The start of a new year strikes me as an inherently optimistic time. There is the afterglow of the holiday season, celebration with friends (during pre-coronavirus times), time for reflection on the previous year, and then turning over a new leaf in a new year. This sentiment is especially true moving on from the extra burdens of 2020. There are also the rituals like the traditional Southern New Year's Day meal to bring wealth and prosperity. It will be the only time this year that I eat collard greens. Collard greens represent the color of money, and my food preferences should not come between us.
Another ritual is the formulation of New Year's resolutions. This year, I am focusing on the six "Fs" of life — family, friends, fun, fitness, faith, and finance. If you thought you did not have any Fs left to give after last year, you may be wrong.
The last "F" — finance — can go in many directions. Let me outline some of my financial New Year's resolutions that may also fit into yours.
I will save at least 10 percent of my income to a 401(k) plan. A 10 percent to 15 percent retirement savings target should put you on a path to be able to retire and maintain a similar lifestyle in retirement. Employer-sponsored retirement plans like a 401(k) or 403(b) are among the most convenient, efficient savings vehicles available to investors. The payroll deduction feature makes saving, as well as investment, automatic. There is preferential tax treatment whether you make traditional pre-tax contributions or Roth after-tax contributions. Last, employers will often offer matching contributions that provide an immediate return on your investment by simply participating in the retirement plan.
I will maintain at least three months' worth of living expenses in a savings account as an emergency cash fund. The emergency fund can cover expenses in the event of job loss or income reduction. The coronavirus pandemic drove home the importance of these safety nets. Even though the CARES Act and subsequent laws provided expanded unemployment insurance and some direct aid, nothing was assured, nor will it be in the future. The rule of thumb is to maintain three months' worth of living expenses in a savings account if you are in a dual income household (i.e., both spouses are working) or six months' worth if only one spouse works and/or income is highly variable.
I will contribute to 529 plan accounts for my children's college savings. College can be expensive. How expensive? The current estimated annual full cost of attendance at the University of Memphis is $26,386. To fully fund those college costs, you would need to invest approximately $333 per month from birth through their first year of college. Just the direct costs — tuition, fees, and books — are still $11,512 annually, necessitating savings of $145 per month. Make a savings plan that integrates with your personal savings and open a 529 plan account to earmark and invest the funds. 529 plan accounts offer potential tax-free investment growth if funds are used for qualified education expenses.
I will review my home mortgage to potentially refinance. Mortgage interest rates are at historic lows. If you have no plans to move in the near term, refinancing can create significant savings. On a $200,000 mortgage balance, the difference between a 4 percent and 3 percent fixed rate over 30 years is approximately $111 per month or $40,400 over the life of the loan. Of course, refinancing costs and the remaining term of the mortgage must be taken into consideration.
I will blow some of my finances on another "F" resolution — fun. A beach vacation sounds nice after being cooped up. Happy New Year!
Tim Ellis, CPA/PFS, CFP, is senior investment strategist and wealth strategist for Waddell & Associates.