Amplify Financial : Your 20's & 30's

Your 20's & 30's

It’s never too early to plan ahead

Here are a few ideas from our financial planner, Dan Dillard, on how best to plan for emergencies, manage cash flow, set realistic goals and work with your partner in managing the household checkbook.

Starting Out

#1 Cash Reserves
Your cash reserves are a pool of funds you keep readily available for access in an emergency or another highly urgent, short-term need. If you are reliant on a single income, your cash reserves should be equal to six months of routine living expenses. If you can depend on two, relatively equal incomes, your cash reserves should hold three to four months of expenses. Occasionally, low job security or a high level of income volatility might suggest having a reserve of up to 12 months of expenses. The actual number of months selected should reflect these and other significant risk factors, such as the adequacy of insurance coverage and the condition of any property you own.

The single greatest threat facing workers today is layoff. Having solid cash reserves can insulate you from some of the immediate effects of losing your job. In the event of a medical emergency or other financial crisis, this cushion could make the difference between staying afloat or sinking into debt.

This money should be kept where it can be readily accessed. A federally insured savings account is considered one of the safest places to put money being reserved for emergencies, but when interest rates are in the basement, there may be better alternatives. Money market deposit accounts and various types of term deposits, such as certificates of deposit (CDs), typically offer higher interest rates with little, if any, increased risk. Term deposits are effectively a loan to the institution and not intended for withdrawal prior to the expiration or maturity date. Financial institutions generally assess a substantial penalty for early withdrawal. Staggering the maturity dates of fixed-term investments provides a means of minimizing the impact of this disadvantage.

If anything is certain, it is that the personal and financial circumstances of you, your family, and your loved ones are very likely to change within the span of a year or two. A new child comes along, an aging parent becomes more dependent, a larger home or new car brings increased expenses, or maturing offspring leave the nest. Because your cash reserve is your first line of protection in a financial crisis, it is important to review it annually. If the amount and structure of your reserve no longer matches current needs, you should make the appropriate adjustments. An overly large reserve can mean that opportunities for better returns are being overlooked. In contrast, an undersized reserve increases the risk for financial chaos and stress in a time of sudden need.

#2 Budget
When most people hear “budget”, they cringe. Many negative feelings are associated with budgeting, and many see it as a financial diet that limits your spending and your enjoyment of life.

A budget is simply a way to track your cash flow, to analyze spending and to identify ways to accomplish your goals. Once you know where your money is going, you can determine how much you have available for savings, re-allocate resources, control spending and plan for future goals.

Before you establish a budget, you should examine your financial goals. Start by making a list of your short-term goals (e.g., new car, vacation) and your long-term goals (e.g., your child’s college education, retirement). Next, ask yourself: How important is it for me to achieve this goal? How much will I need to save? Armed with a clear picture of your goals, you can work toward establishing a budget that will help you reach them.

To develop a budget that is appropriate for your lifestyle, you’ll need to identify your current monthly income and expenses. You can jot the information down with a pen and paper, or you can use one of the many software programs available that are designed specifically for this purpose.

Start by adding up all of your income. In addition to your regular salary and wages, be sure to include other types of income, such as dividends, interest and child support. Next, add up all of your expenses. To see where you have a choice in your spending, it helps to divide them into two categories: fixed expenses (e.g., housing, food, clothing, transportation) and discretionary expenses (e.g., entertainment, vacations, hobbies). You’ll also want to make sure that you have identified any out-of-pattern expenses, such as holiday gifts, car maintenance, home repair and so on. To make sure that you’re not forgetting anything, it may help to look through canceled checks, credit card bills and other receipts from the past year. Finally, as you list your expenses, it is important to remember your financial goals. Whenever possible, treat your goals as expenses and contribute toward them regularly.

Once you’ve added up all of your income and expenses, compare the two totals. To get ahead, you should be spending less than you earn. If this is the case, you’re on the right track, and you need to look at how well you use your extra income. If you find yourself spending more than you earn, you’ll need to make some adjustments. Look at your expenses closely and cut down on your discretionary spending. And remember, if you do find yourself coming up short, don’t worry! All it will take is some determination and a little self-discipline, and you’ll eventually get it right.

