up to $100,000 from your 401(k) plan regardless of your age and without the normal 10% penalty. Also be aware that the CARES Act also removed the 20 percent automatic withholding that is normally set aside to pay taxes on this money. With that in mind, you should save some of your withdrawal since you will owe income taxes on the money you remove from your 401(k).

401(k) Loan

The Cares Act also made it possible for consumers to take out a 401(k) loan for twice the amount as usual, or $100,000 instead of $50,000. According to Fidelity, you may be able to take out as much as 50% of the amount you have saved for retirement. However, not all employers offer 401(k) loan options through their plans and they may not have adopted the new CARES Act provisions at all, so you should check with your current employer to find out. 

A 401(k) loan is unique from a 401(k) withdrawal since you’ll be required to pay the money back (plus interest) over the course of 5 years in most cases. However, the interest you pay actually goes back into your retirement account. Further, you won’t owe income taxes on money you take out in the form of a 401(k) loan. 

Taking Money out of Your 401(k): What You Should Know

Only you can decide whether taking money from your 401(k) is a good idea, but you should know all the pros and cons ahead of time. You should also be aware that the advantages and disadvantages can vary based on whether you borrow from your 401(k) or take a withdrawal without the intention of paying it back. 

If You Qualify Through the CARES Act

With a 401(k) withdrawal of up to $100,000 and no 10% penalty thanks to the CARES Act, the major disadvantage is the fact that you’re removing money from retirement that you will most certainly need later on. Not only that, but you are stunting the growth of your retirement account and limiting the potential benefits of compound interest. After all, money you have in your 401(k) account is normally left to grow over the decades you have until retirement. When you remove a big chunk, your account balance will grow at a slower pace.

As an example, let’s say you have $300,000 in a 401(k) plan and you leave it alone to grow for 20 years. If you achieved a return of 7 percent and never added another dime, you would have $1,160,905.34 after that time. If you removed $100,00 from your account and left the remaining $200,000 to grow for 20 years, on the other hand, you would only have $773,936.89. 

Money you have in your 401(k) account is normally left to grow over the decades you have until retirement. When you remove a big chunk, your account balance will grow at a slower pace.

Also be aware that, while you don’t have to pay the 10% penalty for an early 401(k) withdrawal if you qualify through the CARES Act, you do have to pay income taxes on amounts you take out. 

When you borrow money with a 401(k) loan using new rules from the CARES Act, on the other hand, the pros and cons can be slightly different. One major disadvantage is the fact that you’ll need to repay the money you borrow, usually over a five-year span. You will pay interest back into your retirement account during this time, but this amount may be less than what you would have earned through compound growth if you left the money alone.

Also be aware that, if you leave your current job, you may be required to pay back your 401(k) loan in a short amount of time. If you can’t repay your loan because you are still experiencing hardship, then you could wind up owing income taxes on the amounts you borrow as well as a 10% penalty.

Note: The same rules will generally apply if you quit your job and move out of the United States as well, so don’t think that moving away can get you off the hook from repaying your 401(k) loan. If you’re planning to leave the U.S. and you’re unsure how to handle your 401(k) or 401(k) loan, speaking with a tax expert is your best move. 

Keep in mind that, with both explanations of a 401(k) loan and a 401(k) early withdrawal above, these pros and cons are predicated on the idea you can qualify for the special benefits included in the CARES Act. While the IRS rules for qualifying for a coronavirus withdrawal are fairly broad, you do have to be facing financial hardship or lack of childcare due to coronavirus. You can read all the potential qualification categories on this PDF from the Internal Revenue Service (IRS). 

If You Don’t Qualify Through the CARES Act

If you don’t qualify for special accommodation through the CARES Act, then you will have to pay a 10% penalty on withdrawals from your 401(k) as well as income taxes on amounts you take out. With a traditional 401(k) loan, on the other hand, you may be limited to borrowing just 50% of your vested funds or $50,000, whichever is less.

However, you should note that the IRS extends other hardship distribution categories you may qualify for if you’re struggling financially . You can read about all applicable hardship distribution requirements on the IRS website.

Taking Money Out of Your 401(k): Main Pros and Cons

The situations where you might take money out of your 401(k) can be complicated, but there are some general advantages and disadvantages to be aware of. Before you take money from your 401(k), consider the following:

Pros of taking money out of your 401(k):

  • You are able to access your money, which could be important if you’re suffering from financial hardship. 
  • If you qualify for special accommodations through the CARES Act, you can avoid the 10% penalty for taking money from your 401(k) before retirement age. 
  • You can take out more money (up to $100,000) than usual from your 401(k) with a 401(k) withdrawal or a 401(k) loan thanks to CARES Act rules. 

Cons of taking money out of your 401(k):

  • If you take money out of your 401(k), you’ll have to pay income taxes on those funds.
  • Removing money from your 401(k) means you are reducing your current retirement savings.
  • Not only are you removing retirement savings from your account, but you’re limiting the growth on the money you take out.
  • If you take out a 401(k) loan, you’ll have to pay the money back. 

Alternatives to Taking Money from your 401(k)

There may be some situations where taking money out of your 401(k) makes sense, including instances where you have no other option but to access this money to keep the lights on and food on the table. If you cash out your 401(k) and the market tanks afterward, you could even wind up feeling like a genius. Then again, the chances of optimally timing your 401(k) withdrawal are extremely slim. 

With that being said, if you don’t have to take money out of your 401(k) plan or a similar retirement plan, you shouldn’t do it. You will absolutely want to retire one day, so leaving the money you’ve already saved to grow and compound is always going to leave you ahead in the long run.

