Hosted by Kevin J. Zywna, CFP® and Allison K. Dubreuil, CFP®
Kevin Zywna, Wealthway Financial Advisors: Tonight, we’re going to talk about prioritizing long term savings to efficiently and maximize your long term savings, the fastest way to grow your net worth. It’s one of the one of the major questions we get on this show. And when we have new clients, we hear, I have a little bit of money, what do I do with it? Where do I start? Where do I put it? Obviously, a lot of that’s going to depend on your phase of life that you’re in. Whether you’re just starting out, having just graduated high school, just graduated college, got your first job, started up in the military getting that first paycheck; or in your 30’s with a family, mortgage, kids, cars; 40s, more cars, more kids, college around the corner, all these kind of competing ages. Then you get to your 50s then you’re like, “Well, I guess I’m getting close to retirement, I better start thinking about that. All kinds of competing interest for your limited funds that we all face. How do you get started? Where do you get started to most efficiently grow your net worth over time? So that’s what we’re going to talk about here tonight, we have nine different savings vehicles strategies that you should consider in order to grow your net worth fastest. This is the order in which you do it. How to prioritize your long term savings to grow your net worth as fast as possible.
Step 1: Secure An Emergency Fund
So first off, it’s the good old fashioned emergency fund that we talked about here on the show all the time. A basic staple of good personal finance is to develop an emergency fund of three to six months. Three to six months of living expenses. So, for example, if your mortgage your car payments, the groceries, the utility bills, electric and so on and so forth, add up to say $5,000 a month, then your emergency reserve funds should be about $15,000 to $30,000. The more stable your job, more stable your career, the lower you can afford to keep that emergency fund, keep that on the on the low side. The more variable your compensation, the less reliable your occupation or less uncertain I should say your occupation, the higher you want to go to want to keep that emergency fund, so keep it to the closer to the six month reserve. This is money that should be set aside in a bank account, not the checking account. But savings account, bank money market account should not be invested should not be subject to market fluctuations needs to be liquid needs to be easily accessible in the event of emergency. And the primary purpose of this emergency fund is to keep you out of trouble. You know, the first thing you do when you find yourself in a hole, stop digging. And so, once you start getting into a financial hole, it’s hard to get yourself out if you don’t have an emergency fund. Then you have car repairs, or you have house repairs, or you get medical bills or whatever life curveball throws at you. You have to go into debt, you put it on a credit card with a high interest rate. It’s very difficult to stop that financial spiral down. So, the emergency fund is your cushion to prevent you from ever getting in a hole in the first place. So, you build up that emergency reserve three to six months. And then most of life curveballs thrown at you can be absorbed by that emergency fund, so you never get into bad debt in the first place. So, number one, start with that emergency fund.
Step 2: Contribute To A Health Savings Account To Employer Match
Number two, and this is one that most people probably wouldn’t consider and not everyone has access to. But it’s a health savings account. Specifically, you want to contribute to a health savings account, if eligible for a match from your employer. Not a lot of employers are that sophisticated yet where they do this. I do know some of the cities I believe the city of Virginia Beach does provide matching funds to a health savings account. But if you have access to a health savings account through your employer, then you want to make sure you contribute as much as necessary to get the employers match – which is essentially free money, an incentive for you to contribute to the health savings account. And a little primer on the health savings account that works in conjunction with a high deductible health insurance plan. So high deductible health insurance plan for an individual that means the deductible must be at least $1,500 or greater. Family coverage $3,000 or greater. So that deductible is the portion that you are responsible for above those numbers the insurance kicks in and the insurance pays out. So, if you’re willing to assume some of that risk, on the low end the $1,500 as an individual or $3,000 as a family, then you can enjoy lower insurance premiums by having that higher deductible type of premium. Then the health savings account is essentially your emergency fund for medical expenses. So, you fund the health savings account. If you do incur medical expenses of a significant nature, you’ve got the health savings funds in the Health Savings Account, to pay for up to your deductible until the insurance kicks in. You don’t find yourself in a big financial hole because of an unexpected medical bill. And then, if possible as you’re trying to build up the health savings account with company matching, you want to pay for minor medical expenses out of pocket. So you go to the doctor, it’s a $20 copay. Don’t use your health savings account. Just pay for that out of your checking account. You go you go to the drugstore and your prescription is $50. Pay for that out of pocket. Don’t use your health savings account. Even though you can doesn’t mean you should. But even though you can try to keep that money in the health savings account and get that built up to make sure that you cover up to the deductible. Long term health savings account is one of the most efficient growth vehicles to protect against medical financial catastrophe and can be used for retirement long term. So, you get a tax break for money that goes in the Health Savings Account. Any interest you earn or investments that grow in the health savings account grow tax free, and the money comes out of the health savings account, tax free if used for qualified medical expenses. So that’s why we love the idea of health savings accounts used in conjunction with a high deductible health care plan. And that’s step two, on your ladder of prioritizing long term saving vehicles to build your net worth.