#3 Debt Management
Most people view debt management – specifically paying off all debt – as the first rule of personal finance. Debt is normally seen as bad, but if managed properly a lot of the negatives are minimized. Debt can be important, especially when starting out in life. Your first priorities should be to follow steps one and two, and then move on to managing debt

There’s acceptable debt and debt that you should try to eliminate first. Before all else, pay off any friends or family that you owe money to; this can be a cause of stress and tension, and since they aren’t banks, they aren’t normally in the position of extending credit.

Next, work on any revolving debt. Revolving debt is money owed to a creditor who sets your monthly payment based on your current balance. Each month your balance varies based on your spending activity from the previous month and any unpaid amount rolled over.

Our strategy for tackling debt is different and many of our clients have tried it and succeeded at it. Begin by taking what is left over at the end of the pay period and splitting it in half. Apply one half of this to the lowest balance of debt that you owe, and the other half to savings. Don’t worry about the interest rates; just tackle the lowest balance first. Once the balance is paid, take the half plus what you were already paying to the lowest balance and apply to the new lowest balance.

The result of this strategy is that you slowly are building up cash reserves for your next emergency, reserves that will allow you to use cash in a crisis instead of going back into debt. And, by attacking the lowest balances first, you can quickly start reducing the number of accounts you have. The human element feels lighter because you have gotten rid of an entire debt relationship.

As you eliminate your revolving debt, you can begin to chip away at your fixed debt – auto loans, student loans, mortgage debt and any debt that appreciates.

#4 Credit Cards
Credit cards can be a useful tool, but need to be used responsibly. Until you build your cash reserves, you may need to turn to credit in an emergency. If you go this route be sure it is used only for emergencies and that you have a game plan to wean yourself off.

Some credit cards offer rewards. People who use the cards for purchases and pay them off every month can take advantage of the rewards without accruing debt. The rewards accumulate and can be exchanged for cash or ‘free’ hotel stays, airfare or merchandise.

Used properly, credit cards can offer you financial leverage you might not otherwise enjoy. If you pay off your balance in full each month, your credit card account acts as a short-term, interest-free loan. This can help alleviate cash flow problems. You can also use a credit card to make large purchases sooner than you could have otherwise, and to buy items when they’re on sale.

The convenience offered by credit cards can often lead to overspending, however. Monitor your card usage and balances. Understanding how to read your monthly credit card statements can help you do both. Make sure your monthly payments fit comfortably within your budget. Learn the signs of credit abuse, and how to avoid becoming an abuser. You’ll also want to take certain steps to reduce the likelihood of becoming a victim of credit fraud.

If you don’t trust yourself with credit, you can put the credit card in a cup of water and freeze it, or put the card in a safe deposit box at a bank across town to prevent “emotional spending”. In the time it takes for the water to thaw — microwaving won’t work — or for you to drive and retrieve the card, you have time to think about your decision and make sure it truly is an emergency.

#5 Working with your partner managing the finances
Do you share a checking account with your significant other? How hard is that to manage?

The stress of financial management can be hard on a relationship. Lack of communication, feelings of restriction, criticism of spending choices and overspending are the main issues couples face.

There is an unwritten rule, or myth that once you are a couple you must have a shared checking account! I don’t know where this came from but I see it all the time, it’s almost a sign of love that we share a bank account. No, a sign of love can be making the spouse a beneficiary on the account, or even having access for emergencies, but sharing may not be necessary. Should you maintain a joint account? The answer depends on several factors. Among them are how you and your partner feel money should be handled, your respective spending and saving habits and whether there are any reasons to keep your money separate. Many couples find that the best solution is to have a joint account in addition to each keeping an individual account.

When working with your partner remember that you are two different people with different things that you consider important – no one is right or wrong and you have to respect what each other believes to be important to them.

You also need to communicate and set goals of what you both want to achieve. Is it a down payment on a home? A vacation? Money for college? Once you determine your goals, work together to achieve them.

One solution to a single, joint account may be to open up one checking account labeled “household account” from which all household fixed and variable expenses are paid. Both incomes will pour into this account first and this account is where budget or cash flow analysis comes in. In the budget you can determine how much you set aside for goals and for personal expenses.

Now, set up two individual accounts that the household account pours into after fixed expenses are met and any goals are accounted for. These individual accounts provide discretionary money to each partner, and allow him or her the freedom to spend what they want, where they want without criticism from the other partner. Because all expense and savings obligations have already been met, there’s no worry that one person is overspending or dipping into savings for personal expenditures.

