Ask A CFP
Cal Brown, MST, CFP® Professional
Vice President, The Monitor Group, Inc.
McLean, VA


Question:

“Thank you for the opportunity to ask a professional this question. I feel like a failure. I got married (we're in our forties) and it has been a financial drain. I am just now at the point where I am able to put about $100 a month in savings. We have no emergency savings, no 401K, no plan on how to pay for our son's education (he's in pre-K, but I REALLY want to be able to pay for his education. I don't want him to have to go into severe debt when the time comes).

Where do I begin in building a good financial plan for me and my family? Since I earn more than my husband, I have taken out a $250,000 term life insurance if something were to happen to me (my husband would also get $75,000 more from a policy my employer carries on me). I am just scared that we're not saving anything for retirement, not saving enough in general.

By the way, as far as cutting any costs, I do not live an extravagant life style---hairdresser (haven't been in years), new clothes (I shop at Wal-Mart). I just quit working a part-time job because I'm tired of working two jobs.

Any advice is appreciated."


Answer:

Goals, Priorities, and Habits.  These are the three keys to building a good financial plan and maintaining a solid financial lifestyle. Clarity on each of these three items is important, if you’re going to follow through.

1. Goals – you mentioned several goals in your question:
    1.  Emergency fund
    2.  Retirement
    3.  College funding
    4.  Risk management (insurance)
   
All of these are good goals to have. The problem is, and the fact of the matter is, you cannot do them all at once! But relax, you’re in good company, as very few people can accomplish all of these instantaneously.

You did not mention getting out of debt (which is also a valid goal), so I’ll assume that is not a problem for you. That’s a very good thing! That is, a good problem not to have.

So, first things first, and that spells…

2. Priorities – the meaning of that word can either be “important” or “do it first”. Since you cannot accomplish all of your goals at once, you must prioritize them. So, what is most important to you? Granted, they’re all important, but you will have to rank them. I will offer a little guidance, but no one can dictate your priorities to you—you’ll have to make that decision yourself.

Standard financial planning wisdom says you should cover your risks first. If something like death or disability happened to you or your husband, all the other financial goals could go down the drain. The proper amount of life insurance should be determined using a “capital needs analysis” which calculates how much you’d need to pay off debts and a large sum (capital) to provide income, using an assumed withdrawal percentage. For example, $250,000 at a 5% withdrawal rate would provide the survivor $12,500/year. Is that enough to supplement the surviving spouse’s income if all the debts and mortgages were paid off?

Next, financial planners will tell you an emergency fund is critical. This will enable you to avoid getting into debt when unexpected expenses show up…and they will! An emergency fund should be in something safe and liquid, such as a savings account or money market fund.

Most planners agree your retirement should be a higher priority than college funding, as your ability to have a comfortable lifestyle for 20-30 years after your working career ends is both a certainty (assuming you don’t die prematurely) and requires a much larger amount. But, emotionally, many parents will rank college for their kids higher. Again, that’s your call, but personally, I believe if a kid truly wants to go to college they will find a way.

My recommendation is to begin saving for both an Emergency Fund and retirement simultaneously. It will take longer to build the Emergency Fund, if you do this, but it will also give your retirement fund more years to compound, and the miracle of compound interest is truly staggering.

Click here for an example of the way compound interest works.

In addition, funding a retirement account will provide serious tax advantages, even at low incomes. Put in plain English, the government will assist you in a major way to save for retirement.

For an example of the tax advantages associated with saving for retirement click here.

And frequently, your employer will kick in extra “free” money (through matching contributions) if you will do this. You should take maximum advantage of all that.

If you want to begin saving for college, the best way to do it is to use the District’s (or your state’s) 529 plan. You will get a deduction on your DC/state income tax return. And, when the money is withdrawn later for college, all of the earnings and growth will come out tax-free. You should go to the website www.savingforcollege.com for more information. I also like the Coverdell Educational Savings Plan (ESA) for people in certain income categories.

The second-best idea is the “Prepaid Tuition Plan.” While it guarantees tuition, it does not cover room & board and other expenses, and portability to other states can be a problem.

Unless you are making a ton of money, you will probably not be able to “max out” your employer-sponsored retirement fund (the maximum contribution if you’re under 50 is $15,500 for the year), save for your Emergency Fund, purchase all the life and disability insurance you need, AND start contributing to a college fund.

This leads to the third key:

3. Habits

Once you’ve established goals and determined your priorities, you’ve got to start habits. The easiest habit is one which requires very little ongoing effort on your part. The best example of this is your employer-sponsored retirement plan. You make a decision up front to have a certain amount withheld from your paycheck every pay period; then, voila! The forced habit kicks in and it is automatic. 

Another example would be the mechanism you choose to establish your emergency fund. It’s not enough to say, “I’m going to save $50 a month and put it into my savings account.” It’s much better to establish an automatic transfer of $50 from your checking account into your savings on a specific day of the month.  Any time you can get your emotional decision-making out of the way you will probably be more successful. Take it from me, there’s always a reason not to save!