Kevin Zywna, Wealthway Financial Advisors: We’re talking about how to prioritize your savings vehicles in order to efficiently grow your net worth as quickly as possible. So, we started out with the emergency fund three to six months of living expenses in a bank account, then we talked about health savings account if your employer offers some sort of match. So, make sure you take advantage of that match and get the tax deduction for the contributions to the health savings account.
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Step 3: Contribute To A Company Retirement Plan (401K 403B) Up To Employer Match
Now number three, after we’ve done that, if you have it available, then we want to make sure you’re contributing to your company retirement plan up to the amount of any employer match there. So, we’re talking 401K plans 403B’s 457TSPs. Now, not every employer matches the employees’ contributions. But if your employer does, that’s free money to you, the employee and incentive for you to take care of your future retirement and contribute to the company sponsored retirement plan. Typically, what we see in terms of a match is about 50% of what the employee contributes up to 6% of your pay. So contribute 6% of your pay, you get another 3% match on top of that, which is like contributing 9% of your pay in total. And if you do that year, after year, after year, you start making real progress to building up your retirement savings through your employer company sponsored retirement plan. So if you have one of those plans where employer matches, you’ve got to contribute to the plan in order to get that free money from your employer, that company match. All right, so that’s number three. What do we do after we contribute to a 401 K plan or company sponsored retirement plan?
Step 4: Pay Off High Interest Loans And Debt
Then it’s time to attack any high interest loans that you have outstanding. Now let’s have a word about that. So not all debt is bad debt. There is such a thing as good debt. Good debt is low interest debt. So if you get any sort of financing incentives with 0% interest rates in order to entice you to buy some appliance or furniture or car or something like that, by all means, you can go ahead and factor that into your decisions. Just know that most of the times those companies are offering 0% financing, they’re making up the money some other way. Usually, the price of the product is a little bit higher, but that’s a little side note there. But if you have 0% financing, well, there’s no rush to pay that off. It’s not costing you anything.
We saw historically low mortgage rates in the United States. At one point, mortgage rates (about 2021) were in the 2%. Like less than 3%. Some people were locking in 30 year fixed rate mortgages. And we were pounding the table all through that process, saying. This is the time to refinance your house, this is a great time to get a mortgage, this is great time to get a long term mortgage. Why? Because the cost of financing was so low. So, if you can borrow a bank’s money at 2.5% – 3% for your 30 year mortgage, you borrow as much as they will give you and you take as long to pay it back to them as they will let you. Now you redirect that extra money that you would have committed to the mortgage through a higher interest rate into other savings vehicles. Especially those that can earn more than two or 3%, such as equity stocks, investments in your company retirement plan or in mutual funds or however you would access the capital markets. But that is good debt.