With that in mind, you should consider some of the alternatives of taking money from a 401(k) plan:

  • See if you qualify for unemployment benefits. If you were laid off or furloughed from your job, you may qualify for unemployment benefits you don’t even know about. To find out, you should contact your state’s unemployment insurance program. 
  • Apply for temporary cash assistance. If you are facing a complete loss in income, consider applying for Temporary Assistance for Needy Families (TANF), which lets you receive cash payments. To see if you qualify, call your state TANF office. 
  • Take out a short-term personal loan. You can also consider a personal loan that does not use funding from your 401(k). Personal loans tend to come with competitive interest rates for consumers with good or excellent credit, and you can typically choose your repayment term. 
  • Tap into your home equity. If you have more than 20% equity in your home, consider borrowing against that equity with a home equity loan or home equity line of credit (HELOC). Both options let you use the value of your home as collateral, and they tend to offer low interest rates as a result. 
  • Consider a 0% APR credit card. Also look into 0% APR credit cards that allow you to make purchases without any interest charged for up to 15 months or potentially longer. Just remember that you’ll have to repay all the purchases you charge to your card, and that your interest rate will reset to a much higher variable rate after the introductory offer ends. 

The Bottom Line

In times of financial turmoil, it may be tempting to pull money out of your 401(k). After all, it is your money. But the ramifications to your future financial wellbeing may be substantial. The CARES Act has introduced new options to leverage your 401(k), without the normal penalties. Find out if you qualify and take time to understand the details behind the options. We recommend speaking to a tax expert if you have any questions or concerns regarding possible tax penalties.

The traditional wisdom is to leave your retirement untouched, and we agree with that. If you’re in a financial bind, consider other options to get you through the rough patch. Tapping into your 401(k) should really be your last resort.

The post Should I Take Money Out of My 401(k) Now? appeared first on Good Financial Cents®.

Source: goodfinancialcents.com

75 Personal Finance Rules of Thumb

by Posted in Loans, Money Basics Tagged , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

A “rule of thumb” is a mental shortcut. It’s a heuristic. It’s not always true, but it’s usually true. It saves you time and brainpower. Rather than re-inventing the wheel for every money problem you face, personal finance rules of thumb let you apply wisdom from the past to reach quick solutions.

I’m going to do my best Buzzfeed impression today and give you a list of 75 personal finance rules of thumb. Some are efficient packets of advice while others are mathematical shortcuts to save brain space. Either way, I bet you’ll learn a thing or two—quickly—from this list.

The Basics

These basic personal finance rules of thumb apply to everybody. They’re simple and universal.

1. The Order of Operations (since this is one of the bedrocks of personal finance, I wrote a PDF explaining all the details. Since you’re a reader here, it’s free.)

2. Insurance protects wealth. It doesn’t build wealth.

3. Cash is good for current expenses and emergencies, but nothing more. Holding too much cash means you’re losing long-term value.

4. Time is money. Wealth is a measure of how much time your money can buy.

5. Set specific financial goals. Specific numbers, specific dates. Don’t put off for tomorrow what you can do today.

6. Keep an eye on your credit score. Check-in at least once a year.

7. Converting wages to salary: $1/per hour = $2000 per year.

8. Don’t mess with City Hall. Don’t cheat on your taxes.

9. You can afford anything. You can’t afford everything.

10. Money saved is money earned. When you look at your bottom line, saving a dollar has the equivalent effect as earning a dollar. Saving and earning are equally important.

Budgeting

I love budgeting, but not everyone is as zealous as me. Still, if you’re looking to budget (or even if you’re not), I think these budgeting rules of thumb are worth following.

11. You need a budget. The key to getting your financial life under control is making a budget and sticking to it. That is the first step for every financial decision.

12. The 50-30-20 rule of budgeting. After taxes, 50% of your money should cover needs, 30% should cover wants, and 20% should repay debts or invest.

13. Use “sinking funds” to save for rainy days. You know it’ll rain eventually.

14. Don’t mix savings and checking. One saves, the other spends.

15. Children cost about $10,000 per kid, per year. Family planning = financial planning.

16. Spend less than you earn. You might say, “Duh!” But if you’re not measuring your spending (e.g. with a budget), are you sure you meet this rule?

Investing & Retirement

Basic investing, in my opinion, is a ‘must know’ for future financial success. The following rules of thumb will help you dip your toe in those waters.

17. Don’t handpick stocks. Choose index funds instead. Very simple, very effective.

18. People who invest full-time are smarter than you. You can’t beat them.

19. The Rule of 72 (it’s doctor-approved). An investment annual growth rate multiplied by its doubling time equals (roughly) 72. A 4% investment will double in 18 years (4*18 = 72). A 12% investment will double in 6 years (12*6 = 72).

20. “Don’t do something, just sit there.” -Jack Bogle, on how bad it is to worry about your investments and act on those emotions.

21. Get the employer match. If your employer has a retirement program (e.g. 401k, pension), make sure you get all the free money you can.

22. Balance pre-tax and post-tax investments. It’s hard to know what tax rates will be like when you retire, so balancing between pre-tax and post-tax investing now will also keep your tax bill balanced later.

23. Keep costs low. Investing fees and expense ratios can eat up your profits. So keep those fees as low as possible.

24. Don’t touch your retirement money. It can be tempting to dip into long-term savings for an important current need. But fight that urge. You’ll thank yourself later.

25. Rebalancing should be part of your investing plan. Portfolios that start diversified can become concentrated some one asset does well and others do poorly. Rebalancing helps you rest your diversification and low er your risk.

26. The 4% Rule for retirement. Save enough money for retirement so that your first year of expenses equals 4% (or less) of your total nest egg.

27. Save for your retirement first, your kids’ college second. Retirees don’t get scholarships.

28. $1 invested in stocks today = $10 in 30 years.

