Five-Part Series: Financial Planning for All Ages (Part 2)
We are putting together a five-part series on what financial decisions you should be thinking about as you approach each decade of your adult life from a young adult into your 70’s. The years involved are when individuals generally earn the majority of their lifetime income from work.
In Part 1 of the series we wrote “Approaching 30 years old – How am I doing financially and what can I do to stabilize my financial future?”
Part 2: Approaching 40 years old — How am I doing financially and what can I do to stabilize my financial future?
Part 2 of this series discusses what financial decisions individuals should be considering as they approach the decade when they are aged 40-49. As you approach 40, there are some measurements that can help you determine if you are on the right track financially. In addition, there are actions that you should be taking to stabilize your financial life as you are approaching a time when you have a growing a family, your employment situation is stable, and there are conflicting financial strains on your budget. The list below shows the general changes in priorities for each of the conflicting uses for your limited available funds.
You can contact me to discuss an individualized plan for your family to prioritize the items below as you approach and you are in your forties at email@example.com .
A few strategies and actions that will help you measure how you are doing financially include the following:
- Maintain and update workable budget. Generally, you already have a written budget, so you need to update and maintain the budget if you find that it is not working for your family. The review of your budget should be done at least annually. You may be surprised where your money is going. Ensure that your monthly budget is realistic, include amounts due on a periodic basis such as vehicle insurance due every 6 months, higher utility expenses during certain months (or use budget payments with your utility company), annual homeowners’ association dues, etc.)
- Maintain no credit card or personal loan debt. This is the debt that financial planners and others refer to as “bad debt” because the debt is not secured by an asset and most likely the money was spent on purchases that you could not truly afford. If this debt is not zero, then you should focus on paying it off before you do anything else except funding your short-term emergency fund. No unsecured debt is acceptable for securing your financial future. You should set up a methodical plan to make automatic payments and consider consolidating multiple accounts into one that has a lower interest rate. The interest rate that you pay is based on your credit score, payment history, and market rates.
- Term Life Insurance. The purchase of term life insurance as you approach your forties is no longer an option, but a necessity to provide financial security to your young and growing family. The rule of thumb used to be five times your annual expenses for the death benefit, but new thinking is for a higher death benefit. The thought behind a higher death benefit for your beneficiaries is because of the cost of health insurance for survivors, future education expenses etc. You should secure a term policy of 20-25 years as you are approaching and into your forties to keep total premium costs at the lowest possible level for providing piece of mind to your family. The earlier age that you purchase the insurance, then the lower the annual premium for the 20-25 years to ensure coverage through at least your planned retirement age. The death benefit should be calculated by adding your annual salary (times the number of years that you want to replace income usually at least 5 years) + your mortgage balance + your other debts + future needs such as college and funeral costs. If you’re a stay-at-home parent, include the cost to replace the services that you provide, such as child care. From that amount subtract your liquid assets such as savings, life insurance you already have in place, and education savings. If the cost of the life insurance is not within your current budget, then at least start with a minimum death benefit of five years of your annual income. I can help you in determining your life insurance needs and fitting the premium into your budget, so feel free to reach out.
- Retirement Savings. As you approach a time in your career when opportunities for promotions and setting yourself up for long-term success there will be many conflicting priorities for your limited financial resources. The term used by financial planners is to pay yourself first by contributing at least the amount that your company will match to your retirement plan at work. You should focus the investment choices on long-term growth options in your retirement plan. If you do not have a retirement plan at work, or maximized the amount you are contributing to your defined contribution plan then focus on fully funding a ROTH IRA invested in a diversified set of mutual funds. The contribution limit to a ROTH IRA is currently $6,000 for someone under 50 years of age and you can contribute another $6,000 as a spousal amount even if the spouse is not employed outside the home because they are raising the children. The future of Social Security and Medicare for an adult approaching their forties is concerning, so you have to save more for your own needs and not rely as much on the government programs such as Medicare and Social Security. If a Roth 401(k) is not available from your employer, then contribute enough to your Traditional tax deferred 401(k) to secure the full employer match and contribute the maximum annual amount to a Roth IRA account at a low fee brokerage such as Vanguard, or Fidelity. If you have additional available funds for retirement then contribute more to your tax deferred 401(k).
