Quick Tip: Take Advantage of a 401(k) Match

Most employers offer a matching contribution to a 401(k) account up to a certain percentage of your gross salary. Whether it is a dollar for dollar match or a 50% match (i.e. $0.50 contributed for each $1.00 you contribute), that is money ready to be handed out to you simply for setting aside money for retirement. And that is something that you should be doing anyway. Bloomberg reports that 91% of 401(k) participants belong to a plan that offers a match. Make sure you are enrolled in your employer's 401(k) matching program and increase your contribution percentage to the maximum matched by your employer. The earlier you start saving, the more you will have for retirement.

How To Improve Your Credit Score

A few tips to keep in mind if you're trying to improve your credit score.

• Only apply for new credit when absolutely necessary. Too many new applications for credit can hurt your credit score.
• Close any unused credit cards but only if they were recently opened. This goes along with the previous tip to help you ensure you do not have too much recent credit open.
• Keep any old credit cards open even if they are unused. Not only is too much recent credit bad for your score, but having a longer history of credit is beneficial for your score.
• Avoid transferring debts to other accounts. This, too, creates more recent credit accounts rather than keeping older accounts. Paying off debts while under the original account is better than transferring it and then paying it off. There may be a trade-off with this since you may be able to lower your interest rate by transferring the balance and, thus, making it easier to pay off more quickly.
• Pay all bills and debt payments on time.
• Check your credit report at least annually to ensure there are no mistakes. Correct any mistakes you may find with the credit reporting agencies.

IRA Basics

An IRA is an Individual Retirement Account.  An IRA can be referred to as an investment vehicle.  If you think of an individual stock, bond, or mutual fund as a passenger, an IRA is the automobile that the passenger rides in.  You can choose from a wide variety of investments to ride in an IRA vehicle.  The primary advantage of IRAs is the tax savings typically associated with them.  Different IRAs have different tax advantages and are often used as the primary vehicle for investing for retirement.

There are four different types of IRAs:

1. Traditional IRA
2. Roth IRA
3. SEP IRA
4. SIMPLE IRA

1.  Traditional IRA:  This is probably the most common IRA.  For the 2010 tax year IRS regulations allow a maximum contribution of $5,000 to a traditional IRA and Roth IRA combined.  The amount can either go all to one IRA or be split between a traditional and Roth IRA.  If you are 50 years of age or older, the combined contribution maximum is $6,000, a bit larger to help you get ready for an approaching retirement.  Contributions are tax deferred, meaning that you can take an income tax deduction for your contributions in the year you make the contribution and pay the tax on that income and its earnings later.  When you withdraw funds from an IRA later in life, you pay income tax on those distributions (withdrawals) and the gains they have earned.  The tax advantage is that you get to deduct the contribution, but when you receive the distribution, you may be in a higher tax bracket.  The maximum contribution may also be reduced based on your adjusted gross income (AGI), filing status, and other circumstances.

Distributions are also governed by rules and exceptions to those rules.  Distributions are subject to your current income tax rate and are also subject to a 10% penalty if withdrawn before reaching the age of 59 1/2.

A 401(k) account can also be rolled over into a traditional IRA because the tax treatment is the same (tax deducted at the time of contribution and paid at the time of distribution).

2.  Roth IRA:  A Roth IRA is a similar vehicle to a traditional IRA with the same combined contribution limit of $5,000, as noted above, or $6,000 if you are 50 years of age or older.  Contributions are also subject to the same AGI limitations.  The primary difference is the tax treatment as contributions are not tax deductible.  The tax advantage, though, is that the distributions received from a Roth IRA, as well as any gains those contributions earn, are not taxable.  The taxes are paid in the year of the contribution (because it is not tax deductible) rather than in the year of the distribution, as is the case with a traditional IRA.  Even though you miss out on the tax deduction, you may pay less tax on the contribution than you would on the distribution if you are in a higher tax bracket at the time of the distribution.  I personally like the tax advantages of a Roth IRA and knowing that the earnings growth and distributions are tax-free.