29. Inflation is about 3% per year. If you want to be conservative, use 3.5% in your money math.

30. Stocks earn 7% per year, after adjusting for inflation.

31. Own your age in bonds. Or, own 120 minus your age in bonds. The heuristic used to be that a 30-year old should have a portfolio that’s 30% bonds, 40-year old 40% bonds, etc. More recently, the “120 minus your age” rule has become more prevalent. 30-year old should own 10% bonds, 40-year old 20% bonds, etc.

32. Don’t invest in the unknown. Or as Warren Buffett suggests, “Invest in what you know.”

Home & Auto

For many of you, home and car ownership contribute to your everyday finances. The following personal finance rules of thumb will be especially helpful for you.

33. Your house’s sticker price should be less than 3x your family’s combined income. Being “house poor”—or having too expensive of a house compared to your income—is one of the most common financial pitfalls. Avoid it if you can.

34. Broken appliance? Replace it if 1) the appliance is 8+ years old or 2) the repair would cost more than half of a new appliance.

35. Used car or new car? The cost difference isn’t what it used to be. The choice is even.

36. A car’s total lifetime cost is about 3x its sticker price. Choose wisely!

37. 20-4-10 rule of buying a vehicle. Put 20% of the vehicle down in cash, with a loan of 4 years or less, with a monthly payment that is less than 10% of your monthly income.

38. Re-financing a mortgage makes sense once interest rates drop by 1% (or more) from your current rate.

39. Don’t pre-pay your mortgage (unless your other bases are fully covered). Mortgages interest is deductible, and current interest rates are low. While pre-paying your mortgage saves you that little bit of interest, there’s likely a better use for you extra cash.

40. Set aside 1% of your home’s value each year for future maintenance and repairs.

41. The average car costs about 50 cents per mile over the course of its life.

42. Paying interest on a depreciating asset (e.g. a car) is losing twice.

43. Your main home isn’t an investment. You shouldn’t plan on both living in your house forever and selling it for profit. The logic doesn’t work.

44. Pay cash for cars, if you can. Paying interest on a car is a losing move.

45. If you’re buying a fixer-upper, consider the 70% rule to sort out worthy properties.

46. If you’re buying a rental property, the 1% rule easily evaluates if you’ll get a positive cash flow.

Spending & Debt

Do you spend money? (“What kind of question is that?”) Then these personal finance rules of thumb will apply to you.

47. Pay off your credit card every month.

48. In debt? Use psychology to help yourself. Consider the debt snowball or debt avalanche.

49. When making a purchase, consider cost-per-use.

50. Make your spending tangible with a ‘cash diet.’

51. Never pay full price. Shop around and do your research to get the best deals. You can earn cash back when you shop online, score a discount with a coupon code, or a voucher for free shipping.

52. Buying experiences makes you happier than buying things.

53. Shop by yourself. Peer pressure increases spending.

54. Shop with a list, and stick to it. Stores are designed to pull you into purchases you weren’t expecting.

55. Spend on the person you are, not the person you want to be. I love cooking, but I can’t justify $1000 of professional-grade kitchenware.

56. The bigger the purchase, the more time it deserves. Organic vs. normal peanut butter? Don’t spend 10 minutes thinking about it. $100K on a timeshare? Don’t pull the trigger when you’re three margaritas deep.

57. Use less than 30% of your available credit. Credit usage plays a major role in your credit score. Consistently maxing out your credit hurts your credit score. Aim to keep your usage low (paying off every month, preferably).

58. Unexpected windfall? Use 5% or less to treat yourself, but use the rest wisely (e.g. invest for later).

59. Aim to keep your student loans less than one year’s salary in your field.

The Mental Side of Personal Finance

At the end of the day, you are what you do. Psychology and behavior play an essential role in personal finance. That’s why these behavioral rules of thumb are vital.

60. Consider peace of mind. Paying off your mortgage isn’t always the optimum use of extra money. But the peace of mind that comes with eliminating debt—it’s huge.

61. Small habits build up to big impacts. It feels like a baby step now, but give yourself time.

62. Give your brain some time. Humans might rule the animal kingdom, but it doesn’t mean we aren’t impulsive. Give your brain some time to think before making big financial decisions.

63. The 30 Day Rule. Wait 30 days before you make a purchase of a “want” above a certain dollar amount. If you still want it after waiting and you can afford it, then buy it.  

64. Pay yourself first. Put money away (into savings or investment accounts) before you ever have a chance to spend it.

65. As a family, don’t fall into the two-income trap. If you can, try to support your lifestyle off of only one income. Should one spouse lose their job, the family finances will still be stable.

66. Every dollar counts. Money is fungible. There are plenty of ways to supplement your income stream.

67. Savor what you have before buying new stuff. Consider the fulfillment curve.

68. Negotiating your salary can be one of the most important financial moves you make. Increasing your income might be more important than anything else on this list.

69. Direct deposit is the nudge you need. If you don’t see your paycheck, you’re less likely to spend it.

70. Don’t let comparison steal your joy. Instead, use comparisons to set goals. (net worth).

71. Learning is earning. Education is 5x more impactful to work-life earnings than other demographics.

72. If you wouldn’t pay in cash, then don’t pay in credit. Swiping a credit card feels so easy compared to handing over a stack of cash. Don’t let your brain fool itself.

73. Envision a leaky bucket. Water leaking from the bottom is just as consequential as water entering the top. We often ignore financial leaks (e.g. fees), since they’re not as glamorous—but we shouldn’t.

74. Forget the Joneses. Use comparisons to motivate healthier habits, not useless spending.

75. Talk about money! I know it’s sometimes frowned upon (like politics or religion), but you can learn a ton from talking to your peers about money. Unsure where to start? You can talk to me!

The Last Personal Finance Rule of Thumb

Last but not least, an investment in knowledge pays the best interest.

Boom! Got ’em again! Ben Franklin streaks in for another meta appearance. Thanks Ben!