- Education Savings. As you approach your forties saving funds into a 529 plan that is invested in a stock mutual fund become more of a priority as your family grows and the children approach the middle to end of their secondary school years. As long as the other priorities are taken care of such as emergency fund, no unsecured debt, and maximizing retirement savings, then during your forties this should be a higher priority for your limited available funds even if you increase the savings a small amount each year until your children enter their post-secondary school years. The accounts are transferable to other relatives if the child that you originally set up the account for does not need the money for their education. The eligible education expenses that 529 plan funds can be used for has expanded substantially over time. Qualified higher-education expenses include tuition, fees, textbooks, supplies and equipment required for enrollment, special needs services and, in some cases, room and board costs. Qualified education expenses also now include up to $10,000 of private elementary and secondary school tuition.
- Maximize Credit Score. You need to maintain a maximum personal credit score because your financial options will be significantly hampered by a poor credit score. Everything from insurance rates, mortgage rates, interest rates on financing of purchases, and reducing existing debt are affected by your credit score. A few important actions that you can take is to maintain your high credit score are paying all of your monthly payments in a timely manner, pay off short term debt by the end of the lower interest period if using a low interest deal, maintain a few credit cards with unused credit limit amounts to show borrowing ability, and only keep a few credit card accounts open at a time. Pay off cars before the end of the loan term by adding extra amounts to your monthly payment.
- Maintain Emergency Fund and Build Asset Repair/Replacement Fund. You have built two emergency funds for yourself to cover short-term and long-term unexpected expenses, so you need to replenish amounts that were used. The next level of building financial security is to begin setting aside funds for repairs and future replacement of the items on your home that will become less efficient, unusable, or cost of repair is not financially feasible. My philosophy is for everyone to have two emergency funds, one for short-term needs and one for long-term needs. The short-term emergency fund should be set up at your local main bank. It should be at least enough to cover insurance deductibles for all of your vehicles, medical expenses, and home maintenance expenses. The long-term emergency fund is related to more catastrophic situations such as loss of job, unusually high medical expenses, or unforeseen emergencies such as a sick relative and you have to travel to see them quickly which will be more expensive. An additional fund should be set up for asset repair and replacement of the item based on an estimate of their useful life. The funds can be saved over time, invested in a money market, or CD, and used to repair or replace assets associated with your home. A few examples of asset replacements that you can fund include roof, HVAC, garage door and opener, electrical system, appliances, and bathroom/kitchen fixtures. For example, a hot water heater has an estimated useful life of 10 years and will cost $1,500 in ten years to replace, then save $150 per year in this fund to replace the asset. As part of this process, it is recommended that you never purchase an extended warranty for your asset purchases and instead place the amount of the extended warranty into this fund. If you always take this approach then you will have funds to replace assets that break down before the end of their useful life and after the initial warranty period. In general, the warranty company is the entity that benefits the most from an extended warranty because they have the data to know how many assets they have to replace during an extended warranty period and know the costs, so they will be able to build a large profit into the extended warranty offerings to customers. You do not have the same data, so you are buying insurance where the risk of needing replacement is minimal and can be offset by saving the equivalent amount of money in an asset replacement account.
- Saving for Long-Term Purchase Goals. You should save money in a separate account for long-term purchases that update, or upgrade your standard of living and provide you with an opportunity for personal experiences that enhance your enjoyment of life. For example, buying or remodeling a house, purchasing a newer vehicle, a vacation, or new furniture. Set up a money market fund with your local bank or brokerage firm earmarked for accumulating this savings. Do not use this account for anything except long-term savings for future purchases and make automatic transfers from your main account to this account. You can start with the minimum amount allowed to open an account and plan out your goals to determine how much to contribute each month. Some internet banks pay around 2.5% currently in interest. In general, as you approach your forties the savings goals should be more practical and family focused since you will have limited funds and this will be less of a priority than some other items on this list.
The next blog will be on how to plan as you approach your 50’s.
To promote the concepts in this blog, the first two individuals (under 50) that email me, or fill out the website contact form will receive a free (skype, zoom, in person) financial planning session from Lydford Financial PLLC.