Getting Married

Getting married is exciting, but it brings many challenges. One such challenge that you and your spouse will have to face is how to merge your finances. Planning carefully and communicating clearly are important, because the financial decisions that you make now can have a lasting impact on your future. Here are a few suggestions to help ensure smooth financial sailing.

Discuss your financial goals
The first step in mapping out your financial future together is to discuss your financial goals. Start by making a list of your short-term goals (paying off wedding debt, new car, vacation, etc.) and long-term goals (things like having children, your children’s college education, retirement). Then, determine which goals are most important to you. Once you’ve identified the goals that are a priority, you can focus your energy on achieving them.

Prepare a budget
Next, you should prepare a budget that lists all of your income and expenses over a certain time period (monthly or annually). You can designate one spouse to be in charge of managing the budget, or you can take turns keeping records and paying the bills. If both you and your spouse are going to be involved, make sure that you develop a record-keeping system that both of you understand. And remember to keep your records in a joint filing system so that both of you can easily locate important documents.

Begin by listing your sources of income (e.g., salaries and wages, interest, dividends). Then, list your expenses (it may be helpful to review several months of entries in your checkbook and credit card bills). Add them up and compare the two totals. Hopefully, you get a positive number, meaning that you spend less than you earn. If not, review your expenses and see where you can cut down on your spending.

Bank accounts—separate or joint?
At some point, you and your spouse will have to decide whether to combine your bank accounts or keep them separate. Maintaining a joint account does have advantages, such as easier record keeping and lower maintenance fees. However, it’s sometimes more difficult to keep track of how much money is in a joint account when two individuals have access to it. Of course, you could avoid this problem by making sure that you tell each other every time you write a check or withdraw funds from the account. Or, you could always decide to maintain separate accounts.

Credit cards
If you’re thinking about adding your name to your spouse’s credit card accounts, think again. When you and your spouse have joint credit, both of you will become responsible for 100 percent of the credit card debt. In addition, if one of you has poor credit, it will negatively impact the credit rating of the other.

If you or your spouse does not qualify for a card because of poor credit, and you are willing to give your spouse account privileges anyway, you can make your spouse an authorized user of your credit card. An authorized user is not a joint cardholder and is therefore not liable for any amounts charged to the account. Also, the account activity won’t show up on the authorized user’s credit record. But remember, you remain responsible for the account.

Insurance
If you and your spouse each have separate health insurance coverage, you’ll want to do a cost/benefit analysis of each plan to see if you should continue to keep your health coverage separate. For example, if your spouse’s health plan has a higher deductible and/or co-payments or fewer benefits than those offered by your plan, he or she may want to join your health plan instead. You’ll also want to compare the rate for one family plan against the cost of two single plans.

It’s a good idea to examine your auto insurance coverage, too. If you and your partner own separate cars, you may have different auto insurance carriers. Consider pooling your auto insurance policies with one company; many insurance companies will give you a discount if you insure more than one car with them. If one of you has a poor driving record, however, make sure that changing companies won’t mean paying a higher premium.

Employer-sponsored retirement plans
If both you and your spouse participate in an employer-sponsored retirement plan, you should be aware of each plan’s characteristics. Review each plan together carefully and determine which plan provides the best benefits. If you can afford it, you should each participate to the maximum in your own plan. If your current cash flow is limited, you can make one plan the focus of your retirement strategy. Here are some helpful tips:

• If both plans match contributions, determine which plan offers the best match and take full advantage of it
• Compare the vesting schedules for the employer’s matching contributions
• Compare the investment options offered by each plan—the more options you have, the more likely you are to find an investment mix that suits your needs
• Find out whether the plans offer loans—if you plan to use any of your contributions for certain expenses (e.g., your children’s college education, a down payment on a house), you may want to participate in the plan that has a loan provision

Starting a Family

Planning for the birth or adoption of a child is an exciting yet stressful time. Along with the fun of picking out a name for your baby and shopping for baby clothes comes the realization that you’re now responsible for a new life. You’ll naturally start thinking about what kind of life you want your child to have, and you’ll need advice about financial matters, insurance and estate planning.