Bad debt is higher interest rate debt, so almost always all your credit cards. Very rarely would you see…well, I guess let’s start with the demarcation point. What is the definition of a high interest rate? What number is that? There’s no hard and fast answer. But I would say it’s anywhere between six to 8%. If you are above 8% in this environment, that is currently high interest rate debt that you want to work to pay down quickly. If it’s below 6%, then you probably don’t have to rush to pay that off as quickly and you want to take that excess cash flow, make sure you’re doing the other things that I talked about: emergency reserve, Health Savings Account match, companies sponsored retirement plan match, those types of thing. Between six and eight kind of a gray area, a lot of student loans line up in the six to eight area. So that would probably require a little bit more drilling down into your own personal financial situation. I know a lot of student loan payments are put on pause right now due to the government as some legal wranglings work through the system. But anything below six, consider that decent, low cost debt. Above eight is high costs. That’s where you want to attack with extra money. That type of debt, certainly any credit cards, personal loans, unsecured loans, we’re starting to see mortgage rates creep up into the sixes, no cars yet to be alarmed by that. But certainly, a factor consider when you are purchasing a new house because that’s almost double what the rates have been over the last 10 years. And that starts to impact your monthly payment – still relatively reasonable by historical standards. If we were to start to see mortgage rates, again, at the eight or higher level, that is when we would start to reshape and shift our thinking. Start to encourage people maybe to redirect excess cash flow to their mortgage, as opposed to try to max out any investment account savings because above a percent that’s a hard number to keep up with there. So there’s your sort of metrics on why after you’ve taken care of some base level savings, where you can get company match, then you want to go after that high interest rate debt student loan typically falls in the middle there and something that you want a little bit more study and analysis on.
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Step 5: Max Out Your Contributions To Your Health Savings Account
And then the fifth thing that you we want to come back to the health savings account after we paid off that high interest loan debt. Go back to the health savings account. Remember, the first point was just to get enough for the company match. You’ve done that okay, you paid off all your high interest debt, you got your company match for the for the retirement plan. Now come back to the health savings account and try to max out your contributions to the health savings account. So how much can you contribute per year to health savings account? Well, if it’s an individual plan $3,850 for this year 2023. If it’s a family plan, and you don’t have to have your own family on it, you just need you and one other person in your family to qualify as a family plan, then you can contribute up to $7,750 for this calendar year. If you are age 55 or older, you can contribute another $1,000 as a catch up contribution. So, $7,750 for family plus $1000 to catch up, and $3850 as an individual. We’re talking about prioritizing long term retirement savings. How to efficiently allocate your assets, your savings, in order to maximize all opportunities and grow your net worth fastest. I already talked about emergency fund, the Health Savings Account up to any company match your company retirement plan. If you have any company match, you have to get all that company matching money. Do that one, two and three, four, you pay down high interest rate debt, anything 8% or over. You got a 2 or 3% mortgage? Fantastic sleep like a baby. Don’t try to pay that off quickly. Redirect that extra money into these other savings vehicles. You will benefit long term. Not all debt is bad debt. Low interest rate debt is good debt if you manage it appropriately. Five, go back to the health savings account after you got any company match the health savings account. Make sure you try to max out the contributions to your health savings account, if you have one. They are an excellent savings tool to pay for medical expenses and at age 65 that can be used for anything, not just medical expenses. So it functions as an IRA at age 65 where you can withdraw money for any purpose without penalty. Now you will have to pay ordinary income tax on the money that comes out of it. But you have to do that on traditional IRAs anyway, but you don’t have to pay any penalty. On the Health Savings Account at age 65. or older, you can also use that money to pay for medical insurance, such as Medicare, which we all pay for at age 65. So an excellent long term savings vehicle for medical expenses, or for retirement in general at age 65, one of the reasons we love those health savings accounts.
Step 6: Max Out Your Company Retirement Plan Contributions
After that six, you’ve maxed out your health savings account, if you have one. Now you got to try to max out your company retirement plan. That’s usually the most efficient, most effective way of savings for the majority of people. It’s so easy, it comes right out of your paycheck. You set it up with payroll or human resources, a lot of times now, larger companies, you go to a website, you just type in the amount percentage or dollar amount of your paycheck each paycheck, you want to go into your company retirement plan, and try to contribute as much as you can, that the IRS will allow you based on contribution limits each year. So for this calendar year 401KS, 403B’s, 457s, TSPs: $22,500 is the maximum amount you can contribute this calendar year. If you are age 50 or older, you can contribute another $7,500 for a total of $30,000 a year. And if you have a 403B, you can do another catch up. If you have 15 or more years of service, you can contribute another $3,000 on top of that for $33,000 a year. So you can see there’s a long runway there and you can really start growing aggressively your retirement savings if you have the financial resources to do that. So that should be a focus, after you’ve taken care of the other steps to build up your financial foundation. See if you can max out your company retirement plan.
