Finances in Focus

  • Parent Category: News
  • Published: Saturday, 08 November 2014 15:52
  • Written by Michael Wright

It probably doesn't happen as much as you’d like, but from time to time, you have some extra disposable income. When this happens, how should you use the funds? Assuming you have adequate emergency savings — typically, three to six months' worth of living expenses — should you pay off debts or fund your IRA or another investment account?

There's no one “correct" answer — and the priority of these options may change, depending on your financial goals. However, your first step may be to consider what type of debt you're thinking of paying down with your extra money. For example, if you have a consumer loan that charges a high rate of interest — and you can’t deduct the interest payments from your taxes — you might conclude that it's a good idea to get rid of this loan as quickly as possible.

Still, if the loan is relatively small, and the payments aren't really impinging on your monthly cash flow that much, you might want to consider putting any extra money you have into an investment that has the potential to offer longer-term benefits. For instance, you might decide to fully fund your IRA for the year before tackling minor debts. (In 2014, you can contribute up to $5,500 to a traditional or Roth IRA, or $6,500 if you’re 50 or older.)

When it comes to making extra mortgage payments, however, the picture is more complicated. In the first place, mortgage interest is typically tax deductible, which makes your loan less "expensive." Even beyond the issue of deductibility, you may instinctively feel that it's best to whittle away your mortgage and build as much equity as possible in your home. But is that always a smart move?

Increasing your home equity is a goal of many homeowners — after all, the more equity you have in your home, the more cash you'll get when you sell it. Yet, if your home's value rises — which, admittedly, doesn't always happen — you will still, in effect, be building equity without having to divert funds that could be placed elsewhere, such as in an investment. In this situation, it’s important to weigh your options. Do you want to lower your mortgage debts and possibly save on cumulative interest expenses? Or would you be better served to invest that money for potential growth or interest payments?

Here's an additional consideration: If you tied up most of your money in home equity, you may well lose some flexibility and liquidity. If you were to fall ill or lose your job, could you get money out of your home if your emergency savings fund fell short? Possibly, in the form of a home equity line of credit or a second mortgage, but if you were not bringing in any income, a bank might not even approve such a loan — no matter how much equity you have in your house. You may more easily be able to sell stocks, bonds or other investment vehicles to gain access to needed cash.

Getting some extra money once in a while is a nice problem to have. Still, you won't want to waste the opportunity — so, when choosing to pay down debts or put the money into investments, think carefully, and then make a decision and stick with it.

Along the same lines, but with a bit of a twist, did you know that September is National Preparedness Month? Sponsored by the Federal Emergency Management Agency (FEMA), National Preparedness Month seeks to educate Americans on preparing for natural disasters and other types of emergencies. But you'll also need to prepare for unexpected events in many other areas of your life — particularly those events related to the financial security of you and your partner, should you have one.

Here are some of the most important of these events, along with possible preparations for them:

Unanticipated early retirement - If you encounter a "downsizing" or other occurrence that results in the loss of a job, or even the end of a career, before you expected it, would you be able to avoid major disruptions to your lifestyle?

To help prepare for such a loss of income, make sure to fully fund your IRA each year. The maximum contribution is $5,500 per year plus an additional $1,000 for those age 50 and older.

Disability - Even a short-term disability can seriously harm your finances — and a long-term disability could prove devastating. Your employer might offer some form of disability insurance, but it may not be sufficient. So you may need to explore private coverage. And do not say "only old folks have this happen’’ because something as silly as a bicycle riding crash, car accident or fall while camping or hiking can result in a crippling injury. This really does affect all ages of my readers!

Personal liability - If someone were ever injured on your property or due to some action of yours, you could face legal actions demanding hundreds of thousands of dollars. To help protect yourself, consider adding umbrella liability insurance.

Changing family situation - Changes in your life — marriage, divorce, remarriage, children, stepchildren — things which as more and more states allow we gays and lesbians to marry can drastically affect your estate plans and the type of legacy you want to leave are now coming into play. To prevent unpleasant surprises for your partner, make sure you periodically review beneficiary designations on your investment accounts, such as your IRA and 401(k), and work with your tax and legal advisors to update your estate-planning documents — will, living trust and so on — as needed. Right now, gays and lesbians are especially prone to problems bet wen estates and families and even with the latest changes, you and not some sister you dislike in Orlando should decide who gets your money and home. Get things in writing, get the T's crossed, the I's dotted and keep the info updated or maybe an ex or that evil sister will end up with your money and not your current spouse!

Outliving your money - Once you reach retirement, your greatest concern may be that you'll outlive your money. To help prevent this from happening, create a sustainable withdrawal strategy — that is, determine how much you can take out each year from your investment and retirement accounts, and stick to this amount. As a friend's dad (who lived to be 84) said often in the last few years of his life — he retired at age 54 — "If I’d known I was going to live this long, I would have saved more money!” No truer words have ever been spoken!

Need for lone-term care - You can’t predict whether you will ever need to enter a nursing home or require the assistance of a home health care worker, but one thing is for sure — these services are extremely expensive.

Consider this: The national average for a private room in a nursing home is nearly $84,000 per year, according to a recent survey by Genworth, a financial security company. To help prepare for these costs, you may want to consult with a professional financial advisor who can suggest appropriate solutions.

Untimely death - Your absence could jeopardize your partner's and family's financial security, particularly if you passed away while your children (if you or your partner had kids) were still at home. To help ensure that your family could remain in the home and that any children could go to college, if they choose, make sure you have adequate life insurance.

Your passage through life will be filled with twists and turns, and you can't always see what lies ahead. But you can ease your journey by preparing yourself for the unexpected.