If you enjoyed this article and want to read more, I’d suggest checking out my Archive or Subscribing to get future articles emailed to your inbox.

This article—just like every other—is supported by readers like you.

Source: bestinterest.blog

What You Need to Know About Filing Taxes Jointly

by Posted in Refinance, Taxes Tagged , , , , , , , , , , , , , , , , , , , , ,

couple filing taxes jointly

As a married couple, you and your spouse have the option of filing taxes jointly or separately. The IRS does encourage you to file your income tax returns jointly by providing a host of resources and incentives to do so. There are a lot of advantages to filing taxes jointly. However, there are also some instances where doing so might not be the best idea for your circumstances. Here are some things to know about filing taxes jointly and what it means for your finances.

What Does Filing Taxes Jointly Mean?

The IRS allows you to file taxes jointly as a married couple if you are married by the final day of the tax year-the 31st of December. Even if you are in the process of divorcing but haven’t finalized it by December 31st, you’re still considered married.

As a married couple filing under the “Married Filing Jointly” status, both of you can record:

  • Both your incomes
  • Each of your exemptions
  • Each of your deductions

Experts agree that filing your taxes jointly only works if one of you has a significantly higher income. However, if both of you work and have itemized deductions that are both large and unequal, then it may be a better idea to file separately.

However, the IRS considers you unmarried if the following conditions apply to your union:

  • You and your spouse lived apart from each other for at least the last six months of the year-business trips, military service, school and medical care are not taken into consideration.
  • You were the primary shelter provider for your dependents for at least the last six months of the year.
  • You paid over half the cost of upkeep for your home in the last six months of the year.

Whenever you choose to file your income taxes jointly, you need to realize that both of you are legally responsible for both the taxes and returns. If one of you understates the taxes due or tries to trick the system, then both of you are held liable for the penalties that are incurred. That is, unless one of you can prove that he/she wasn’t aware of what the husband/wife was doing and did not benefit in any way from the deceit. Proving this can be difficult because your finances are intertwined.

Tax law is tricky. If you and your spouse are having a difficult time determining your tax liability, it would be best to talk to an experienced tax preparer to ensure that you file your income tax return correctly. Whenever you file your taxes under married filing jointly, both of you will use the same tax return to report your income, credits, exemptions and tax deductions.

What Kind of Tax Credits Are Available for People Who File Jointly?

Several advantages come with filing taxes jointly. Primarily, these advantages come in the form of tax credits for couples who choose to file jointly. Some available tax credits include:

Earned Income Tax Credit

The Earned Income Tax Credit is one of the most substantial credits you can get from filing jointly. Generally speaking, this tax credit offsets some of your Social Security taxes. Your eligibility as well as the amount of credit is determined by your gross income, investment income and earned income. Here are some of the associated eligibility terms:

  • You have to be at least 25 years old but younger than 65 years.
  • Both of you must have valid Social Security numbers.
  • Both of you must have lived in the country for more than six months.

If you are married but decide to file separately, you don’t qualify for this credit.

American Opportunity Tax Credit

Formerly known as the Hope Credit, the American Opportunity Tax Credit helps families pay for four years of post-high school education. As a married couple filing jointly, the full American Opportunity Tax Credit is available if your adjusted gross income is $160,000 or less. The students in question must be enrolled for at least half-time and be in the school for at least one academic year. The best part is that this credit is offered on a per-student basis.

Lifetime Learning Credit

Similar to the American Opportunity Tax Credit, the Lifetime Learning Credit was also set up to help pay for post-secondary education. The main difference is that the LLC is available for many years of post-secondary education as opposed to just the first four as is the case with the American Opportunity Tax Credit. As a married couple filing jointly, you could get up to $2,000 per-student if you make less than $114,000 jointly.

Child and Dependent Care Credit

If you have to pay for childcare for kids under 13 years of age, then the Child and Dependent Care Credit is there for you. The credit is also available if you’re caring for a spouse or a dependent who is either physically or mentally incapable of taking care of themselves. The credit gives you up to 35% of qualifying expenses.

Savers Tax Credit

Formerly known as the Retirements Savings Contribution, the Savers Tax Credit is available to you if you have a qualified investment retirement account such as a 401(k) and other specific retirement plans. When filing jointly, you can get up to $2,000 in credit.

The Pros and Cons of Filing Taxes Jointly

Typically, the benefits of filing jointly tend to outweigh the cons. Here are some advantages of filing taxes jointly:

  • You can use your spouse as a tax shelter and save money.
  • Your jobless spouse can have an IRA.
  • You can greatly benefit from the tax credits that come with filing jointly.
  • Filing together can take less time and cost you less.

As is the case with everything that has a positive side, filing jointly also has its negative side:

  • Both spouses are responsible for the returns.
  • Your refunds can be blocked if one of you has a garnishment for unpaid child support or loan.

How Filing Taxes Jointly Works for Same-Sex Marriage

The Treasury and the IRS announced that all legally married same-sex couples must adhere to the same rules and laws as married heterosexual couples. That means that you can either file taxes jointly or separately.

When it comes to income and gift and estate taxes, they’re be treated the same as any other couple filing a joint tax return. It also applies to their filing status, their exemptions, standard deduction, employee benefits, IRA contributions, and the earned income and child tax credits.

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How to Avoid Paying Taxes on a Savings Bond

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U.S. savings bondsSavings bonds can be a safe way to save money for the long term while earning interest. You might use savings bonds to help pay for your child’s college, for example, or to set aside money for your grandchildren. Once you redeem them, you can collect the face value of the bond along with any interest earned. It’s important to realize, however, that interest on savings bonds can be taxed. If you’re wondering, how you can avoid paying taxes on savings bonds there are a few things to keep in mind. Of course, one key thing to keep in mind is that a financial advisor can be immensely helpful in minimizing your taxes.