I should also make a note of the little used nationally, but used more frequently in small businesses, businesses with less than 25 employees, is a simple IRA. So some of you might have those, those IRAs, are set up to your employer now, not individually, even though it says IRA, it’s set up through your employer. Blame the IRS, not me. $15,500 is the contribution limit per year right now to a simple IRA. And if you’re 50 or older, add on another $3500 for a total of $19,000 a year to a simple IRA. So very easy to do. Because it comes right out of your paycheck. It’s tax deductible, so you do not pay tax, you get a tax break for the money that you contribute to the company, your company retirement plan. So it lowers your overall tax bill today. Most people as they get into their higher earning years, their 40s, late 40s, the 50s and the 60s, they’re making maximum lifetime income. And therefore, they’re in the highest tax bracket of their lives for most people at that point in time. So, this is the ideal time to want to try to get tax breaks wherever you can. Trying to max out your company retirement plan is the easiest and best way of trying to do that. So that’s something you want to take advantage of.
Step 7: Pay Down Lower Interest Rate Loans
And then after you’ve maxed out or come as close to maxing out your company retirement plan that you can, then you want to circle back and look at perhaps paying down lower interest rate loans such as student loans. That 6%-8% gray area that I was talking about earlier, where if the interest on your loan is between 6% and 8%. That’s when you want to circle back and try to sort of pick off that type of debt and pay that down. Student loans right now kind of fall in that category. There might be some car loans that we’re seeing in that area as well. Very rarely would you see a credit card there. They’re almost certainly above that percent. Then if it’s below 6%, I would say that’s okay. Certainly, anything in the twos and threes or the fours – that’s outstanding, low debt. You don’t have to really work a rush to have to pay that off. Make the minimum payments on that. Redirect the cash flow to other savings vehicles.
Got a list of nine here of how to prioritize your savings vehicles to most efficiently maximize your net worth and grow that net worth as quickly as possible over time. We get that question a lot on the show and in our practice with new clients, so I’m laying them all out here for you tonight. We want to get a list of nine of them, that’s going to be enough if you can get to number nine, you know then you are cooking with gas, right? There you are, you’re doing about as best as you can do to maximize all savings opportunities to grow your net worth as fast as possible to put you on the path to financial security, first of all. Then eventually, financial independence, where you don’t have to rely on any other source of income or any other sort of person for income than yourself. Once you develop critical mass of savings and investments that you can then live off of.
We went through seven of them. Emergency reserve starts us off, make sure we don’t fall into a financial hole provides a safety net and a cushion so we don’t fall backwards. Easiest way to get ahead is don’t fall backwards in the first place. All right, first is the emergency reserve – three to six months of living expenses. Then, if you have access to a health savings account at work that provides a match from your employer, you want to contribute as much to that health savings account as you can to get all of the employer match, that’s free money. That’s an incentive health savings account with employer match, get after it. If you don’t have one of those or you’ve already done that. Then you go to your company retirement plan, which most of those match a percentage of your contribution to your company retirement plan. So you want to make sure that you are contributing enough to get all of the company match that is available to you again, free money from your employer and incentive for most people, that means you have to contribute about 6% of your paycheck, in order to get 3% additional match from your employer. That’s how most plans are designed. So that should give you something to shoot for there. Then you want to attack high interest rate debt, anything over 8% credit cards, some car loans, personal unsecured loans, those are those are the ones that will keep you stuck in the mud, too high of an interest rate too low of a payment back, you just don’t make any traction, you don’t get ahead, and you don’t get that debt paid down fast enough. So tackle those high interest rate loans above 8%, then circle back to the Health Savings Account. Try to max out. Try to contribute all you are eligible to contribute in any given year to a health savings account for individuals. That’s $3,850. For family plans, that’s $7,750. And if you’re 55 or older, you can tribute another $1,000 as well. So get those health savings accounts maxed up full and then use cash flow, use your regular bank account for small medical expenses. Even though you can use money in the health savings account to pay a doctor’s copay of $50. Or medicines that costs $50 or $25 $100. Try to pay that out of cash flow and keep that money in the health savings account and let that grow tax free. All right. Then, after you’ve maxed out the health savings account, if you have access to it, want to go back to the company retirement plan and try to contribute the maximum annual amount to your company retirement plan right now for most plans 401 ks four, three B’s tsp 457. You’re looking at $22,500. For this calendar year. If you are age 50 or older, you can contribute another $7,500 for a total of $30,000 that you can defer out of your paycheck into your company sponsored retirement plan. All right. So that’s number six, number seven. Now we want to circle back to those lower interest loans. And I would say those in the gray area between six and 8%. If it’s gray, and you’ve got extra cash flow, we’ll go ahead, knock those out. A lot of times student loans fall in that gray area there. Also some car loans as well.
