Building Financial Freedom
Building Financial Freedom Expand All
Does the idea of financial planning for the future seem complex or confusing? Are you worried that you won't be able to save the money you need to send your children to college or to have a comfortable retirement? Well, you're not alone, and there are steps you can take to get started. Learning about the kinds of savings, investment, and retirement plans available to you is a big step on the road to financial freedom.
A good first savings goal is to put aside three to six months of living expenses as a cushion against emergencies. Keep your financial cushion and any funds you plan to use in the near future tucked away in an easy-access savings account, short-term certificate of deposit (CD), or money market account. See Savings Options. Make sure the bank or financial institution where you keep this money is insured by the Federal Deposit Insurance Corporation (FDIC), which protects the money you have on bank deposit up to $250,000 per ownership category which is effective through December 31, 2013. After this date FDIC insurance will return to up to $100,000 per depositor for all account categories except IRAs (and other certain retirement accounts), which will remain at $250,000 per depositor.
Your next step is to figure out what your long- and short-term financial goals are. Do you want to save to buy a home? Are you trying to accumulate money for a child’s college education? Are you planning for retirement? Are you saving for a vacation? Think about it, decide what your goals are, and write them down. Once you have a list, you can prioritize the items in terms of their importance to you, and make an estimate of the time frame (e.g., six months, ten years)— the amount of time you have to reach the goal.
Download the Monthly Spending Plan, to help you understand your monthly income and expenditures
The magic of compounding. If you could save just one dollar a day – less than the price of a cup of coffee in most convenience stores – and invest this money at 4 percent, compounded daily, here’s how it would grow:
| Amount Saved | Savings + 4% Interest | |
|---|---|---|
| One Year | $365 | $372 |
| Five Years | $1,825 | $1,929 |
| Ten Years | $3,650 | $4,487 |
| Thirty Years | $10,950 | $21,169 |
The effects of compound interest are far more dramatic when your investments earn higher rates of return. The Rule of 72 is a useful tool to show how the rate of return affects investments. You can find out approximately how long it will take for your money to double by simply dividing 72 by the rate of return. For instance, at 6 percent, it will take 12 years to double your money (72 divided by 6 is 12 years). At 10 percent, your money may double in a little over 7 years.*
*Please keep in mind that this is just a rule of thumb. The Rule of 72 is based on a hypothetical illustration and does not represent performance of any specific product and therefore there is no assurance that investments would double within a specific time frame.
Savings vehicles tend to be lower-risk/lower-return options. Following is a quick guide to the most common savings vehicles:
Savings Accounts are a good place to store emergency funds and savings for short-term financial goals. Funds are readily accessible, and the Federal Deposit Insurance Corporation (FDIC) currently insures savings accounts up to $250,000 per ownership category which is effective through December 31, 2013. (After this date FDIC insurance will return to up to $100,000 per depositor for all account categories except IRAs (and other certain retirement accounts), which will remain at $250,000 per depositor) Their chief drawback is that interest rates tend to be low. The interest rate paid on a savings account is often less than the rate of inflation, so your money will not grow as fast as the rising price of goods and services. For this reason, savings accounts are usually inadequate to meet long-term goals.
Money Market Accounts are similar to savings accounts, but usually earn slightly higher interest and still allow easy access to your money. Some banks and financial institutions require an initial deposit of $1,000 or more and limit the number of withdrawals you can make during a given period of time. Bank money market accounts may also be FDIC insured up to $250,000 per ownership category which is effective through December 31, 2013. (After this date FDIC insurance will return to up to $100,000 per depositor for all account categories except IRAs (and other certain retirement accounts), which will remain at $250,000 per depositor) Money market mutual funds are issued by other financial institutions (e.g., stock brokerages) and are not FDIC insured and may lose value.
Certificates of Deposit (CDs) are generally FDIC-insured, and usually earn more interest than savings accounts with equally little risk, but with less liquidity. CDs provide higher interest rates in exchange for the agreement to keep your money in the CD for a fixed period of time, usually three months to five years. In general, longer term CDs have higher interest rates. Note that there is usually an interest penalty for taking money out before the end of the agreed-upon time period.