How Savings Bonds Work

Savings bonds are issued by the U.S. Treasury. The most common savings bonds issued are Series EE bonds. These electronically issued bonds earn interest if you hold them for 30 years. Depending on when you purchased Series EE bonds, they may earn either a fixed or variable interest rate.

You can buy up to $10,000 in savings bonds per year if you file taxes as a single person. The cap doubles to $20,000 for married couples who file a joint return. If you decide you want to use some or all of your tax refund money to purchase savings bonds, you can earmark an additional $5,000 for Series I bonds. These are paper bonds, not electronic ones.

When Do You Pay Taxes on Savings Bond Interest?

When you’ll have to pay taxes on Treasury-issued savings bonds typically depends on the type of bond involved and how long you hold the bond. The Treasury gives you two options:

  • Report interest each year and pay taxes on it annually
  • Defer reporting interest until you redeem the bonds or give up ownership of the bond and it’s reissued or the bond is no longer earning interest because it’s matured

According to the Treasury Department, it’s typical to defer reporting interest until you redeem bonds at maturity. With electronic Series EE bonds, the redemption process is automatic and interest is reported to the IRS. Interest earnings on bonds are reported on IRS Form 1099-INT.

It’s important to keep in mind that savings bond interest is subject to more than one type of tax. If you hold savings bonds and redeem them with interest earned, that interest is subject to federal income tax and federal gift taxes. You won’t pay state or local income tax on interest earnings but you may pay state or inheritance taxes if those apply where you live.

How Can I Avoid Paying Taxes on Savings Bonds?

Whether you have to pay taxes on savings bonds depends on who owns it. Generally, taxes are owed on interest earned if you’re the only bond owner or you use your own funds to buy a bond that you co-own with someone else.

If you buy a bond but someone else is named as its only owner, they would be responsible for the taxes due. When you co-own a bond with someone else and share in funding it, or if you live in a community property state, you’d also share responsibility for the taxes owed with your co-owner or spouse.

Use the Education Exclusion 

The word "TAX" spelled out with blocksWith that in mind, you have one option for avoiding taxes on savings bonds: the education exclusion. You can skip paying taxes on interest earned with Series EE and Series I savings bonds if you’re using the money to pay for qualified higher education costs. That includes expenses you pay for yourself, your spouse or a qualified dependent. Only certain qualified higher education costs are covered, including:

  • Tuition
  • Fees
  • Some books
  • Equipment, such as a computer

You can still use savings bonds to pay for other education expenses, such as room and board or activity fees, but you wouldn’t be able to avoid paying taxes on interest.

Additionally, there are a few other rules that apply when using savings bonds to pay for higher education:

  • Bonds must have been issued after 1989
  • Bond owners must have been at least 24 years of age at the time the bonds were issued
  • Education costs must be paid using bond funds in the year the bonds are redeemed
  • Funds can only be used to pay for expenses at a school that’s eligible to participate in federal student aid programs

If you’re married you and your spouse have to file a joint return to take advantage of the education exclusion. And any money from a savings bond redemption that doesn’t go toward higher education expenses can still be taxed at a prorated amount.

There are also income thresholds you need to observe. For 2020, single tax filers can earn up to $82,350 and benefit from the full exclusion. Married couples filing jointly can do so with up to $123,550 in income. Once your income passes those limits, the amount of interest you can exclude is reduced until it eventually phases out altogether.

Roll Savings Bonds Into a College Savings Account

Another strategy for how to avoid taxes on savings bond interest involves rolling the money into a college savings account. You can roll savings bonds into a 529 college savings plan or a Coverdell Education Savings Account (ESA) to avoid taxes.

There are some advantages to either approach. With a 529 college savings plan, you can continue saving money on a tax-advantaged basis for higher education. You won’t pay any taxes on money that’s withdrawn for qualified education expenses. And if you have multiple children, you can reassign the account to a different beneficiary if one child decides he or she doesn’t want to go to college or doesn’t use up all the money in the account.

Contributions to 529 college savings accounts aren’t tax-deductible at the federal level, though some states do allow you to deduct contributions. You don’t have to live in any particular state to invest in that state’s 529 and plans can have very generous lifetime contribution limits. Keep in mind that gift tax exclusion limits still apply to any money you add to a 529 on a yearly basis.

Coverdell ESAs have lower annual contribution limits, capped at $2,000 per child. You can only contribute to one of these accounts on behalf of a child up to their 18th birthday. Withdrawals are tax-free when the money is used for qualified education expenses. But you have to withdraw all the funds by age 30 to avoid a tax penalty.

The Bottom Line

A Patriot BondSavings bonds typically offer a lower rate of return compared to stocks, mutual funds or other higher-risk securities. But they can be a good savings option if you want something that can earn interest over the long term. Minimizing the taxes you pay on that interest may be possible if you have children and you plan to use some or all of your savings bonds to help pay for college. Talking to a tax professional can also help with finding other college tax savings strategies.

Tips for Investing

  • Consider talking to a financial advisor about the best ways to manage savings bonds in your portfolio. If you don’t have a financial advisor yet, finding one doesn’t have to be difficult. SmartAsset’s financial advisor matching tool can make it easy to connect with professional advisors locally in just minutes. If you’re ready, get started now.
  • Savings bonds purchased on behalf of grandchildren don’t receive the same tax treatment for higher education purposes. Generally, the education exclusion only applies if the grandparent is claiming a grandchild on their taxes as a dependent. If your parents are interested in helping pay for your child’s college expenses, you may encourage them to open a 529 college savings account instead, then roll the bonds into it to avoid paying taxes on interest earned.

Photo credit: ©iStock.com/JJ Gouin, ©iStock.com/stockstudioX, ©iStock.com/larryhw

The post How to Avoid Paying Taxes on a Savings Bond appeared first on SmartAsset Blog.

