Kevin Zywna, Wealthway Financial Advisors: Tonight’s topic, how to prioritize long term savings in order to grow your net worth fastest. It’s probably one of the more common questions that we get on the show. When we first meet with prospective clients, they’re like okay, I’ve got some excess cash flow. Where do I put it? Where do I start? Where do I get the biggest bang for my buck? And this is a topic that we’ve tackled for probably the last four or five years. It’s one of our highest listened to podcasts of all the shows that we put out. So obviously, there’s great interest in this topic, so that’s what we’re going to talk about tonight.
Develop A Habit Of Saving
So how do you prioritize your long term savings in order to build a solid financial foundation, turbocharge your net worth as quickly as possible? And let me preface this by saying that first off, any savings is good savings. Okay, so it’s more important that you establish the habit of savings than finding the exactly perfect right vehicle on which to put that savings. However, having said that, once you commit to the savings, then, yes, there are vehicles that you should prioritize over others in order to shore up that financial foundation and then get the biggest bang for your buck long term savings.
#1 Establish Your Emergency Fund
So let’s start out with number one, the emergency fund. That is typically the first place that we always recommend that clients put their excess cash flow. We recommend that they build up an emergency fund, an emergency reserve, and put it in a safe, stable, non-volatile bank account. And the general recommendation is while you’re accumulating assets, while you’re in savings mode, is to have about three to six months of your living expenses tucked away, safe and sound in a bank savings account. So if your monthly expenses are $10,000 then you want to have $30 to $60,000 put aside in bank savings accounts. And that money is your security blanket. That is your peace of mind. That is your way to fall asleep easy at night, knowing that you with a three to six month cushion. You’ve got a fair amount of life’s unexpected emergencies protected with your emergency fund. So you know, the car repairs, unexpected medical expenses, large house repairs, the biggie and unforeseen loss of job when income stops, then you have that reserve on which to draw to get you through to the next job, hopefully.
But having that emergency fund, one of the main things it does is it keeps you out of bad debt. And so most people, when they don’t have an emergency fund, where do they go when they need, you know, big expense. Where do they go to pay it? They go to their credit card. And credit card debt is one of the worst form of debts that you can have in your financial house because it is very high interest rate debt and the banks give you very small payments to have to repay it, and so it gives you the illusion of sort of safety and security, because you can charge a big balance on it and make small payments to pay it back over time, but over time you’re going to pay a ton of interest, excess dollars in the form of interest on credit card debt. So your emergency fund is the staple of a good, solid financial foundation, and the launch pad to all other savings vehicles.
#2 Take Advantage Of Employer Sponsored Health Savings Accounts
And then after you have your emergency reserve of three to six months of living expenses, then we like to see our clients take advantage of a health savings account through their employer, if their employer has a match for their contribution to a health savings account. Not too many people take advantage of this, but it’s an excellent long term savings tool. In addition to making sure you have large medical expenses covered as well, if those crop up. Health Savings Accounts are triple tax advantaged. You get a tax break for money going into the health savings account. The money grows in the account, tax deferred. And then it comes out, tax free if used for qualified medical expenses. And you know, there was a lot of teeth, gnashing and wrangling of hands when Obamacare first came out, and there was a lot of denigration of High Deductible Health Plans. So a health savings account works in tandem with a high deductible health plan. And so that means a High Deductible means that when you go to the doctor, it’s not going to be a $20 copay. And we in this country have become accustomed to going to the doctor only costing $20. No, it doesn’t cost $20. That’s all typically your insurance plan requires you pay. And so once the High Deductible Health Plans came out. Health Insurance Plans came out that was seen as inferior insurance or poor coverage, or bad health care, where you know that the idea of insurance got conflated with care when they’re two separate things. A High Deductible Health Plan used in conjunction with a health savings account is an excellent tool to protect against a possible high expenses of health care, as well as build a solid foundation for the future. Because a health savings account withdrawals are tax free if used for qualifying medical expenses. You can also take money out of a health savings account at age 65 or later for any purpose. Now, funds withdrawn for any purpose at age 65 or beyond, are subject to ordinary income tax rates, but so are your traditional IRAs, or your 401 K’s, or your four three B’s, or your tsps.. They’ll come out as ordinary income as well. So point being health savings account where you can get an employer match is the second place that we’d like to see our clients contribute to when they have excess cash flow. Anytime you can get an employer match for any type of contribution, you should take it, I guess I should say, almost any. There might be some exceptions, but almost anytime you get employer match, that’s free money from your employer. That’s an incentive from your employer to try to get you to take care of certain aspects of your financial life and take your own initiative, to take financial care, take care of your own financial life. So health savings account with an employer match.
