Fundamentals in Focus
The Building Blocks of a Secure Financial Future
by Alacias Eager
Danielle is a thirty-one-year-old Administrative Assistant and resident of Buffalo, New York. She works for a small firm that provides her with an annual salary of $42,000 and access to a 401(k), which she has yet to fund. Her position also supplies her with health insurance which she uses in combination with a copay program to ensure access to her prescription medications.
In many ways, Danielle’s financial situation is pretty good. She genuinely enjoys her job and the overall culture of the company. She keeps her expenses down by sharing her apartment with one roommate, whom she thoroughly enjoys, although one day she would like to own a home of her own. The only debt she carries is $28,000 in federal student loans, which she would like to eliminate as quickly as possible. Danielle is also aware that she should have some sort of emergency savings and has set aside her most recent tax return and stimulus amounting to just over $4,000. The truth is that Danielle is doing a commendable job, but she’s floundering. She doesn’t want to settle for mediocrity but doesn’t really have a plan.
Laying a strong financial foundation upon which to build requires deliberate planning. Danielle’s first step is evaluating her current expenses. This is an area where she is doing incredibly well. She lives below her means, leaving room to address other financial priorities, the first of which is her company retirement plan. Danielle’s employer will match up to 6% of her contributions. This means that for every dollar she contributes, up to 6%, her company will do the same. Since Danielle hasn’t been contributing at all, she’s essentially been leaving money at the table. There’s no hard and fast rule about what percentage of income Americans should be contributing when it comes to their retirement accounts, but most financial planners suggest a minimum of 15%. In Danielle’s world, this equates to just over $6,000 per year.
If Danielle’s 401(k) had a Roth option that would be her best choice. Unfortunately, it does not. So, she will contribute 6% to the company’s traditional 401(k) so that she gets the full amount of the company match. That still leaves her with 9% to contribute to retirement. Next, Danielle should consider opening a Roth IRA, and setting up automatic contributions from her checking, which can be done through any discount brokerage. A traditional retirement account is structured in such a way that it gives the account holder a tax advantage in the year of the contribution. It lessens their taxable income, and thus creates a lower tax bill. However, a Roth operates differently. Roth 401(k)s or IRAs are funded with money that has already been taxed. While its users don’t see a tax savings in the current tax year, those funds grow tax-free, which becomes a tremendous advantage in retirement. Subsequently, since contributions to Roth accounts have already been taxed, account holders can withdraw their own contributions (but not it’s growth) at any time. Therefore, these funds can easily become available for things like home purchases or emergencies.
Once Danielle has set up her retirement contributions, she should turn her attention to emergency savings before tackling her student loan debt. This will prevent her from taking on additional debt if something unexpected should arise while she is focusing on her student loans. Experts have varied recommendations as to what constitutes a fully funded emergency savings with some stating that three to six months of expenses is appropriate. Others suggest that six to eight months is more secure. Since Danielle’s desire is to annihilate her student loan debt, she might build her emergency savings to the three-month guideline for now and then refocus her attention on the debt.
Throughout the COVID-19 pandemic, America’s federal student loan debt has essentially been placed on pause. Borrowers like Danielle haven’t had any payments due in over a year, a policy which isn’t set to expire until October 1, 2021. Until then, interest rates have been set to 0%. So, any payments that are made by borrowers will serve to reduce the principle of the loan. Of course, many borrowers are hopeful that further student loan relief in the form of forgiveness is coming down the pipeline, but thus far, that hasn’t been granted.
In the meantime, the best course of action to get financially organized is to return to the fundamentals. This means examining and reducing expenses where possible, automating retirement savings, building an emergency fund, and eliminating debt. Remember to take it one step at a time.
Alacias Enger is a performing artist, writer, and educator. She lives with her partner in New York City, and is the founder of blogs “Sense with Cents” and “Travel Cents.” Follow her on Twitter @sense_w_cents.