How to Fine-Tune Your Finances in 2021
January is perfect timing for “Financial Wellness Month”, as it reminds us from the start of the year to pay attention to our money. The holiday season tends to increase spending, New Year’s financial resolutions are staring back at us, and preparation for tax filing is upon us.
When it comes to evaluating our financial health, here are some key areas to examine:
Smart Spending
More than half of Americans spend more than they earn and 70 percent consider their level of debt to be problematic. Almost 50 percent have credit card debt, more than 40 percent have a mortgage or a car loan and more than 30 percent have student loan debt.
Before you start putting together a budget, it’s a good idea to track your spending habits over several months to get an accurate look at where your money is going. Use a simple spreadsheet or a personal finance app to calculate what you spend and where. Group your expenditures into categories such as reoccurring bills, groceries, eating out, entertainment and so on.
After you monitor your spending habits over time, you can determine where you might be able to cut back if necessary. This will also give you a monthly budget moving ahead. Continue to track your spending to keep on course with that budget.
Effective Saving
Clearly, the pandemic devastated the savings of many people. Yet well before Covid-19, the Federal Reserve Bank reported that 40 percent of U.S. households cannot cover a $400 emergency expense, leaving them unprepared and vulnerable to financial crisis in a recession.
Creating an emergency fund for unexpected life expenses is one of the most important financial moves you can make. Start by determining how much you need to save and then create a schedule for how much you will put away each week or each month. Track your progress and do what works best for you to keep this money separate from your spending change.
Maintaining a regular saving schedule will prevent the need for financing options later. Putting your funds in a separate, high interest-earning account, as well as keeping some cash handy, is a good option to consider.
Purposeful Borrowing
The purposeful use of debt is undoubtedly one of the more controversial financial planning topics. Most of us use debt to buy a home, which is generally recommended as long as the amount is reasonable. Beyond that, try avoiding debt whenever possible. It is far too easy for debt to get out of control – with disastrous effects.
Student loan debt is affecting all age groups and has surpassed $1.6 trillion. Tackling it is another item that incoming President Biden is looking to help address.
Wise Investing
Investing is a powerful tool used to build wealth and save for the future, yet nearly half of all American families have nothing saved for retirement. Whether you're making $50,000 or $200,000 a year, putting money away is a challenge. The sooner you start saving for retirement, the better. Time is on your side when you start early, thanks to the power of compound interest. Even if you’re well on your way to retirement age, there’s no time like the present. The most important move is to start.
Several types of investment accounts can help you save for retirement. The most common are 401(k)s and Individual retirement accounts (IRAs).
A 401(k) is a tax-deferred, employer-sponsored account. You will pay taxes on the money only when you withdraw it. You can contribute up to $19,500 each year to your 401(k), with additional catch-up contributions of $6,500 for those 50 and older.
IRAs are also tax-deferred but are not offered through your employer; you have a choice of where your investments are made. You can contribute up to $6,000 each year to IRAs ($7,000 if you’re 50 and older). There are several different types of IRAs – including a traditional or Roth IRA. Each plan has different rules regarding taxation and withdrawals. Speak to your financial advisor to determine which plans work for your situation and always consult a tax advisor to understand all of the associated tax benefits and implications.
Changing Taxes
By now, we have all adjusted to the changes that occurred with the 2017 Tax Cuts and Jobs Act. But incoming President Biden has proposed a number of new taxes aimed at the wealthy, among them a return to the top tax tier of 39.6% for those earning at least $400,000 a year, although he has not specified if that will be for single filers, joint filers, or both.
Biden also proposes eliminating the qualified business income (QBI) deduction for anyone with income more than $400,000. Today, the QBI works as a tax deduction that allows eligible self-employed and small-business owners to deduct up to 20% of their QBI on their taxes. In general, the total taxable income in 2020 must be less than $163,300 for single filers or $326,600 for joint filers to fully qualify.
Biden also wants to replace IRA and 401(k) tax deductions with a flat credit. This would be a big benefit for those with modest incomes and reduce tax benefits for those with higher incomes. The Biden plan would also end beneficial treatment for stock option plans for high earners.
On the capital gains side, the top rate would equal the ordinary income tax rate for income exceeding $1 million. That is a big change. It appears likely he will increase the current $10,000 cap on state and local taxes (SALT) taxes that can currently be deducted.
Saving for Future Healthcare
Long-term healthcare such as nursing homes or assisted living is expensive. Although 70 percent of Americans will need it, more than 60 percent have nothing saved. Consider a health savings account (HSA) if you’re enrolled in a high deductible health plan. Contributions to a flexible spending account (FSA) also offer tax breaks but you generally must use the money in the year you save it. Contribute as much as you can to your IRA and 401(k) – you’ll be able to use this money in retirement for healthcare expenses. And as always, get the best health insurance your budget will permit.
After all, we have endured in 2020 and the beginning of 2021, many of us are determined to take some time out of our busy lives to reflect and plan for what lies ahead. Do you know your numbers? Numbers are specific, clear, easy to understand, and can be a reference point to help determine whether your financial plans are progressing. See where you stand and ask whether you can do better.
Written by Walid Petiri
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