#3 Take Advantage Of Employer Sponsored Retirement Plans
Then right after that is making sure that you contribute to your company retirement plan up to the point you get the maximum employer match. So company retirement plans. That’s your 401 Ks, TSBs, 403Bs. And where you’re where most employers now match some level of contribution to the company retirement plan. In order to incentivize you to do that, one of the most common matching plans that we see is that the employer will match 50% of the employee’s contribution up to 6% of their pay. So what that really works out to is you have to contribute 6% of your gross pay, then the employer will give you 3% additional of your gross pay for a total of 9% of your gross pay, savings. And we can say, from professional experience, once you get to about 15 to 20% of savings of your gross income, you could start that early enough you are well on your way to becoming financially independent at some point later in your life. So getting to 9% is pretty close between your contribution and the employer match. So emergency reserve first, to protect against life’s unforeseen emergencies, health savings account where you can get an employer match, and then your company retirement plan at least up to getting the most company match from your employer that you absolutely can.
Where Should You Keep Your Emergency Fund?
Tonight, we’re talking about how to prioritize long term savings in order to grow your net worth fastest over time. And yes, any savings is good savings, but there are preferred orders in which you can direct your excess cash flow in order to gain grow your net worth faster and more efficiently. So we talked about the emergency fund making sure you have three to six months of living expenses tucked away in a bank account. I should mention so when we talk about bank assets, this is typically, we don’t mean your checking account. Your checking account is a transactional account. Checking account is where most of your bills get paid out of, and the debit card comes out of. That’s not a good place to put your emergency phone, because the temptation for most people is too great. We really think an emergency fund should be segregated from your checking account. So whether that means the bank’s basic savings account that maybe you can’t access so easily with your debit card or without with checks and you have to at least go online and transfer money over to your checking account just. There just that could be somewhat of an impediment to make you think twice before sliding money over from your emergency fund, you know, to buy a new suit or something like that that you that is not an emergency, so at least get it into a savings account.
But nowadays, with interest rates that we’re seeing out of some bank products in the fours or sometimes maybe even 5% we don’t think a basic savings account is even good enough, because at least most of the banks that we’re seeing around here, the basic savings account still play paying about 1% I’m sorry, point 1% interest, but a good place for emergency fund would be in like a bank money market account or a high yield savings account. Each bank calls it something a little bit different, but usually these are funds that are obviously separate from your checking and separate from the basic savings account, they offer higher earning interest rates, but they also come with a little bit of restrictions or handcuffs. So usually, typically would be, you might have to have a minimum deposit in a high yield savings account, like, say, $5,000 or $10,000 and then you can only make, say, about six withdrawals per month, but for most people’s emergency fund of three to six months living expenses, and the fact that you’re only going to dip into this account in the event of a financial emergency, those hurdles are relatively easily overcome. So nowadays, we are recommending our clients take advantage of these high threes, fours and sometimes low fives, interest savings rates out of these different bank products, or even short term CDs will work as well, and by short term means six months, six months to no longer than a year, depending on other factors in your financial situation. But I would say it’s okay to have your emergency fund, at least a portion of the emergency fund, in a six month CD. A lot of times, even if you had to break into the CD, the penalties for doing so are usually minor like a little bit of unearned interest or some uncredited interest or something like that. So even those will work in this environment as well. So a little bit more clarity on what you should do with your emergency fund assets in the bank.