Distributions are also subject to a penalty of 10% if taken before reaching age 59 1/2 or if withdrawn within five years of opening the Roth IRA.

3.  SEP IRA:  A Simplified Employee Pension (SEP) IRA is an employer established and funded SIMPLE IRA and is often used by small business employers in place of a 401(k).  Employers can contribute directly to employees’ traditional IRA accounts, or sole proprietors can contribute for their own benefit.  The tax advantages and early distribution penalties are the same as a traditional IRA.

  

4.  SIMPLE IRA:  Savings Incentive Match Plan for Employees (SIMPLE) IRAs are retirement plans sponsored and administered by employers, which allow employers to contribute up to $11,500 (limit for 2010).  These can also be used for sole proprietor's benefit.  The tax advantages and early distribution penalties are the same as a traditional IRA.  The penalty becomes 25% if the distribution is within two years of first participating in the SIMPLE IRA plan.

As noted, these are the basics for understanding IRAs as an investment vehicle for retirement.  The IRS regulations regarding IRAs are considerably more extensive but mostly apply to special circumstances and exceptions to the general rules.  These basics can assist in finding the right retirement account for you.

Avoid Debt: Having Good Credit

Avoiding debt is possible but not always realistic when it comes to purchasing a house. The key then becomes ensuring that the debt you do incur is manageable based on your income. In order to keep any debt incurred as low as possible, you need the interest rate as low as possible. That is where your credit comes into play: the better the credit, the lower the interest rate you can get.

The first step in keeping your credit clean is knowing what your credit looks like. Everyone is entitled to a free credit report each year. Visit AnnualCreditReport.com or Credit.com to sign up for a free credit report. You will not receive your actual FICO score, but you will receive a comprehensive look at your credit history. To find out your FICO score, you can pay for that at MyFICO.com for about $15. Some of these sites also provide some advice on how to improve your credit from where it currently stands.

The primary way to ensure you have good credit is to pay off your debt on time. If you use a credit card, pay the full monthly balance before the due date each month. If you have a mortgage, make sure your monthly payments are made on time for the full amount. If you have a large purchase or payout to make coming up, use a budgeting strategy to save for it rather than borrowing more money for it. Excessive debt will hurt your credit rating as well as your financial foundation. The same strategies that can be used to pay down your debt will also help you increase your credit rating and, in turn, strengthen your financial foundation.

Build a Reserve: Available Cash

The key to building a reserve is obviously not to spend it. There are many reasons to build a reserve including emergencies, education for you and/or your children, retirement, or other large purchases. The bigger the reserve for each of these purposes, the more likely you'll be able to avoid debt when they come around. Although, you can't exactly go into debt to build your retirement fund as you may be able to with other situations.

The most important reserve to start is a cash reserve. Your reserve for unexpected emergencies requiring cash payout needs to be in liquid investments. That means it could be in the form of cash itself, a checking or savings account where it can be withdrawn quickly, or even a money market account. With each of these, the interest earned increases ever so slightly. Cash in your house will earn nothing, while cash invested in a money market account may earn dividends slightly larger than what you may get from a savings account at a bank or credit union. All of these locations are liquid and allow you to access the cash when it is needed. My rule of thumb is to keep enough cash in these locations to live off of for at least 3 to 6 months if you were to have no income. The amount will differ for everyone based on their spending habits. This will allow 3 to 6 months to find another source of income, most commonly to replace a lost job, or provide for a large unexpected payout without other consequences.

Having enough cash on hand will bring greater peace of mind, knowing that when the unexpected comes along you will have enough cash to get by without falling into a more difficult situation.

Financial Foundation Key #5: Teach Others

Struggling financially can be very painful whether you are a child wishing for enough money to purchase a new toy or an adult with greater financial responsibility. Understanding the basic principles of family finances can help overcome such pain and frustration, so it is key to teach others the primary principles laid out in #1-4.