Having a child will affect you financially
When your family grows, it’s a good time to review or make a budget. Your day-to-day living expenses may increase dramatically, while your income may decrease if you stay home with your baby temporarily or permanently. Your savings plan may change as well if you decide to save for your child’s education or put a portion of your money into an emergency fund. In addition, having a child often affects your taxes positively. Due to the increased exemptions, deductions and credits you may be able to claim, you may find yourself paying less income tax in the future.

Having a child will change your insurance needs
New parents need to protect their families by reviewing their current life, health, and disability insurance, making sure that their current policies are adequate, and purchasing additional insurance if needed.

Having a child means reviewing your estate plan
Planning for your child’s future in the event that you die is crucial. You’ll need to draw up or revise your will, nominate a guardian for your child, review your beneficiary designations and make sure that your assets are distributed according to your wishes. You may also want to set up a trust to ensure that estate funds are used to benefit your child.

Other planning issues
Taking time off from work after the birth of your child
If you’re working, you and your partner (if any) may need to decide whether either one of you wants to stop working temporarily or permanently once your child is born. Either of you may be eligible for short-term paid or unpaid leave from your employer, or you may be able to take up to 12 weeks unpaid leave under the Family and Medical Leave Act of 1993. If you do decide to work, you’ll need to investigate child-care options, perhaps even before your child is born.

Applying for vital records after the birth of your child
It’s important to remember to apply for a Social Security number for your child as soon as possible after he or she is born because you’ll need the number to fill out your income tax return for the year. In addition, you’ll want to apply for a birth certificate. Many hospitals now routinely allow you to apply for these records before you leave the hospital with your child and will file the paperwork for you.

Buying a Home

An old rule of thumb said that you could afford to buy a house that cost between one and a half and two and a half times your annual salary. In reality, there’s a lot more to take into consideration. You’ll want to know not only how much of a mortgage you qualify for, but also how much you can afford to spend on a home. In order to know how much you can truly afford, you need to take an honest look at your lifestyle and your standard of living, as well as your income and what you choose to spend it on.

Getting to the bottom line
If you have unlimited resources, you can afford to buy whatever home your heart desires. For most of us, though, that’s not the case. Unless you can afford to buy a house outright, you’ll probably need to get a mortgage to help you pay for it. So, determining how much house you can afford is often a case of determining how much of a mortgage you can afford. Start with some simple math: Take your monthly income and subtract all of your non-housing-related expenses. What you’re left with is the amount per month that you have available to allocate toward housing.

Other housing expenses to factor in
In determining what you can afford to spend on a home, you should also take into account other housing-related expenses. The total amount of expenses may depend in part on what type of home you buy and where it’s located. Such expenses include:

• Maintenance costs—everything from weekly rubbish removal to a new roof
• Utility costs—electricity, heating and/or air-conditioning, gas, water and/or sewer
• Homeowner association fees or condominium assessment fees

Deduct the monthly portion of these expenses from what you estimated your monthly housing allowance to be, and you’re getting close to determining how much of a monthly mortgage payment you can afford. Of course, mortgage lenders have a slightly more sophisticated way of determining how much they think you can afford.

Lenders use qualifying ratios
Lenders use formulas called qualifying ratios to calculate how much of a mortgage you qualify for. These ratios are based on your gross monthly income, your housing expenses, and your long-term debt.

The first qualifying ratio a lender scrutinizes is your housing expenses to income ratio. According to the Government National Mortgage Association (Ginnie Mae), in order to qualify for a conventional mortgage (one not insured or guaranteed by the federal government), your housing expenses generally should not exceed 28 percent of your gross monthly income. Your monthly housing expenses include mortgage principal, interest, taxes, and insurance; consequently, this ratio is often abbreviated as PITI. The ratio is also known as the front ratio.

The second ratio that a lender looks at (known as the back ratio) is one that takes into account your expenses that extend 11 months or more into the future (e.g., a car or student loan). These expenses are considered long-term debt. Your monthly housing expenses, plus your other long-term debt, determine what’s known as your debt ratio, or PITIO. To qualify for a conventional mortgage, Ginnie Mae indicates that these expenses generally should not exceed 36 percent of your gross monthly income.

Mortgage prequalification and pre-approval
Consider shopping for your mortgage before you start shopping for your house. Compare the mortgage rates and terms offered by various lenders, and then get preapproved or prequalified with the lender of your choice. That way, you’ll know how much you can spend on a house before you fall in love with one that’s just out of your reach. Make sure you understand the difference between prequalification and preapproval.

