Last Week’s Question of the Week: When does a Power of Attorney terminate? Is it, A) during your life, or B) upon your death?
ANSWER: All powers of attorney terminate upon death.
HOST: Today’s topic is about having Emergency Reserves/Savings at all stages in life. I am assuming this is important for a lot of reasons.
KLAAS FINANCIAL: Yes, we want to remind our listeners who are in the thick of retirement planning to also remember the importance of having emergency savings, and we want to offer some reminders why.
Your cash reserve should include 3-6 months’ worth of living expenses, and ideally 1-3 years’ worth depending on your age and income.
Remember, it only takes one unexpected event, a broken furnace, a leaking roof, an unexpected medical bill, a dead car, or a job loss that wasn’t planned to derail your retirement funding.
That’s why we all need emergency savings on hand, no matter how much we earn or what our expenses look like. Yet an alarming 45% of Americans don’t have the money to cover three months of living expenses, according to a report published by the Center for Financial Services Innovation.
With all of this said, the ratio of personal savings to disposable income as of May 2019 was sitting at approximately 6.1% which is actually pretty good for a national savings rate, but what is important is that some of your savings available is after-tax money for emergencies.
So, what should you be doing if you don’t have an emergency reserve:
- If you are putting everything into a retirement account and have very little in savings, it is probably a good idea to perhaps back off your retirement savings for a moment and accumulate some income and put this into a traditional savings account.
- Create a process, a systematic savings plan where you are paying yourself first and make building your cash reserve a priority. Most banks or credit unions let you set up automatic transfers between your checking account and higher yielding savings or money market account.
- Cut back on nonessential spending: The average American wastes $5,339 a year on nonessential expenses like restaurant and takeout meals, coffee, rideshares, and leisure events. If you’re behind on emergency savings but regularly spend money on these or other luxuries, then it’s time to start cutting back.
- Set up a Budget. The amount you are saving should become a budgeted item like your mortgage, and you will watch this built up over a few months; once it is built to be a healthy amount, you can switch automatic transfer of funds to a smaller amount, and then go back to increasing your retirement funds.
HOST: It makes sense to have that rainy-day fund, but how much is too much? And what about big items that may be coming up that you may want to fund?
KLAAS FINANCIAL: We want all of our listeners to have a “comfort zone” with the amount that they have on hand in their local savings account. So how much is too much?
Most people have heard that having a 3-6-month cash reserve is a good beginning. For the “average person” (whoever that is, exactly), perhaps having $15k-25k available may be a good amount. If you have nothing in savings, let’s shoot for $5k as your target, then 10k. These need to be achievable goals. Obviously, debt that you may be paying on may be impeding these goals. So, clearing debt first, helps with saving goals.
Remember what Warren Buffet says about savings: “Don’t save what is left after spending; spend what is left after saving.” He further suggests that your money should always be working FOR YOU.
Having an emergency savings is important but keeping aside money for upcoming “BIG SPENDS” is important too. Perhaps an upcoming wedding for your daughter, or a new patio or kitchen. If the project or event is going to happen in the next 6-12 months, this should probably be held in cash.
Liquidity is very important at different stages of life. Money that will be used soon for a down payment on a home should not be risked. For instance, $50,000 is enough for 20% down on a $250,000 home.
Too much cash is probably $50-100k sitting in the bank making almost ZERO interest. Unless you are going out tomorrow and purchasing a new house, the likelihood that you need that much cash which is earning nearly nothing is a losing strategy with regards to purchasing power… a lot of that money really needs to be invested.
HOST: So, once my emergency savings is overflowing, what to do next with after-tax money?
KLAAS FINANCIAL: Great question. Yes, we talk all the time on this show about putting away money into IRAs, Roth IRA’s and your retirement accounts at work. But what about money that is not any of these? This would be left-over disposable income. What should you do?
Remember: For all of these accounts, please make sure you have listed beneficiaries.
HOST: If I need money from my individual after-tax account, will I pay a penalty and taxes?
KLAAS FINANCIAL: If it is an investment account you will pay capital gains tax if your account has grown and if you take a distribution but never a penalty since these are not retirement accounts.
Remember that capital gains rates are more favorable today than income tax rates. For most people, cap gain rates are either 0% or 15%. Only if your income for an individual is more than $434k or $488k for a couple do you hit the 20% Cap Gains rate in 2019.
You will never pay a penalty on taking money out of an after-tax account — UNLESS IT IS AN ANNUITY. Distributions from after-tax annuities can cause a penalty if you are under 59-½, and remember that these distributions will be taxable at ordinary income tax rates, instead of CAP GAINS TAX.
HOST: That brings us to the Money in Motion Listener Question Corner. A listener, Heather, called in with this question: “ “I am 55 years old and just received an inheritance of $30,000. Should I put this into my savings account, invest it, or pay off debt first?”
KLAAS FINANCIAL: Thanks Lori for sending us that question!
That is a question we hear often. Obviously, since we don’t know the whole financial picture for you, this is hard to answer. You can call our office and perhaps speak to one of our advisors for a better response.
But as a general response, we would look at paying down any debt you may have first. Look at how this inheritance may help you pay down things like your mortgage or car, or even credit card debt. Secondly, look at how much you have in your emergency reserves to make sure you are good there. Finally, we may suggest you look at investing the residual. But this is a great question… Thanks for asking, Heather!
Catch C.J. Klaas and Maleeah Cuevas on Money in Motion every Thursday on Madison's 1310 WIBA from 8:05-8:35am.