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Got Cash? What to Do with Extra Money

by Posted in Uncategorized Tagged , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

I received a great email from Magen L., who says:

I no longer have any retirement savings because I cashed it all out to pay my debt. We also sold our home and moved into an apartment just as the pandemic was hitting. With the sale of our house, the fact that my husband is working overtime, and the stimulus money, we've saved nearly $10,000 and should have more by the end of the year. My primary question is, what should we do with it?

Right now, I have our extra money in a low-interest bank savings [account], and I'm considering moving it to a high-yield savings [account] as our emergency fund. Is that a good idea? For additional money we save, I intend to use it as a down payment on a new house. However, should I be investing in Roth IRAs instead? What is the best option?

Another question comes from Bianca G., who says:

I have zero credit card debt, but I have a car loan and a student loan. I will be receiving a large amount of money sometime next year. If my fiancé and I want to buy a home, is it better to pay off my car first and then my student loan, or should I just pay down a big portion of my student loan?

Thanks Megan and Bianca for your questions. I'll answer them and give you a three-step plan to prioritize your extra money and make your finances more secure. No matter if you're a good saver or you get a cash windfall from a tax refund, an inheritance, or the sale of a home, extra money should never be squandered.

What to do with extra cash

Maybe you're like Magen and have extra cash that could be working harder for you, but you're not sure what to do with it. You may even be paralyzed and do nothing because you have a deep-seated fear of making a big mistake with your cash.

In some cases, having your money sit idle is precisely the right financial move. But it depends on whether or not you've accomplished three fundamental financial goals, which we'll cover.

To know the right way to manage extra cash, you need to step back and take a holistic view of your entire financial life.

To know the right way to manage extra cash, you need to step back and take a holistic view of your entire financial life. Consider what you're doing right and where you're vulnerable.

Try using a three-pronged approach that I call the PIP plan, which stands for:

  1. Prepare for the unexpected
  2. Invest for the future
  3. Pay off high-interest debt

Let's examine each one to understand how to use the PIP (prepare, invest, and pay off) approach for your situation.

How to prepare for the unexpected

The first fundamental goal you should have is to prepare for the unexpected. As you know, life is full of surprises. Some of them bring happiness, but there's an infinite number of devastating events that could hurt you financially.

In an instant, you could get fired from your job, experience a natural disaster, get a severe illness, or lose a spouse. If 2020 has taught us anything, it's that we have to be as mentally, physically, and financially prepared as possible for what may be around the corner. 

While no amount of money can reverse a tragedy, having safety nets can protect your finances. That makes coping with a tragedy easier.

Getting equipped for the unexpected is an ongoing challenge. Your approach should change over time because it depends on your income, debt, number of dependents, and breadwinners in a family.

While no amount of money can reverse a tragedy, having safety nets—such as an emergency fund and various types of insurance—can protect your finances. That makes coping with a tragedy easier.

Everyone should accumulate an emergency fund equal to at least three to six months' worth of their living expenses. For instance, if you spend $3,000 a month on essentials—such as housing, utilities, food, and debt payments—make a goal to keep at least $9,000 in an FDIC-insured bank savings account.

While keeping that much in savings may sound boring, the goal for an emergency fund is safety, not growth. The idea is to have immediate access to your cash when you need it. That's why I don't recommend investing your emergency money unless you have more than a six-month reserve.

The goal for an emergency fund is safety, not growth.

If you don't have enough saved, aim to bridge the gap over a reasonable period. For instance, you could save one half of your target over two years or one third over three years. You can put your goal on autopilot by creating an automatic monthly transfer from your checking into your savings account.

Megan mentioned using high-yield savings, which can be a good option because it pays a bit more interest for large balances. However, the higher rate typically comes with limitations, such as applying only to a threshold balance, so be sure to understand the account terms.

Insurance protects your finances

Another critical aspect of preparing for the unexpected is having enough of the right kinds of insurance. Here are some policies you may need:

  • Auto insurance if you drive your own or someone else's vehicle
  • Homeowners insurance, which is typically required when you have a mortgage
  • Renters insurance if you rent a home or apartment
  • Health insurance, which pays a portion of your medical bills
  • Disability insurance replaces a percentage of income if you get sick or injured and can no longer work
  • Life insurance if you have dependents or debt co-signers who would suffer financial hardship if you died

RELATED: How to Create Foolproof Safety Nets

How to invest for your future

Once you get as prepared as possible for the unexpected by building an emergency fund and getting the right kinds of insurance, the next goal I mentioned is investing for retirement. That’s the “I” in PIP, right behind prepare for the unexpected.

Investments can go down in value—you should never invest money you can’t live without.

While many people use the terms saving and investing interchangeably, they’re not the same. Let’s clarify the difference between investing and saving so you can think strategically about them:

Saving is for the money you expect to spend within the next few years and don’t want to risk losing it. In other words, you save money that you want to keep 100% safe because you know you’ll need it or because you could need it. While it won’t earn much interest, you’ll be able to tap it in an instant.

Investing is for the money you expect to spend in the future, such as in five or more years. Purchasing an investment means you’re exposing money to some amount of risk to make it grow. Investments can go down in value; therefore, you should never invest money you can’t live without.

In general, I recommend that you invest through a qualified retirement account, such as a workplace plan or an IRA, which come with tax benefits to boost your growth. My recommendation is to contribute no less than 10% to 15% of your pre-tax income for retirement.

Magen mentioned Roth IRAs, and it may be a good option for her to rebuild her retirement savings. For 2020, you can contribute up to $6,000, or $7,000 if you’re over age 50, to a traditional or a Roth IRA. You typically must have income to qualify for an IRA. However, if you’re married and file taxes jointly, a non-working spouse can max out an IRA based on household income.