Prequalification is simply the process of estimating how much money you’ll be able to borrow based on the qualifying ratios appropriate for the type of mortgage you’re considering. Preapproval, on the other hand, means the lender has verified your income and checked your credit references. Once you’re preapproved, you’ll get a letter stating that the lender will give you a mortgage up to a certain amount, provided that certain conditions are met (e.g., the property is appraised for an amount sufficient to cover the mortgage). Preapproval lets you know exactly how large a mortgage you can get. It also gives you more credibility as a buyer, since the preapproval letter lets the seller know that you’ll qualify, financially, for a mortgage if your purchase offer is accepted.

Make sure you really can afford it
Remember that mortgage lenders can only tell you how much of a mortgage you qualify for, not how much you can afford. If homeowners insurance and property taxes are escrowed with your lender, these expenses will increase your monthly mortgage payment. The payment amount will be even more if you’re required to carry specialty policies such as flood or earthquake insurance in addition to homeowners insurance. And if property taxes are especially high, you may find that you’re unable to afford the home.
Tip: Keep in mind that your actual mortgage payment will also depend on your interest rate and the term of the loan. Generally speaking, lower rates of interest and longer terms equal lower monthly mortgage payments.

Now might be the time to think about revising your budget. Perhaps you can think of ways to reduce your non-housing-related expenses; doing so will free up money that you can apply toward your housing costs.

Also keep in mind any future plans that may affect your budget. Perhaps you’ll need to buy a new car in a few years. If you haven’t already done so, perhaps you’ll be starting a family soon. If you have children, as soon as they’re in kindergarten you’ll need to think about saving for their college expenses. No matter how much of a mortgage a lender tells you that you qualify for, you must always be sure your mortgage payment is not beyond your means. After all, it’s the roof over your head.

Saving for College

No matter the age of your child, it’s not too early or late to plan for college expenses. Education savings plans like Section 529s and CESAs allow you to start planning for your child’s future early on. But for those who have not started yet, there are many options available to prepare yourself and your child for an affordable education. Read on to learn more about the opportunities available to your family.

Section 529 Plans
Long-term investment vehicles for education.
Section 529 College Savings Plans are tax-favored college investment programs. You can contribute to a Section 529 Plan regardless of your annual income or age. Each U.S. state sets its own maximum limit for lifetime contributions, but all state plans are in excess of $100,00 with the average limit being about $220,000. With your 529 plan:

• Any earnings accumulate tax-deferred, and withdrawals for qualified expenses are not subject to Federal income tax.
• Withdrawals for non-qualified expense are subject to income tax and a 10% IRS penalty
• Beneficiary may be reassigned to another family member
• Variety of professionally-managed investment options available
• Investment options may be changed annually
• There are several potential Estate Planning benefits

Investors should consider the investment objectives, risks, charges, and expenses associated with a 529 Plan carefully before investing. The issuer’s official statement contains this and other information about the investment. You can obtain an official statement from your financial representative. Read carefully before investing.

Coverdell Education Savings Account (CESA)
Tax-free accounts for educational expenses
CESAs help you save for a child’s primary, secondary or college educational expenses until the child reaches 18. Parents and grandparents may set up a CESA, contributing up to a total of $2000 per year per child. Contributions and earnings may be withdrawn from the CESA tax-free to pay for qualifying education expenses. Non-qualified withdrawals are subject to taxes and penalties. Limitations may apply, but if your income is too high you may have other options.

Savings Bonds
Tax-advantaged education investments
U.S. Series EE and Series I Savings Bonds are another tax-advantaged investment for education expenses. Eligible individuals can use these bonds to pay for a child’s qualifying education expenses while excluding income earned on the bonds for Federal tax purposes. Savings bond interest is also exempt from state and local income taxes. Income limitations apply, and only bonds issued after 1989 can be used.

Custodial Accounts
Gifting assets to your child for potential tax benefits
Custodial accounts, established under the Uniform Gifts to Minors Act and the Uniform Transfers to Minors Act (UGMA/UTMA), are a traditional way to invest for a child’s education. The assets are held in the name of the child, but are managed by the custodian. UGMAs/UTMAs may provide tax benefits for higher income families because the earnings are usually taxed at the child’s tax rate.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.