Brookfield's Reardon Offers Top 10 Financial Tips

Shakespeare's Top 10 Financial Tips

Tip#3: It's Not What You Make. It's What You Keep That Counts

By Kevin Reardon, CFP

Recently one of my kids asked one of the all-time great questions, “Dad, how much money do you make?” Reflecting back to a similar conversation I had with my father, I recall clearly his response. He said, “It’s not what you make that matters, but rather what you keep that counts”.

During my career as a financial advisor, the concept of keeping what you earn has proven to be one of the main objectives we strive to accomplish for clients, and it comes in several forms:

Taxes: Silently Depleting your Funds

With every dollar earned in the form of wages, we owe Uncle Sam, i.e. the Federal Government, a piece of our earnings. In addition, many of us pay state income taxes, unless you live in a state that doesn’t impose such tax. Don’t forget that every employee pays a 6.2% tax for Social Security (up to $106,800 in 2009) and 1.45% tax to Medicare (unlimited). Of course, most states impose sales taxes on every purchase we make, pulling more dollars out of our pockets. If you own a home, the property tax is a large annual expense that depletes our budget.

Savings

If you’re seeking financial independence, having a consistent savings plan is a must. Saving money with a 401k or 403b employer-sponsored retirement plan is one of the best ways to keep what you earn. Contributions to these types of qualified retirement plans happen automatically and are done on a pre-tax basis. The automatic savings component of these plans is critical, as the dollars come out before you have a chance to spend them. The pre-tax nature of these contributions is important because the government does not tax the contributions going into the plan. Once the funds are inside a qualified retirement plan, the growth of the investments is not taxed until you pull the money out. This allows your funds to grow more quickly than other investments and to build a larger nest egg.

Money inside Roth IRAs not only grows tax deferred, but qualified withdrawals are not considered taxable income. In essence, once money is contributed to a Roth IRA, it is tax-free forever. In 2010, every individual, regardless of taxable income, will be allowed to convert IRA assets into Roth IRA accounts. You will pay income tax upon conversion, payable in 2011 and 2012, but then the funds will be tax-free.

Lifestyle

Many of us would cringe at the thought of living on only a few hundred dollars per month, but in some parts of the world that income would put you in the top 1% of all wage earners. Your financial independence relies less on your income level than it does on your lifestyle and expenses. Contrary to popular belief, we do have control of our lifestyle and spending patterns.

The United States has developed a culture of consumption in the last two decades that’s eroding people’s savings and preventing them from keeping what they earn. The biggest lifestyle budget busters are homes, automobiles, credit card usage, and children. As the size of the American family has shrunk in the last 30 years, the size of our homes has increased dramatically and at great expense. Not only is the purchase price substantially higher than a smaller home, but the annual maintenance, insurance, and property taxes are a larger financial burden. Smaller homes are cheaper and less costly to maintain and help us keep more of what we earn.

The automobile has been transformed in the last 30 years from a mode of transportation to that of a status symbol. The cost of a new luxury vehicle or SUV today may be more expensive than the homes we grew up in. With every additional dollar spent on a car, there are fewer dollars left over for savings. Consider driving your current car longer than you have in the past and consider a more affordable used car for your next purchase.

Credit cards have proven to be the demise of many family budgets, and eat away at our hard earned savings. Charging something on a credit card is easy to do, and allows us to lose sight of our spending habits. Humor your mother or grandmother, and try using an envelope system of budgeting for one month. This entails pulling out a predesigned amount of money from your checking account each month and segregating money into envelopes for various expenses during the month. Allocate a percentage for groceries, entertainment and eating out, kid’s activities, gas & car maintenance, etc. When you deplete the envelopes, you are done spending money until your next check.

Children are the other major drain to family’s finances. Rarely do we parents say ‘No’ to our children. Specifically, we don’t say no to the cellular phones and the monthly bill that comes with them, the I-pods and the cost of the countless downloads, cable TV, and expensive extracurricular events (select sports teams, dance & ballet lessons, school trips or foreign exchanges). Keep more money in your pocket. Teach your children fiscal responsibility, and just say ‘No’ next time a ‘want’ occurs.

Keep more of your earnings by clearly identifying your most important goals and recognizing that less important goals and desires need to be avoided. Keeping more of what you earn brings piece of mind as well as financial independence that will last a lifetime.

Kevin Reardon, CFP® is a Fee-Only financial planner and president of Shakespeare Wealth Management in Brookfield. He is also a member of the National Association of Personal Financial Advisors (NAPFA).