For workplace retirement plans, such as a 401(k), you can contribute up to $19,500, or $26,000 if you’re over 50 for 2020. Some employers match a certain percent of contributions, which turbocharges your account. That’s why it’s wise to invest enough to max out any free retirement matching at work. If your employer kicks in matching funds, you can exceed the annual contribution limits that I mentioned.

RELATED: A 5-Point Checklist for How to Invest Money Wisely

How to pay off high-interest debt

Once you're working on the first two parts of my PIP plan by preparing for the unexpected and investing for the future, you're in a perfect position also to pay off high-interest debt, the final "P."

Always tackle your high-interest debts before any other debts because they cost you the most. They usually include credit cards, car loans, personal loans, and payday loans with double-digit interest rates. Remember that when you pay off a credit card that charges 18%, that's just like earning 18% on an investment after taxes—pretty impressive!

Remember that when you pay off a credit card that charges 18%, that's just like earning 18% on an investment after taxes—pretty impressive!

Typical low-interest loans include student loans, mortgages, and home equity lines of credit. These types of debt also come with tax breaks for some of the interest you pay, making them cost even less. So, don't even think about paying them down before implementing your PIP plan.

Getting back to Bianca's situation, she didn't mention having emergency savings or regularly investing for retirement. I recommend using her upcoming cash windfall to set these up before paying off a low-rate student loan.

Let's say Bianca sets aside enough for her emergency fund, purchases any missing insurance, and still has cash left over. She could use some or all of it to pay down her auto loan. Since the auto loan probably has a higher interest rate than her student loan and doesn't come with any tax advantages, it's wise to pay it down first. 

Once you've put your PIP plan into motion, you can work on other goals, such as saving for a house, vacation, college, or any other dream you have. 

Questions to ask when you have extra money

Here are five questions to ask yourself when you have a cash windfall or accumulate savings and aren’t sure what to do with it.

1. Do I have emergency savings?

Having some emergency money is critical for a healthy financial life because no one can predict the future. You might have a considerable unexpected expense or lose income.  

Without emergency money to fall back on, you're living on the edge, financially speaking. So never turn down the opportunity to build a cash reserve before spending money on anything else.

2. Do I contribute to a retirement account at work?

Getting a windfall could be the ticket to getting started with a retirement plan or increasing contributions. It's wise to invest at least 10% to 15% of your gross income for retirement.

Investing in a workplace retirement plan is an excellent way to set aside small amounts of money regularly. You'll build wealth for the future, cut your taxes, and maybe even get some employer matching.

3. Do I have an IRA?

Don't have a job with a retirement plan? Not a problem. If you (or a spouse when you file taxes jointly) have some amount of earned income, you can contribute to a traditional or a Roth IRA. Even if you contribute to a retirement plan at work, you can still max out an IRA in the same year—which is a great way to use a cash windfall.

4. Do I have high-interest debt?

If you have expensive debt, such as credit cards or payday loans, paying them down is the next best way to spend extra money. Take the opportunity to use a windfall to get rid of high-interest debt and stay out of debt in the future. 

5. Do I have other financial goals?

After you’ve built up your emergency fund, have money flowing into tax-advantaged retirement accounts, and are whittling down high-interest debt, start thinking about other financial goals. Do you want to buy a house? Go to graduate school? Send your kids to college?

How to manage a cash windfall

Review your financial situation at least once a year to make sure you’re still on track.

When it comes to managing extra money, always consider the big picture of your financial life and choose strategies that follow my PIP plan in order: prepare for the unexpected, invest for the future, and pay off high-interest debt.

Review your situation at least once a year to make sure you’re still on track. As your life changes, you may need more or less emergency money or insurance coverage.

When your income increases, take the opportunity to bump up your retirement contribution—even increasing it one percent per year can make a huge difference.

And here's another important quick and dirty tip: when you make more money, don't let your cost of living increase as well. If you earn more but maintain or even decrease your expenses, you'll be able to reach your financial goals faster.

Source: quickanddirtytips.com

What Causes of Death are not Covered by Life Insurance?

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The death of a loved one is hard to take and while a life insurance payout can ease the burden and allow you to continue leaving comfortably, it won’t take the grief or the heartbreak away. What’s more, if that life insurance policy refuses to payout, it can make the situation even worse, adding more stress, anxiety, anger, and frustration to an already emotional period.

But why would a life insurance claim be refused; what are the causes of death that may cause your life insurance coverage to become null and void? If you or a loved one has a life policy, this article could provide some essential information as we look at the reasons a death claim may be refused.

What Causes of Death are Not Covered?

The extent of your life insurance coverage will depend on your specific policy and this is something you should check when filing your life insurance application. Speak with your insurance agent, ask questions, and always do your due diligence so that you know what you’re buying into and what sort of deaths it will provide cover for.

Life insurance policies have something known as a contestability period, which typically lasts for 1 to 2 years and begins as soon as the policy starts. If the policyholder dies during this time, they will investigate and contest the death. 

This is generally true whether her you die of a heart attack, cancer or suicide. However, if this period has passed, they may only contest the death if it results from one of the following.

Suicide

Suicide is a contentious issue where life insurance is concerned. On the one hand, it’s a very serious issue and one that’s often the result of mental health problems, so there are those who believe it is deserving of the same respect as any other illness. 

On the other hand, the life insurance companies are concerned that allowing such coverage will encourage desperate people to kill themselves so their loved ones will be financially secure.

It’s a touchy subject, and that’s why many companies refuse to go anywhere near it. Some will outright refuse to pay out for suicide, but the majority have a suicide clause, whereby they only payout if the death occurs after a specific period of time.

If it occurs before this time, they may return the premiums or pay nothing at all. And if they have reason to believe that the policyholder took their own life just for financial gain, they will almost certainly investigate and may refuse to pay.