Step 8: Contribute To An IRA
Now, after you’ve done all that, if you have excess cash its time to contribute to IRAs – individual retirement accounts. Now there are income limitations that you have to be aware of. order to determine which type of IRA you are eligible for. And, if your income is below, for married filing joint $116,000, then you can contribute to a traditional deductible IRA. If your income is above that, but less than $218,000, married filing joint, then you can contribute to a Roth IRA. And for those of you who don’t have access to any company retirement plan, you can make deductible contributions to a traditional IRA regardless of income. So, make sure and then the maximum you can contribute to an IRA this year $6,500. If you are age 50 or older, add another $1,000 for a total of $7500. Charles in Virginia Beach, we have a few minutes. Welcome to Dollars & Common Sense.
Maximizing Funds In An IRA
Caller: Thank you. I’m already retired, over 73. So I have to take out my IRA money funds as minimum amounts. But my question is, I’ve got an opportunity to put it in a savings, all of my amount of my IRA, which is $160,000. I could put that into a 5% savings. Would it be beneficial for me to go ahead and withdrawal that out now and put it into the 5% savings and then in the long run would I save money?
Kevin Zywna, Wealthway Financial Advisors: Well, when you say withdraw it, take it out, that means to me that you owe the IRS, right. That your money that you take out of a traditional IRA is subject to ordinary income tax, which is the highest level of tax rates that we have. So you want to be very careful about how much money you take out of an IRA. Now, it is possible perhaps, to keep the money in the IRA protected wrapper and simply move it from wherever it is now, to this, I guess, maybe bank that has a CD offering 5%. So, if you decide to go in that direction, you don’t want to withdraw the money out of the IRA, and then use it to purchase the 5% vehicle you’re talking about. You want to try to keep it in the tax protected IRA wrapper, and just move it to another location and purchase this 5% vehicle if you want to. Now so that’s step number one, make sure you can do that. And that should be done carefully and thoughtfully. Number two is should you do it in the first place at all? I don’t think so. You said you’re 73?
Kevin Zywna, Wealthway Financial Advisors: You know, we don’t consider retirement, the age to start getting conservative. You probably still have another 20 years of life expectancy ahead of you. That’s a long time horizon. I would not lock in 5% rates today, I would keep my money invested in a well managed diversified investment portfolio of stocks for the long term, so that you can keep your purchasing power ahead of inflation. So I hope that framed it out a little bit for you. Okay, yeah. All right. Good. All right, Charles, thanks for the call. I appreciate it.
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Step 9: Invest In A Brokerage Account Or Mutual Fund
We’re going to wrap it up with number nine and prioritizing our long term savings vehicles to maximize your net worth as fast as possible after the IRAs. Well, that’s a regular old brokerage account. So if you have excess cashflow, it can always be go into a mutual fund, I should say it could go to Vanguard or Fidelity or Schwab, but there’s no tax breaks that you get for contributions to a regular brokerage fund. The investments that you make in there do grow tax deferred until you sell those investments. Then they are taxed at capital gains rates, which are lower than ordinary income tax rates. And for most people, the capital gains rate is 15%. So there you have it, then the order to prioritize your savings to maximize your net worth as fast as possible.
Kevin J. Zywna, CFP®