Take Steps To Take Advantage Of Employer Sponsored Accounts
Then Health Savings Account to make sure, if you have a company match on a health savings account, make sure you get that free money from your employer. Then make sure you’re taking advantage of your company retirement plan and making sure you’re getting at least the amount of the company match again, more free money from your employer, more incentive from your employer to take charge of your own financial future, but you have to act. You have to go to human resources, or you have to go to website, or you have to go to payroll, and you have to sign up, and you have to fill out a form, or you have to go online and press some buttons, and then you have to forego that income and redirect it into the company retirement plan, which means you’re going to have to live on a little bit less today, but you’ve got to take that action. No one’s going to do it for you if you don’t take that initiative, the days turn into weeks, turn into months turn into years, and time passes you by. And time is one of the most valuable allies we have in building wealth over time. It doesn’t take a lot of money to one day have a lot of money if you have enough time on your side, but you have to act all right after the company sponsored retirement plan, make sure that you’re getting the full match there.
#4 Pay Down High Interest Rate Debt
Then you want to go after higher interest rate debt. So credit card debt, student loans with interest rates above, I’d say, 6% in this environment you get if you have student loans above six, where some car loans, car loans, now or no, there’s no, not too much. 0% financing anymore, 1% financing. We’re seeing fives and 6% on car loans. So car loans above 6% then so that excess cash flow, you want to start chunking down that higher interest rate debt, and ideally when it comes to credit cards. The proper use of credit cards is for convenience, not procuring debt load from month to month. That’s what your emergency fund is designed to prevent against, because the interest rates on credit cards are, I mean, the best rates that you might be able to get from some credit unions or affiliated community banks or something like that might be 12 to 15% but most credit cards are 18, 20, 22, 25% annual interest rates, and that’s a killer from an interest rate perspective, and given the low payments of credit cards, they just if you only make the minimum payments, you will almost never pay them off. So you’ve got to chunk down that higher interest rate debt.
Tonight, we are talking about how to prioritize your long term savings in order to grow your net worth fastest. And so one of the things, the last thing we were talking about, is to step number four, pay down higher interest rate loans. And that’s credit card debt, maybe student loan debt, maybe car loans with interest rates greater than 6% so then you get interest rates greater than that, then you could start trying to attack those and drive those balances down as quickly as possible.
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Benefits Of Health Savings Plans
After you get that under control, then we want to go back to the health savings account. I remember, that’s step number two, make sure you get any matching funds in your company health savings account, if they give them to you. First of all, health savings accounts provided by companies are not all that common yet, and then those that have a match are even more rare. But for those who do, the city of Virginia Beach, I know does this? They have health savings accounts and they provide an employer contribution. So for those that do, make sure you contribute enough in that health savings account to get the match and then move on, but once you’ve taken care of contributing to your company retirement plan to get the match and pay down those high interest rate debt, then you want to go back to the health savings account and see if you can’t max out, put the maximum annual contribution into a health savings account.
And so what is that? Well, if you are covered under an individual health insurance plan with a high deductible, qualifying high deductible health insurance plan, and then you are eligible for the health savings account. Then an individual can contribute this year, $4,150 to a health savings account. And then, if you are covered under a family plan, then you can contribute up to $8,300 this year. And for those of you who are age 55, or older, you can add another $1,000 to both of those figures in order to max out your contribution for 2024 so those are the maximum contributions that you can make this calendar year. Each year, they tend to creep up a little bit with inflation. And remember, the value of the health savings account is to provide sort of like an emergency fund for health services, so that even if you have a hot one, one of the benefits, the main benefits of having High Deductible Health Plans, and why we should not demonize them like they have been for so long, is because they afford you a lower insurance premium, there’s a lower monthly cost to a high deductible health plan because it means you are assuming more risk on the low end of the insurance or the cost spectrum.
So if you were willing to absorb at least for an individual, about to $1,600 or for a family plan, $3,200 if you’re willing to absorb that much in a year, then you can enjoy a lower premium brought about by a higher deductible health plan. Well, where am I going to get the money? If I have to go to the doctor. You’re going to get it from your health savings account that you’re contributing to on a regular basis, and you’re getting tax breaks for as well. And I should note that the family plan coverage does not mean that you have to have your entire family under one insurance plan. You just need to have you, the employee and one other person in your family on your coverage as well, and that constitutes a family plan, family coverage, and allows you the higher $8,300 contribution limit for this year. So a little bit of nuance in there that should see if you can take advantage of.
