The flexibility of a 529 plan is one of its biggest advantages for grandparents.
Establishing a 529 account and making regular contributions is one way to save for future educational expenses.
Are you saving more money than you want to or planned? Probably not. Does it seem that even when your income goes up you can’t save more money? Where does your money go? How much money are you saving? If you have a hard time answering these questions―and most people do―there are some easy solutions.
First, try a manual or “back of the envelope” approach. Start by identifying your annual income from your W-2 tax wage statement or year-end payroll stub. Then identify how much you contributed to investment accounts like your 401(k), IRA or 529 college savings plans. Next, calculate how much cash you accumulated or depleted by comparing your bank account balances from the beginning of the year to your balances at the end of the year. If your bank account balances were higher at the end of the year than at the beginning, you accumulated cash. If they were lower, you depleted some cash.
To calculate the percentage of your income that you saved, divide the amount you contributed to investment accounts plus any cash that you accumulated minus any cash that you depleted by your annual income total. For example, if your annual income was $100,000 and you contributed $15,000 to your 401(k) and accumulated $5,000 in your bank accounts, you invested or saved $20,000 or 20% of your income. That is very good and you may be able to stop here, unless you want to learn more about where you are spending your money so that you can try to save even more.
If your income was $50,000 and you contributed $1,500 to your 401(k) and $500 to a 529 college savings plan and your bank balances remained about the same, then you saved 4% of your income. Obviously, the higher your income, the greater percentage you should be able to save. However, it doesn’t always work out that way, as people tend to ratchet up their lifestyle spending as their income increases. As a general rule, you should try to save 10% to 25% of your income. Saving 5% is better than nothing, but it’s probably not enough to accumulate a retirement nest egg in the long run.
What technological resources are available to help you boost your savings? You have a wide range of options to choose from. Your bank website may have a resource to help classify and summarize expenses. Your credit card company may provide an annual statement that shows you how much you spent in certain categories. Check out the “restaurant” or “entertainment” categories and you may be shocked how the discretionary expenses add up.
Two popular software packages that can help you track your spending and saving are Quicken and Mint.com. Quicken is a PC-based software and Mint.com is web-based. They are both owned by the same parent company, Intuit.
Mint.com is free and automatically collects your transactions from your bank and credit card accounts. It assigns an expense category based on the merchant code that is tracked when you swipe your credit card or debit card. For example, if you swipe your card at Kroger’s it will be classified as groceries and if you fill up your tank at Speedway it will show as gasoline. You can manually edit any entries in Mint.com and you do have to manually categorize any checks your write and any cash transactions.
Quicken is similar to Mint.com, but you have to manually download your transactions. Credit card transactions are automatically categorized, just as they are with Mint.com. Quicken has a much wider range of reporting capabilities and more flexibility in choosing historic time periods for reporting. Quicken also has an “Easy Answer” function to answer the questions “How much did I pay to…” or “How much did I spend on…” for a wide range of time periods that you can select. Quicken also offers bill pay and check writing capability to further simplify your cash management. Different versions of Quicken are available that cost between $60 and $90 before rebates and discounts.
Whether you use manual or software methods to track your income, expenses and savings, the process is enlightening and well worth your effort!
About Bruce J. Berno, CFP®
Most investors have more than one investment account. They may have an employer’s 401(k), an IRA rollover, a Roth IRA, a joint taxable account and a college 529 plan. Some accounts, such as retirement accounts, all have the same goal, while other accounts, such as a joint taxable account or a college 529 plan, may have different goals. Cash flows, or deposits or withdrawals, from various accounts may be different too. For those with multiple investment accounts, a “Total Portfolio Approach” will help establish an asset allocation as well as an asset location strategy.
- Asset allocation influences long-term expected returns and volatility.
- Asset location influences liquidity and income tax efficiency.
For example, an investor may determine that an asset allocation of 70% stocks, 25% bonds and 5% money market funds is ideal for long-term expected returns and volatility.
Does this mean every account will have the same asset allocation? Maybe not. First, the employer 401(k) plan may have a Stable Value Fund, which is attractive but not available in the other accounts. The 401(k) plan may not have a good U.S. small company fund or international fund choice. The Roth IRA may be the last asset to tap into and possibly leave as an inheritance, so more aggressive investments may be appropriate. An investor may need a large cash balance in the joint account to pay for a lump-sum expense within the next year, such as a new car or wedding. The beneficiary of the college 529 plan may be in high school now and the investor doesn’t want to risk a 20% drop in the stock market when the student is a senior in high school.
Implementing the target asset allocation in this case may mean:
- A higher allocation to bonds in the 401(k) to take advantage of the Stable Value Fund
- A larger allocation to stocks in the rollover IRA, including U.S. small company or international funds that are better than the 401(k) choices
- A more aggressive long-term Roth IRA strategy that is more than 75% in stocks
- More than 5% cash in the joint account to cover the new car or wedding
- A higher bond or cash allocation in the college 529 plan to minimize stock market risk
Using this asset location strategy will improve liquidity because there will be more money market funds in the joint account and college 529 plan, and it will be possible to withdraw from these for short-term needs.
Asset location can also optimize tax efficiency by having high-income or tax-inefficient investments (such as real estate, commodity or inflation-protected bond funds) in a tax-deferred account such as the IRA rollover or Roth IRA.
Investors should focus on what they can control. Investors cannot control the short-term direction of the stock market or interest rates, but they can control their asset allocation and asset location. A Total Portfolio Approach increases the likelihood that an investor will achieve their personal financial planning goals.
About Bruce J. Berno, CFP®
Bruce J. Berno, CFP® is the founder of Berno Financial Management, Inc. a fee-only comprehensive personal financial planning and investment advisory firm headquartered in Cincinnati, Ohio. Since 1993, Berno Financial Management has been helping individuals and families achieve financial peace of mind. For more information about Berno Financial Management, visit http://www.bernofinmgt.com/.