Children can especially be taught at a young age how to be responsible for their own money. As they grow and gain more responsibility, they will also gain more money and need to know how to handle it in a way that they don't regret. As children learn to work, they will also learn the value of the rewards that come from the effort put forth. An incentive for children to save their money rather than spending it all is found in helping them understand how their money grows by earning interest. Parents may even consider an additional incentive by matching a percentage of what the child sets aside for savings similar to an employer 401(k) match. This requires some sacrifice by the child (saving money rather than spending it) for a greater good (to build greater wealth in the future). This way, parents have something to reward the child for (setting aside savings) rather than giving out an allowance for nothing.

As you help your children and others around you become more financially responsible, you may actually find it easier to be more financially responsible yourself. That, in the end, will lead to a strong financial foundation.

Financial Foundation Key #4: Give to Charity

Giving away hard-earned money is not exactly an intuitive way to make more money, but I have experienced that benefits come in other forms to us and our families by generously helping out those in need.

Another good thing about charitable donations is that they can be deducted from your taxable income. Yes, you are still giving away some money, but you are actually giving away less than you think due to the tax savings you receive. In other words, $100 given to charity and listed in your itemized deductions, is really only a $75 donation for someone in the 25% tax bracket. The result is the charity receives the full benefit of $100 even though you only pay $75. So who pays the other $25? Well, that is indirectly paid by the government to your charity. So when considering how much to give to charity, remember that if you itemize your deductions on your income tax return, you are actually giving less. Which, in turn, means you can give more, right?

Money Magazine shares a few tips on selecting a charity if you don't already have one or two favorites you donate to regularly. Find the article here.

Keep on giving, because what goes around, comes around.

Financial Foundation Key #3: Build a Reserve

How many times have you wished that you had more money? Whether it is to make a fun splerge or to have more to pay monthly bills, it's probably safe to say that most people wish they had more money to spare, especially when times are tighter as they are in today's economy. Building a financial reserve will bring a greater peace of mind. It may also save you when that unexpected emergency comes along.

The key to building such a reserve lies in your action of diligently setting aside whatever amount is deemed appropriate on a regular basis as well as in in the principle of the Time Value of Money. Yes, setting aside a budgeted amount each week will increase your reserve over time, but just as important, the time value of money works on increasing it the form of interest or other returns.

What is the Time Value of Money? The basic notion is that one dollar today is worth more than one dollar in the future. No, this is not actually due to inflation, but rather that your dollar set aside today will earn a percentage return if invested or placed somewhere other than beneath the mattress. If you set aside $100 now in a savings account that is earning 1% interest, then you will have $101 in one year. You may say that doesn't sound like much, so that is why finding an investment with a much better return is important. A modest return may be around 6%, meaning that $100 returns $6 and turns into $106 by the end of the year. Not much better? Well, that is why consistent saving is the key. Compound interest then begins to work in your favor. $100 put into that same account in the second year means that interest is earned on the $106 and the additional $100. That result is interest paid of $12.36. The fist year only paid you $6 and now the second year is paying you more than double that. I think you can probably start to see the pattern and apply it whether you are adding that $100 each month, each paycheck, or each week. The interest or return you get begins to build on itself rather quickly.

Many organizaitons and universities use such a principle when obtaining grants to fund certain campus projects. The funds required to construct a building, for example, are obtained and spent while an additional amount to maintain the building into perpetuity is obtained. That doesn't mean that infitnite dollars are being poured into the building, but that an amount is set aside to pay for the maintenance of the building. The amount set aside earns it's own income in the form of returns that exceeds the cost of maintaining the building. In other words, the money is doing the work. Individuals can also slowly build up such a reserve on the same principle.

The key to building your reserve is to not spend it. This may sound obvious, but many find themselves wanting that little extra cash for a new toy. Limit the reasons to tap into this reserve, and spend it for emergencies only. Don't spend the rainy day fund on a bright sunny warm day or you may regret it when the clouds start looming overhead.

