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Financial Compass: Savings

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By Rick McKinstry – Dallas South News Contributor

As we travel around the Financial Compass, our next stop is Savings. Three key areas of Savings are: 1) saving for unexpected expenses, 2) emergency fund saving, and 3) retirement savings.

An amount of $1,000 should be saved to cover non-recurring or unexpected expenses. The primary purpose of these funds is to protect your budget. Establishing a budget helps to account for all expenses that routinely happen whether the expense occurs daily, weekly, monthly or annually. The point is that the expense is known and expected. If you are not operating within the constrains of a very tight budget and without funds for unexpected expenses, you are vulnerable to budget busting expenses.

The importance of Saving to build an emergency fund, especially in today’s environment, cannot be stressed enough. A good rule of thumb is that an individual or family should have 3-6 months worth of emergency funds. One month of emergency funds should be equivalent to one month of your average monthly budget.

Though the challenge of Saving 3-6 months of emergency funds is significant, the benefit of reaching this plateau is even more significant. Research has shown that the greatest sources of stress for adults are related to money and employment. The stress associated with these two sources is greatly reduced when you have cash reserves available to cover expenses in case of income interruption.

Three to six months of emergency funds also provides the financial freedom to expand spending beyond basic needs to include some things that aren’t necessarily needed but are wanted. Finally, having an adequately funded emergency fund reduces the need to immediately draw upon retirement plan funds should there be an interruption of income.

Saving for retirement is the third very important area of savings. Statistically speaking, 2/3 of retirees depend on Social Security for ½ of their retirement income.   A third are dependent on Social Security for 90% or more of their retirement income and 22% depend on Social Security for 100% of their retirement income. To put that into context, the average Social Security retirement annual benefit is only $13,920, a mere $3,000 more than the 2009 poverty level of $10,830.

401(k) plans still offer the best opportunity to build retirement income. Unlike traditional defined benefit pension plans in which the employer is committed to providing a fixed payment to retirees from retirement to death, the 401(k) plan is simply a tax-deferred savings plan.  As such; all of the risk associated with the plan is borne by the employee, not the employer.

The responsibility of funding the plan is that of the employee, though in many cases the employer will match a percentage of the employee’s contribution. It is also the responsibility of the employee to invest the funds within the plan. Lastly, upon retirement, the obligation of the employer is limited to providing the employee with the balance of the account while the employee has the responsibility of managing those funds during retirement.

All funds contributed by the employee into a 401(k) are immediately vested to the employee whereas employer matches typically vest over some predetermined period of time. The ownership of these funds affords the employee access to the funds prior to retirement most notably through the form of 401(k) loans and direct rollover distributions. This access often has a detrimental impact on plan balances and is the primary reasons the average 401(k) at retirement is only $65,000.

When borrowing from 401(k) funds, employees should be mindful of the fact that loan repayments are made from after-tax dollars, not pre-tax dollars as are the original contributions. Additionally, employees should know that in case of company separation the loan balance becomes immediately due and if not repaid, the balance is considered a premature distribution and both income taxes and a 10% early distribution penalty will apply.

A direct rollover distribution occurs when an employee separates from the employer and instead of rolling the 401(k) balance directly from the employer’s qualified plan to another qualified plan, takes the distribution directly. In this case, just as is the case with unpaid loans, the employee is charged with both income taxes and a 10% early distribution penalty.

In summary, Saving for the present and for the future is key when is comes to sound financial management. Saving now lessons the risk associated with income interruptions. Saving for the future lessons our dependence on Social Security.

Next month we’ll address Wise Spending.

Rick McKinstry is Personal Financial Planner (PFP) and owner of RLM Financial. He has an MBA from Indiana University and can be reached via email at rlmckin79@hotmail.com or at (972) 821-8948.

Edited by Shawn Williams

Categories: Business, Rick McKinstry
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  • http://phelps.donotremove.net Phelps

    This is the sort of education that will benefit South Dallas more than anything else.

    01(k) plans still offer the best opportunity to build retirement income. Unlike traditional defined benefit pension plans in which the employer is committed to providing a fixed payment to retirees from retirement to death, the 401(k) plan is simply a tax-deferred savings plan. As such; all of the risk associated with the plan is borne by the employee, not the employer.

    The flip side to this is the biggest advantage — the control of the plan also rests with the employee. A lot of traditional pensions are horribly mismanaged, neglected, and outright stolen from by the employers. The same way that you can borrow against your own 401K, your employer can borrow against your pension — and if they default on that loan, your options are limited. Your pension is generally as secure as your company is stable and honest — and when those two things go, you are left with what you have, which usually isn’t much.

    Though the challenge of Saving 3-6 months of emergency funds is significant, the benefit of reaching this plateau is even more significant. Research has shown that the greatest sources of stress for adults are related to money and employment. The stress associated with these two sources is greatly reduced when you have cash reserves available to cover expenses in case of income interruption.

    I know (hope) you are going to get to it in wise spending, but I have felt so much better since I lowered my comfort level and lived more frugally (thankfully starting before the recession) and built that savings cushion up. Convenience purchases are great at the time, but they don’t have the overall oomph that knowing that you can’t have the rug jerked out from under you by an accident or a layoff is so, so much better. On top of that, the accidents have happened, and instead of being nightmares financially and emotionally, they turned into simple temporary setbacks in building up those savings.

  • Lawrence Woods

    I not to long ago lost my job I was very stress out gain weight(not much,but eough).The great thing I did prior too losing my job I took inventory of my finances.Cut out all my wants and focus only on the needs.Paying attention in my youth paid off knowing the TRUE VALUE OF A DOLLAR PAID OFF.Listen to my uncle(Rick) and mom paid off.Still I must save for the future and pass on what I to my children,that is the key.It does us no good as parents to know what we know and they don’t.Parents lets teach our children the importance of saving,credited scores,shopping for the best prices,ask for the discount.Name brand is not always the best brand.

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