What Are Company Retirement Plans?
Okay, so after we max out our health savings account, then we’re going to go back to the company retirement plan. So company retirement plans typically your 401 K’s your 403 B’s your 457, tsps. We want to see how close we can get to maxing out the contributions in those plans. And so how much can you contribute for 2024 so for most of those plans, $23,000 is the maximum annual employee portion of contributions that you can make to the plan. And then for those of you who are age 50 or older, you can contribute an additional $7,500 this year, for a total of $30,500 for calendar year 2024, and a little bit of a wrinkle for your 403 B teachers and hospital workers. If you have 15 years of service or more, you can add another $3,000 on top of that in terms of contributions.
Consider A Simple IRA
And I don’t want to forget, which I usually do my simple IRA friends, there are some small and medium sized companies that their retirement their company retirement plan is a simple IRA, for reasons known only to Congress, the contribution limits and SIMPLE IRAs are, unfortunately, somewhat lower than the other traditional forms of retirement plans. $16,000 is the maximum you can put into a simple IRA this year. Or if you are 50, age 50 or older, you can add another 3500 to that, for a total of 19,500 contribution to a simple IRA. Don’t see too many of those nowadays, but we are aware of few companies here locally that use them as their primary retirement vehicle.
#5 Pay Down Low Interest Rate Debt
So we’ve got maxing out the health savings account. We’re maxing out the company retirement plan. Then we want to go back to lower interest rate loans. So those are debt less than 6% then you can kind of start chipping away at maybe a car loan that you got a few years ago that’s only costing you three or 4% on. Get that out of the way. Try to knock that out. One of the areas that we would say you don’t need to rush to pay down is that and, and this is a little counterintuitive for a lot of people, because they don’t do the math right, but you don’t need to try to rush and pay down a low interest rate mortgage. If you have, which most people certainly do now, a 30 year fixed rate mortgage that is either in the twos, which we have seen in the threes or in the fours, then I would say, do not pay extra on your mortgage. But Kevin, do you know how much extra interest I’m going to pay? You know how much interest I could save over the lifetime of that loan if I paid it down faster? Yeah, I do, but I also know how much more money you could earn if you redirected that additional payment that you would have put on the mortgage into a vehicle that earns more than that interest rate is costing you.
And that, namely, is your company retirement plan, as long as you get it invested properly, okay, big caveat there. You can’t just get it into the plan. You also have to get it invested properly invested for growth. That means primarily, if not exclusively, equities, not bonds, not stable value funds. Okay, it’s got to be invested in stocks for long term growth. You do that, that money is better off there long term than adding to your mortgage and paying off cheap debt. I mean, I we have one client that actually has, like, 1.9 or something like that, 30 year fixed rate mortgage. I said you must have bought that down with points and or something like that. How much did you pay in closing costs? They’re like, No, that was just the rate we got time and like, they hit the lending lottery at that point. I said, do not pay that. You should. You should laugh yourself to sleep every night that some bank out there lent you hundreds of 1000s of dollars for under 2% for the next 30 years. That is absolutely fantastic. So if you have low mortgage rate, do not necessarily rush to pay that off. Redirects that extra cash flow into higher earning investment vehicles.
We’re going to finish up with prioritizing long term retirement savings to turbocharge your net worth and to grow it fastest over time. So about nine different strategies that you can employe. The order, emergency fund, health savings account, up to the point you get an employer match, then company retirement plan, up to the point you get the maximum country company match, then you want to pay down your higher interest rate loans, anything above 6% in this environment, start chunking that away. Then go back to the Health Savings Account. Try to max that out. Go back to the company. After you do that, go back to the company retirement plan. Try to max that out. And then go after smaller interest rate loans, those below 6% and only then do we look to funding IRAs, traditional IRAs, Roth IRAs.
How Is A Minimum Credit Card Payment Calculated?
But before I get into that, I see Bill back on the phone line. So we’re going to go out to Williamsburg and speak with Bill. Good evening. Bill, you’re on Dollars & Common Sense.