Individual Retirement Arrangements (IRAs) are sometimes called "traditional IRAs." IRAs were established by Congress to encourage people to save for retirement by providing tax advantages. Qualifying individuals may contribute up to $5,000 annually to an IRA. If you're aged 50 or over, you may make catch-up contributions of $1,000 beginning in 2006. Tax benefits vary depending on your income and whether you contribute to other tax-advantaged savings plans (e.g., a 401(k) plan). In addition to a possible tax deduction of IRA contributions, earnings in an IRA grow tax deferred until withdrawals begin. Your money must be designated as an IRA, in an approved account. You have a wide choice of investment options, including stocks, bonds, mutual funds, CDs. Funds in an IRA are considered long-term savings and, as with 401(k) plans, you may be subject to a 10 percent IRS penalty as well as to tax liability for premature withdrawals - generally before the age of 59 1/2. Consult a qualified financial or tax professional for more complete information.
Roth IRA. Contributions to a Roth IRA are made with after-tax dollars, but investments grow tax-free. Qualifying individuals may contribute up to $5,000 annually to an IRA. If you're aged 50 or over, you may make catch-up contributions of $1,000. Roth IRAs have income limits. That is, you may not make contributions if your adjusted gross income is more than $110,000 (filing singly) or $160,000 (filing jointly). Investment options are the same as those in a traditional IRA. Unlike traditional IRAs, though, all contributions to a Roth IRA are made with after tax monies. However, if you meet the distribution requirements of the plan, withdrawals of both contributions and earnings are tax-free. If you don't need the tax deduction you can get on a traditional IRA, a Roth IRA is probably a good choice if you qualify. Like traditional IRAs, early withdrawals may be taxed or may incur tax penalties. Consult a qualified financial or tax professional for more complete information.
Build Your Personal Safety Net
Social Security.You've probably paid into it for most of your life; don't forget to include it in your financial planning. The income you receive from Social Security when you reach the eligibility age (age 65 for full benefits, rising to age 67 for those born in 1960 or later) is based on a percentage of your earnings averaged over most of your working lifetime. If you die, your spouse may be entitled to your benefits. Social Security is intended to supplement other pension and savings plans. In general, workers with average earnings can expect Social Security benefits of about 40 percent of his or her lifetime average wages. Each year near your birthday, the Social Security Administration sends out a report of your work history and anticipated benefits. Always read this report carefully and contact Social Security if there are any errors. You can also check the record of your earnings and get a statement of your anticipated benefits by calling Social Security at 800-772-1213 or visiting their website: www.socialsecurity.gov.
Insurance: Protecting You, Your Family, and Your Assets. As any financial planner will tell you, insurance is an important part of building and protecting your financial freedom. Unexpected events — disability, illness, and accidents — can spell financial disaster for you and your loved ones if you don't plan ahead.
Life Insurance can provide financial protection for your loved ones, in the event of your death. It's important if you are married, and even more important if you have dependent children. Your income can be considered your family's most valuable asset. Your income is used to obtain the necessities of life and, of course, provide the creature comforts. The need for that income continues, whether or not you’re here to provide it.
Although the primary purpose of life insurance is protection, certain types of life insurance may provide benefits for you and your family while you're still living. Whole life and universal life insurance policies, for example, may accumulate cash value on a tax-deferred basis. The accumulated cash value can be used to supplement your retirement income or help pay for a child's education. Cash value withdrawals may be taxable and will not only reduce the cash value, but also the death benefit amount.
Term life insurance offers protection for your loved ones for a specified period of time - usually from one to 20 years. If you stop paying premiums, the insurance stops. Term policies pay benefits if you die during the period covered by the policy, but they do not build cash value.
Health Insurance coverage helps pay the cost of medical care due to illness or injury. Without health insurance, you run the risk of being financially drained by a serious illness or accident. Many people have access to group coverage through their employers. And in many cases, employers subsidize health benefits. Health insurance may also be available at group rates through professional associations and affinity groups. Coverage can also be purchased individually, but if you have access to an employer-subsidized plan, it's probably your most cost-effective option.
Disability Insurance replaces a portion of your income when you can't work due to illness or injury. Most policies replace 50 to 70 percent of income. Any benefits from a disability policy you purchase yourself are tax-free. If your employer provides the insurance as a benefit, however, you will pay tax on the payments you receive if you become disabled. If your employer provides a 60 percent disability policy, you may want to consider a supplemental policy covering an additional portion of your income. Disability income insurance is an often overlooked form of protection; check with a financial professional to determine if it’s appropriate for you.
