How To Prep Your Finances For 2021

Welcome to my series on how to prep your finances for 2021. Over the next few weeks I’ll be sharing twenty lessons to help you start the new year on the right foot.

Lesson 1: Rethink your savings strategy.

As 2020 saw many folks dip into their savings, either as a result of a pay reduction or loss of employment, it’s prime time to rebuild your savings. Pre-COVID, the old “rule of thumb” was to set aside three to six months worth of living expenses for a rainy day. Now that we know “unexpected” events can become a reality, it can make sense to set aside sixth months (at a minimum) to a year if possible.

While it can be painful to see funds sitting in the bank earning near zero (more on that later in this series), you’ll be glad to have the funds accessible if the need arises. And while your typical savings account may indeed pay you close to nothing, rethink where you park those funds.

As discussed in this article by Nerd Wallet, several online banks will offer high yield savings accounts that are readily accessible. Consider leaving enough in your regular checking’s/savings to avoid monthly bank fees and leverage a higher yielding savings account with the rest.

Lesson 2: Downsizing your home can help you jumpstart your retirement.

Soon to be an empty nester? Consider downsizing and put your home equity to work. While moving out of the home where you raised your family can be difficult, there are some nice perks on the other side of that hurdle. The key is to use your home equity to serve your financial goals.

Since a big part of retirement is recreating the paycheck you’ll no longer receive, you’ll need to find a way to bridge the gap between income and expenses. If your projections show a wide gap, consider using the proceeds of your home equity to create an income stream.

On the flip side of that coin, consider investing the equity proceeds to bring your financial plan back into alignment. As discussed in this article by Home Light, the median home equity value is $140k.

Throughout your career you’ve likely made sacrifices for the better of the family. Now that you are able to put yourself first, a lump sum can bring you up to speed.

Lesson 3: Refinancing can help you lower your monthly expenses.

Rates are back to all time lows and re-financing has started to make a lot of sense. While saving money on interest can lower your monthly expenses, it can also help get your finances back on track.

  1. Take the savings and add them to your retirement funds. If you’ve fallen behind on saving for retirement, the monthly savings from a smaller mortgage can go a long way. Factor in compounding, and you may find yourself back on track.
  2. If you have high interest debt (i.e. credit cards), pivot the monthly savings and direct it towards your high interest debt. If your bank isn’t paying you 15% on your savings, why should your credit company earn that much ?
  3. If you’ve become accustomed (and can comfortably afford) your current mortgage payment, consider paying the same amount on your new, lower mortgage. By applying the surplus to principal, you’ll speed up repayment schedule and be one step closer to being debt free.

Lesson 4: Re-think your Retirement accounts.

We all know how strange this year has been. From quarantine to remote work, we’ve all had to re-think a number of our daily routines. Though not a “routine,” add retirement accounts (Roth’s) to the list.

Many employees took pay cuts to avoid being laid off. Other’s made less due to a slowdown in general business. If you find yourself in either situation, consult with your tax pro and see if you have any new options available to you this year.

Chances are you may be in a lower tax bracket. As such, Roth conversions could make sense. As I wrote about in my most recent article, Roth conversions are essentially a way of paying taxes now (presumably at a lower tax bracket) instead of later. It may be difficult to see the immediate benefits, but tax free retirement income is nothing to scoff at.

There are more nuances to the process, and you’ll want to be extra careful not to convert too much (work closely with your advisor and tax pro), but the rewards are well worth it.

Lesson 5: Ramp up your contributions.

In the first four parts to this series, I touched on the importance of taking stock of where you are today and prepping for the future.

If going through the first four steps finds you on stronger footing than previously imagined, now could be the time to ramp up your retirement savings.

Earlier this year, many folks decided to reduce their 401k deferrals in anticipation of smaller paychecks. If you’ve found that “tightening the belt” wasn’t all that necessary, there’s still time to increase and possibly max out your contributions.

For 2020, the max deferral is $26,000 ($19,500 + $6,500 catch up if you’re over 50). Unlike deposits to IRA’s and Roth IRA’s, 401k contributions generally have to be made by year end – leaving you with a little under three months to budget the remaining deferrals.

While ramping up your retirement savings provides many benefits, two key items with immediate payoff:

  1. It can get your financial plan back on track.
  2. Every pre-tax dollar you contribute can reduce your taxable income.

Be sure to check in next Friday for the next five installments of 20 Money Lessons from 2020.