Financial Foundation Key #2: Use a Budget

A budget is sometimes considered the most despised tool for tracking your finances. No one really wants to lock themselves down to a budget that keeps them from spending what they want. But that is just it, some people may need something to keep them from spending more than they make. A budget is the only way to track your spending against an expectation or plan. Whether you follow a budget strictly or simply use it at the end of the month to see where your money went, it can be the most useful tool in your finance shed.

The usefulness of a budget lies in the accuracy of actual expenditures. If actual expenses are not tracked at the same level of detail as your budget, your budget is not able to report meaningful information at the end of a period. I've created my own Excel spreadsheet (available for download) of a simple monthly budget that can easily be customized to fit the categories that apply to your family. Also keep in mind that you will need to track your actual expenses at the same level of detail for the budget to be truly useful. In the end, you simply need to know whether you are spending more than you make.

You may notice that I've included lines in the budget sheet for investments. Budgeting monthly contributions to retirement accounts, education accounts for kids, and other savings for a rainy day is important to remember. Otherwise you may feel that you are living within your means, but in actuality you have nothing set aside for unexpected events or even expected events such as retirement someday.

I'll also note that there are several applications that can assist in budgeting, tracking actual expenses, planning, and reporting such as Quicken. These tools are obviously full of more tools than a simple spreadsheet, but they usually require additional time commitments to make them useful. One online tool is Mint.com, which is a free site to help you classify your income and expenses automatically by syncing up with your banks and other financial institutions. I've recently opened an account to test it out, but need to play around a little more to see how useful it can be. At first glance, it will at least consolidate your bank and credit card activity (and any other activity with a financial institution within its database) and show some helpful reports to know your standing. Of course, the reports are only as accurate as the data used to create them so be aware of how certain expenses are automatically being classified. Mint.com is also being acquired by Intuit, the maker of Quicken, so there may be changes ahead for Mint.com users once Intuit decides how it wants to integrate Mint.com into its product offerings.

Hopefully some of these tools help you in managing your finances in a way that works best for your family.

Financial Foundation Key #1: Avoid Debt

This sounds like a simple suggestion on the surface, but if you are already being swallowed by the jaws of debt, you probably find little solace in this advice. You have learned the hard way that debt can be all-consuming with interest that never sleeps or takes vacation.

First, for those who have no debt, you are among a small percentage of the population. Going into debt is necessary for the average person to purchase a house. Not many people have enough cash lying around to buy a house over the weekend. This debt is obviously permitted even if you want to live on a strong financial foundation. The keys to the debt incurred for a house purchase is to do your research on interest rates, keep a good credit rating, and ensure that your monthly payment will fit within your current budget. Many web sites offer mortgage payment calculators to assist with this, but don't forget to factor in your other monthly expenses when comparing to your monthly income. If your monthly mortgage payments exceed your monthly income when added to your other monthly living expenses, you may have to either reconsider your home purchase, or find a less expensive home. The days of a starter-home do not have to be a thing of the past.

Now, if you already have plenty of debt to share with others, you may need a plan to help you get out of it. Although this can seem overwhelming, one simple principle can be applied to eventually rid yourself of the stress of such a burden. A debt elimination calendar most effectively illustrates the idea. Using the example below, you can easily create a spreadsheet with a column for each debt in the elimination plan. The idea would be to put the debt carrying the highest interest rate on the left in order to pay it off first, while still meeting other debt payments. As the higher interest-carrying debt is paid off, additional cash is freed up each month to put toward the next debt column. Individual circumstances and timelines will obviously vary depending on your personal cash inflow and payment requirements. Another key is to pay as much as your cash inflow and budget allow, not just the minimum payment. For example, if you are able to pay off all credit card debt, which usually carries the highest interest rate, as you begin the program, you are making a good investment since you will save yourself all the money that would have been paid in interest in the future. Be sure that your debt elimination sheet is consistent with your income and budget.



I think this is a mindset that needs to be one of the keys to building a strong financial foundation. It's not a one-time get-out-of-debt-and-I'm-done solution, but rather is a frame of mind that has to continue whether we are deep in debt or not. Helping build that financial foundation will help you withstand any economic storm.