Arghhhh!!! I Didn't to Save for... Camp, Car Insurance, Property Tax....
Okay, you are getting used to me banging on about SPENDING LESS THAN YOU EARN each month, right? Maybe you’ve even taken my advice, looked at your spending and started spending less than you earn (take-home) each month. Why do you STILL feel so squeezed financially? Is this normal?
Barring any other extraordinary issues like home renovation, divorce, addiction, or secret double-life, the issue may be that you have not accounted for your ANNUAL NEEDS. What are annual needs you might ask, well, remember when you said you didn’t want to pay fees or interest on your car insurance by taking the monthly payment option and you’d be able to pay it every six months? What about when you decided to reduce your monthly mortgage payment in favor of paying your property tax annually? You’d find a way, right. Anyone hear the sound of a can being kicked down the road.
Annual Needs are those items you do not pay for every month (or every other), but you do not as of yet, explicitly save for. They can kick you in the rear financially and also put you on a slippery slope towards revolving credit card debt if you get surpised by them. Here are some typical Annual Needs:
- Insurances - Car, term life, long term care paid every 6 or 12 months
- Property tax
- Family or Summer Vacation
- Summer Camp!!! (what a racket that is…)
- Estimated taxes if you are self-employed
- Christmas travel/gifts/celebrations
- Children’s activities that are paid in one lump sum
Do not forget your Annual Needs! Here’s how I like to remember them:
- Make a list of your Annual Needs
- Ascribe a total amount to each. You will have the exact amount for some like property taxes, and you will have to estimate others like family vacations.
- Total you Annual Needs
- Take the total and divide by 12 (months in the year)
The total divided by 12 gives you the amount you need to put aside each month to cover your annual needs. Save EACH month and put the money in your general savings account until you need it. You can reduce the total by the take-home amount of an annual bonus or a very consistent tax refund and divide the remainder by 12 if you plan to put your annual bonus or tax refund toward the items on your Annual Needs list.
The bottom line you must save for your annual needs as well as spending less than you earn each month to be financially fit. If you know ALL your expenses monthly and annual are taken care of, you will feel more relaxed and fearless about your finances.
Everyone with a Spouse or Children Needs Life Insurance - But Which Type?
Just when you thought my posts couldn’t get any racier, I'm going to discuss the glamorous, exciting world of life insurance. Like flossing, it's not fun or glamorous, but it has to be done. Before you start snoozing, read the rest as it could save you a lot of money.
First, I'm lumping Whole/Universal/Variable together under the word "whole." I define "whole" life insurance as insurance you have UNTIL YOU DIE versus Term life insurance, which you have until the term is over OR you die, whichever comes first. If you have specific questions on Whole/Universal/Variable, email me by just responding to this post.
Term Life insurance provides a benefit to your beneficiary IF you die during the TERM of the insurance policy. You buy Term Life for INCOME REPLACEMENT in the event of your UNTIMELY death. Typically, you would want the term of the policy to be:
- During the time your minor children are economically dependent on you;
- Before you retire, if you have a spouse that depends on your income; and
- Possibly into the early part of your retirement if you still have a mortgage to pay off.
Typically, a married person with kids would buy term life insurance around when they begin having children and would buy it for a term of 20-30 years. It’s generally sold in 5 year increments. If you are in generally good health and a non-smoker, it is far less expensive than Whole Life insurance. It provides the security your family needs until either your kids are launched or you retire. Your retirement takes care of your surviving spouse. Both spouses should have some Term life income replacement until retirement.
Whole Life insurance pays the beneficiary WHEN you die. We will all eventually die. Hopefully, we will be very old when we die. If you die while in retirement and you’ve saved appropriately for retirement, there is NO NEED for income replacement upon your demise.
Aside from making for excellent motives in film noir movies, why would anyone buy a Whole Life policy for themselves or their spouse? There are only two solid reasons to seek out Whole Life insurance and do not let some broker who makes a huge commission selling Whole Life insurance convince you otherwise:
- You have a child(ren) who is disabled and will never be economically independent.
- You have SO MUCH MONEY that your children may face a huge inheritance tax bill when you die and you want them to have some cash to pay uncle Sam when they inherit (so sad for them…)
If you cannot tick the box for either of those two, you DO NOT NEED Whole Life insurance. Yes, brokers will tell you about estate planning and whole life's investment quality and that you can sell it face value whenever you want, but in most cases it would still be better to invest that money directly yourself than try to get some return from a Whole Life policy.
Here’s why: Insurance companies do some math that I won’t bore you with to arrive at a “face value” number. They use a number called a ‘discount rate’. Calculating discount rates is more art than science, but suffice it to say, they set the discount rate so that it benefits THEM not YOU.
As for estate planning, if you planned well, your children will inherit what you saved and invested wisely (and didn't use in retirement). BTW, I feel the same way about annuities, but that's another post.
In general, most people need term life insurance for the time their kids are at home and before they are living fully off retirement benefits. They need enough for income replacement (I will do another post on how much you should have) and they DO NOT NEED Whole Life insurance.
