By John Stylianou, Accountant
Many Americans are finding themselves in a precarious financial situation because they are not saving enough to retire comfortably or to reach other financial goals. If you find yourself in this situation, the only solution is to take charge of your financial future by saving more money. The effort and sacrifice you make now may be well worth the effort years down the road.
Many people assume that they can rely on social security to fund the bulk of their retirement needs. In fact, your social security benefits will probably be in the range of 20% to 40% of your pre-retirement wages. In other words, unless you can get by on 20% to 40% of your current paycheck during retirement, you need to save more money.
How can you save more money? One of the best ways is to have a set amount of money taken from every paycheck and automatically invested into a retirement account or savings account. Tax-deferred retirement accounts offer a smart way for you to save money for retirement. If your employer offers a 401(k) or SIMPLE retirement plan, contribute the maximum amount allowed. In addition, contribute to your individual retirement account. The money you contribute to a retirement account can reduce your taxable income and grow tax-free until withdrawn.
To give your savings purpose, set specific financial goals. For example, it’s advisable to have an emergency fund of approximately six months’ worth of living expenses to cover any cash outlays that may catch you by surprise. Nothing can derail your financial plans faster than a series of mishaps that force you to take drastic financial measures. Other saving goals may include a college savings fund, vacation fund, or a fund for major purchases.
You should be saving 10% of your earnings. Seem impossible? If you took a new job at 10% less pay, you would get by.
SHOULD YOU PREPAY YOUR HOME MORTGAGE?
As you know, the stock market has been exceptionally volatile in recent years. As a result, many people are beginning to shift their funds into more stable investments. One such investment, often overlooked because it’s so near at hand, is prepaying your home mortgage.
Paying off your mortgage early offers several advantages. For one thing, it reduces your total interest payments. Say, for example, you have a 30-year fixed rate mortgage at 7% and your mortgage balance is $150,000. By paying an extra $50 each month toward the principal, you can reduce your total interest cost by over $34,000. Not only that, your mortgage balance will be paid off four years early. Prepaying your mortgage also provides a guaranteed rate of return. In the above example, if you’re in the 27% tax bracket and itemize mortgage interest on your tax return, making prepayments will generate a 5.1% return. Nowadays, that’s better than many bond and certificate of deposit rates. Another advantage: Prepaying your mortgage may shorten the time you’ll have to carry private mortgage insurance.
If you’re carrying balances on high-interest credit cards or consumer loans, you’ll want to pay those off before putting extra money into your mortgage. Paying down high-interest debt also provides a guaranteed return.
Paying down your mortgage may not always be the best investment choice. Many economists expect the stock market to recover from its doldrums eventually. By purchasing stocks or stock funds now (perhaps through your 401(k) plan), you may have the opportunity to buy low and sell high. If stocks earn an average 8% return over the next 15 years, you may wish that you’d plowed cash into stocks instead of your mortgage.