Dangerous Hobbies and Driving

If you die in a car accident and it is deemed that you were driving drunk, your policy may not payout. Car accident deaths are common, and this is a cause of death that policies do generally cover, but only when you weren’t doing something illegal or driving recklessly.

Deaths from extreme activities like bungee jumping or skydiving may be questioned, especially if these hobbies were not reported during the application. 

Illegal Acts

Your claim can be denied if you are committing an illegal act at the time of your death. This can include everything from being chased by the police to trespassing. A benefit may also be refused if you die for an intentional drug overdose using non-prescription drugs. 

Smoking or Pre-existing Health Issue

Honesty is key, and if you lie during the application or “forget” to tell them about your smoking status or pre-existing medical conditions, they may refuse to payout. It doesn’t matter if they performed a medical exam or not; the onus is not on them to spot your lie, it’s on you not to tell it in the first place.

This is one of the most common reasons for an insurance contract to be declared void, as applicants go in search of the cheapest premiums they can get and do everything they can to bring those costs down. They may also believe they will get away with their lies, either because they will give up smoking in a few months or years or because they will die from something other than their preexisting condition.

But lying in this manner is risky. You have to ask yourself whether it’s worth paying $100 a month for a valid policy that will payout without issue or $50 for a policy that will likely be refused and will cause endless stress for your beneficiaries.

War

Life insurance benefits generally don’t extend to the battlefield. If you’re a solider on the front line, your risk of death increases significantly, and many insurance policies won’t cover you for this. This is true even if you’re not in active duty at the time you take out the policy. More importantly, it also applies to correspondents and journalists.

You don’t invalidate your policy by going to a war-torn country and reporting, but if you die resulting from that trip, your policy will not payout.

Dismemberment

Your life insurance policy likely won’t pay for dismemberment or critical illness, but there are additional policies and add-ons that will provide cover. You can get these alongside permanent life insurance and term life insurance to provide you with more cover and peace of mind. 

They will come at a significant extra cost, but unlike traditional life insurance, they will payout when you are still alive and may make life easier after experiencing a tragic accident or serious illness.

We recommend focusing on getting life insurance first, securing the amount of coverage you need from a permanent or term life policy, and only then seeing if there is room in your budget for these additional options.

How Often Do Life Insurance Policies Payout?

We have recommended life insurance many times at PocketYourDollars and will continue to do so. We often state that it is essential if you have dependents and want to ensure they’re cared for when you die. But as much as we recommend it and as simple as the process of applying often is, there is one simple fact that we often overlook:

Life insurance companies rarely payout.

It’s a stat you may have seen elsewhere and it’s 100% true. However, contrary to what you might have heard or assumed; this is not the result of a refusal to pay the death benefit when the policyholder passes away. Sure, this accounts for some of those non-payments, but for the most part, it’s down to one of the following:

The Policyholder Survives the Term

The majority of life insurance policies are set to fixed terms, such as 10, 20 or 30 years. If anything happens during this period of time, your loved ones collect your death benefit, but if you survive, the policy ends, no money is paid out, and if you want another policy you will need to pay a larger sum.

The Policyholder Accepts the Cash Value

Whole life insurance policies are like investments crossed with life insurance. Your loved ones get a death benefit if you die, but it also accrues interest and can be cashed out. When this happens, the insurer collects, you get a sum of money, and it feels like a win-win, but in reality, the insurer has just dodged a bullet.

The Policyholder Stops Making Payments

As soon as you stop making your premium payments, you lose cover and you run the risk of your policy being canceled. This is true for pretty much any type of policy and it happens regardless of the policy term. 

Unlike a credit card company, which may chase you for payments, a life insurance company will place the burden of responsibility on you. After all, a creditor loses money when you don’t pay, whereas a life insurance company comes out on top.

This often happens when individuals take out substantial life insurance policies at a young age, only to suffer drastically changing circumstances. Imagine, for instance, that you’re 20-years-old and you buy a house with your spouse-to-be, with a view to settling down and starting a family. You assume that you’ll need it for a long time, so you take out a 30-year-term.

But 10 years down the line, your spouse leaves you, the family you wanted didn’t happen, and you’re all alone with no dependents, and with growing debts, bills, and obligations. At that point, life insurance becomes a burden, so you may stop making payments, thus allowing the insurance company to profit from 10 years of insurance premiums.

Summary: It’s Not That Cut-Throat

You don’t have to look far to find consumers who feel they have been wronged by life insurance companies, consumers who will expend a great deal of time and effort into calling out these companies for their perceived wrongdoings. But they often exaggerate the situation due to their extreme anger and this creates unrealistic anxieties and expectations.

The truth is, while there are people who have been genuinely wronged, they are in the extreme minority. The vast majority of family members who were refused a death benefit were let down by the policyholder and by the lies they told on their policy.

Policyholders lie about their weight, smoking status, and medical conditions, and when caught up in this lie, they often claim they made an honest mistake. But the truth is, most life insurance companies will overlook simple mistakes and only really care when it’s obvious that the policyholder lied. 

And let’s be honest, it doesn’t matter how forgetful you are, you’re not going to forget that you’re a chain smoker, alcoholic, drug user, extreme sports fan or that you recently had a medical crisis!

If the policy was filed honestly, you shouldn’t have an issue when you collect, even if it’s still in the contestability period. As discussed above, life insurance companies stack the dice in their favor. They use statistics and probability to carefully set the premiums and benefits, and they rely on policyholders forgetting to pay and outliving the term. They don’t need to “rob” you in order to make a profit. So, be honest when applying and you won’t have anything to fear.

What Causes of Death are not Covered by Life Insurance? is a post from Pocket Your Dollars.

Source: pocketyourdollars.com