Pay for Stuff with Pre-tax Dollars: Do You Use Your Dependent Care FSA to Full Advantage?
Ask yourself the following questions about your Dependent Care Flexible Spending Account (and you thought today's post wasn't going to be fun!):
- Do you smile and nod when anyone mentions FSA?
- Did you sign up because you heard some parents talk about it at the bake sale last week?
- If somebody bet you a million dollars that you couldn't explain how your FSA works would you lose the bet?
If you answered ‘yes’ to any of those questions, read on. Your FSA stands for Flexible Spending Arrangement (or Account). Here are the things you should know:
- The money you set aside is PRE-TAX thus reducing your taxable income on April 15th
- Married (filing jointly) filers are limited to $5,000/year and single filers $2,500/year
- Only the parent with custody can use an FSA for childcare if you are divorced
- If you married, BOTH spouses must work to qualify unless one spouse is disabled
- Children must be 13 or younger for expenses to qualify
- Adult spouses (or claimed adult dependents) must be unable to work or care for themselves
Okay, now you know if you qualify, what can you spend these lovely pre-tax dollars on?
- Physical and in-home care (e.g. nanny, au pair, daycare, institutional care)
- Summer camps!!!!
- Before or after care
- Transportation provided by a caregiver (e.g. special buses, driving, etc.)
- Application fees and deposits for care, but only if care is actually provided
But, kindergarten, pre-school, summer school, tutoring, tuition DO NOT qualify, neither does babysitting by a minor or sibling. Overnight camp, activities or enrichment programs (like ballet or soccer) and housekeeping DO NOT qualify either.
Here’s what you MUST REMEMBER:
- You MUST USE ALL the funds in your FSA account the year you put them in or they are GONE.
- It’s also your responsibility to put in for reimbursement. DO NOT forget or you will not be paid back.
- You should also weigh the benefits of pre-tax dollars with the child/dependent care tax credit. Take the larger one. This is a good article to help you compare them.
- You have to RE-ENROLL every year, it’s not automatic.
Bottom line is that it’s not a foregone conclusion that you should use your FSA. If you think there’s a chance you may forget to do your reimbursements or not use it all up before the end of the year, DO NOT DO IT. It’s one of those things that sounds good, but is only good if you use it exactly as it is designed.
"Why Can't I have it? I Work Hard." - Entitlement, it's the New Black
In this season of new year's resolutions, why can't people stick to their great intentions for the year? Well, one answer might be that these intentions require commitment and discipline. Those are hard. People feel entitled to a little bit of easy fun; instant gratification, if you will.
Same logic applies to personal finance, unfortunately. Clients ask me all the time, “I work so hard, why can’t I go out a few nights/week?” or “why can’t I buy a pair of shoes or sport gear?” Although you do work hard and earn a good living, you are still not entitled to spend more than you earn. Period. It’s not my rule, it’s a math rule and math does not play favorites. It’s the same for everyone. You could buy on credit that you cannot pay off at the end of the month, but we all know why that’s a bad idea.
You cannot spend more than you earn (you should spend even less so you have some left over for goals and savings, but that’s another post). Using that rule, you have a pot of money that comes into your household each month and a pot that goes out for necessary expenses like mortgage, car payment, electric bill, groceries, etc.
The amount left over after you pay for the “must-haves” each month is for Full Discretionary Spending” or fun like clothes, entertainment, etc. You should have some full discretionary money. You are human after all, but the key is not spending more than you have for full discretionary items. If you want more left over for full discretionary, you need to prioritize.
Here are the priority decisions I recommend you make:
- Instant gratification vs. your long term goals. You have to weigh how great it will feel to pay off all your debt or go on vacation, against how great it will feel for a few minutes to have that sports gear or new pair of shoes. Unfortunately, you may have to remind yourself of that every time you want to buy something that goes OVER your monthly amount of full discretionary money..
- Prioritize your must-haves and try to stream-line. You value going to the gym, but does it have to be a fancy gym or can it be simple and, dare I say, cheap? Is looking good a bigger priority than having more discretionary money for instant gratification? Both are equally valid.
- Keep your eye on the prize. Figure out your 3 key financial goals. Maybe it's private school, a big house, paying off debt, or saving for college? All the other priorities and expenses revolve around your ‘key 3’. If you want a big house, you spend a lot on housing and have less for other things. Keep your key 3 in mind ALL the time including when you feel entitled to something new.
Nothing I’m saying here is new to you, but here’s what you should try to remember:
- You are not entitled to spend more than you earn no matter how much your friends or neighbors earn or have or spend or do. Math is math, it’s that simple.
- You have some full discretionary money. You can go out to eat. Figure out how much full discretionary money works for your household and enjoy it. But, do not spend more than you have.
- Prioritize your expenses and be honest with yourself about what is important to you. Know that all your other decisions allow you to go after your big priorities and get them.
You are doing well. No matter how well you do, your lifestyle and desires will always expand to meet your income… Thinking about your priorities will help you not feel so deprived when you have to say ‘no’ to yourself in order to save for your key 3.