Long-Term Care Insurance is designed to help pay for nursing home care; home health care; and/or assisted living if you become cognitively impaired or need assistance with certain activities of daily living such as eating or dressing. Long-term care insurance can protect you, your family, and your assets. The cost of this insurance varies with age - in general, the older you are, the more it will cost. Cost will also be based on the maximum daily benefit you choose and other variables. Long-term care insurance can be particularly important to a married couple. Without it, if one spouse needs long-term care, the other may suffer financial hardship to pay for care for their spouse.
Homeowners Insurance protects your financial investment in your home. A basic homeowners policy provides compensation for damages to your home and its contents due to specifically named risks such as lightning, theft, fire, smoke, wind, and explosion. Another important benefit of homeowners insurance is liability coverage that protects you, and family members who are part of your household, if someone finds you legally responsible for injuries or damages, either on or off your property. The extent and amount of coverage needed depends on your situation, but if you can afford it, it is wise to insure your home for 100 percent of its replacement cost. If you rent your home, consider a renters policy that covers your possessions (e.g. furniture, stereo equipment, jewelry).
Auto Insurance is more than vehicle coverage for loss or repairs after an accident. It is a financial safety net that can help you offset various accident-related costs including medical expense due to injury to yourself or others; lost wages due to injury; and benefits to survivors when an accident results in death. Additionally, auto insurance helps to protect you from the financial impact of lawsuits if you are judged legally liable for an accident. Most states require purchase of basic auto insurance coverage.
Before purchasing any type of insurance, educate yourself and compare coverage from at least three insurance companies. A qualified financial advisor can help you determine the types and amounts of insurance coverage are right for you.
Choosing insurance is an important decision, best made with the help of professionals who understand your personal and financial situation. Consult a qualified insurance agent or financial planner to find out how insurance fits into the "big" picture of your financial future.
Financial Advisors or Planners
Planning to achieve your financial goals is a complicated job that can be made easier with the help of a qualified financial advisor or planner. For a fee generally based on the nature and complexity of the plan, financial planners assess the "big picture: of your financial situation and make financial planning recommendations that are right for your particular needs. Financial professionals can address budgeting, saving, taxes, investments, retirement, and insurance. The "big picture" approach distinguishes financial planners from other professionals, like estate attorneys or accountants, who focus on a particular financial area (e.g., taxes). A qualified financial planner can help you understand how each financial decision you make relates to other financial decisions. In general, financial planners and advisors will offer the following services:
- A thorough examination of your financial history, including tax returns, debts, investments, retirement information, insurance policies, and wills.
- Development, in consultation with you, of a written, personal financial plan. The plan may include ways to improve investment returns, recommendations for building up retirement funds, ways to reduce tax payments, and recommendations for insurance coverage. A good financial planner will make sure you understand the proposed plan and your options.
- Implementation of your plan, if you'd like it. A financial planner may refer clients to specialists (e.g., lawyers, accountants, stockbrokers) to provide services they cannot, but the financial planner should disclose any referral fees he or she might receive.
- Periodic reviews of your plan, including recommended changes when needed.
You may want to hire a financial planner to draw up a comprehensive financial plan, and then decide whether to implement the plan yourself or ask your financial planner to help you put your plan into action.
References
The Intelligent Investor (Revised)
by Benjamin Graham & Jason Zweig
Published by HarperCollins Publishers
The Wall Street Journal Guide to Understanding Money & Investing (Third Edition)
by Kenneth M. Morris & Virginia B. Morris
Published by Lightbulb Press, Inc
Consumer Information from the Federal Government
The quarterly Consumer Information Center Catalog lists more than 200 helpful federal publications. Obtain a free copy by calling 888-8-PUEBLO; on the Internet at
Other Resources
The following Professional Associations can provide referrals to qualified financial professionals in your community, as well as information on how to find, interview, work with, and check the disciplinary history of financial professionals.
Financial Planning Association
The FPA consumer website offers tips and tools for financial planning.
Institute of Certified Financial Planners
Search for a CFP® or find information about personal financial planning.
National Association of Personal Financial Advisors (Fee-only Planners)
The NAPFA website has consumer information and a search tool for finding a fee-only financial planner
American Institute of Certified Public Accountants
The AICPA website provides consumer information on financial literacy and has a “Find a CPA” feature.
International Association of Registered Financial Consultants
Search for a Registered Financial Consultant or learn more about the IARFC on this site.
Financial Industry Regulatory Authority
Visit this site to check the disciplinary history of a financial planner or advisor. You can research advisors and brokers on the "Investor Information."