Caller: What is the way to calculate the minimum payment on a credit card. Do you happen to know? I know you, you borrow money. It’s over a certain amount of interest, it’s over a certain amount of years. Imagine originally. And then each time you borrow, every month, they add it to the balance and all that. And then they calculated over a certain number of years, I guess. And then they then that your minimum payment divided by either 12 or 24 or whatever it is that keeps you paying forever on it, like you say, eventually you’ll pay it off. I’m sure, if you pay the minimum payment continuously, but over how many years are we talking before it actually is paid off?
Kevin Zywna, Wealthway Financial Advisors: I don’t think there’s a standard answer to that. I think every credit card company does it a little bit differently, and I and I don’t actually know what it would be paid off ever, but it feels like it’s at least 20 years or something like that. The return the payment rate on your balance is usually calculated at just like a couple percent of the outstanding balance, and then when you factor in interest payments on top of the principal, you aren’t you aren’t making much of a dent into that principle at all. So making minimum payments on a credit card is a sign that you’re going in the wrong direction and you’re digging yourself a financial hole. Now, I understand life happens, and sometimes it comes at you faster than you anticipate, and that’s your only option is credit card and credit card debt, and if that’s what you need to do to buy some time, to hang on, to get through a financial rough patch then, well, so be it. You know, life is not perfect, and we have to do the best we can with the circumstances we have. But if you find yourself in that situation where you have revolving credit card debt that you cannot pay off, and you are only making the minimum payments, you have to resolve to try to nip that in the bud, stop that as soon as possible. Don’t add any more balance to the credit card. And then try to increase that minimum payment, double it every single month until you start making a real dent in that credit card balance once they’re paid off. Keep them paid off in full. Use them only for convenience, and make sure you pay them off in full every month when that bill comes in.
Details On IRAs
All right, thanks for the call, Bill. I have a couple more points I want to make about prioritizing long term retirement savings. It was up to IRAs so you can contribute to IRAs each year up to $7,000 per year. For 2024 if you’re age 50 or older, add another $1,000 a total of $8,000 you can contribute to either a traditional or a Roth. You can contribute to both in the same calendar year, but you cannot exceed the total contribution limit. So if it’s only 7000 you’re under 50, then it’s 7000 you could only contribute a total of 7000 to both the traditional and the Roth, but you can do both in the calendar year. Just can’t exceed the annual contribution limit. And then there are income limitations that prevent some people from may either making contributions to IRAs or making the full contribution to the IRAs. And while this can get a little number heavy, I’ll try to keep it simple for single people, it. If you are if your modified adjusted gross income is $146,000 or greater, and married filing jointly $230,000 or greater, then you start to phase out. It’s called of the total Roth contribution limits, which means you can’t contribute the full amount. And for traditional IRA contributions, if you’re single, 77,000 or if you’re married filing joint $123,000 if you start making above those numbers, then you can’t make the full contribution to a traditional deductible IRA, so you got to watch out for those things as well. And then finally, after you take full advantage of whatever Ira opportunities.
What Is The Difference Between Roth And Traditional IRAs?
Oh, and I guess I should mention, what’s best Roth or traditional IRA? We get that question a lot if you are eligible for both, generally speaking, when you are relatively young and new in the workforce, and you are probably making entry level wages and a low end of the wage scale, and you’re building your career, probably best to make Roth contributions at that period of time, As you get older, gain more experience, get pay increases throughout the years. You once you get to mid career, and you start going up into tax brackets, and your taxes start to become a bigger and bigger component of your expenses, that’s a good time to then shift to either to traditional IRAs, if you can qualify for them, or make sure you’re taking full advantage of your pre tax contributions to your company retirement plan. That’s when you’re going to get the biggest tax bang for your buck.
#6 Use A Taxable Brokerage Account
And then finally, so the last savings vehicle is what we would call a taxable brokerage account, or regular after tax contributions to a mutual fund company like Vanguard or fidelity, or in our case, we set up taxable brokerage accounts at Charles Schwab, and through Schwab, we have the universe of investments available for our clients. But if you So, you don’t get any tax break for money that goes into the account, and there are some tax ramifications on how you invest in the taxable brokerage account. But if you do it well and you do it tax efficiently, it is an excellent savings tool, because the tax rates there are capital gains rates, which are naturally lower than ordinary income tax rates.