At last, you've gotten your career on course and are ready for your next big moves -- perhaps starting a family and buying a home. Before you get too far down that road, map out a long-term plan, says Jim Oliver, a certified financial planner in San Antonio, Tex. "Most people live the lifestyle they want without putting away enough to meet the goals they want later on. It's like having a budget for a trip and not allocating it. Before the trip is over, they run out of money."
Prepare for contingencies. If you haven't done so already, fuel an emergency fund with enough to cover at least six months' worth of basic expenses. That cushion can prevent you from raiding your retirement accounts after a layoff or keep you from borrowing your way out of a crisis. "Debt is the number-one problem that sabotages most couples," says Deborah Fox, of Fox Financial Planning Network, in San Diego.
Before you have children, contribute as much as you can to your 401(k), but don't neglect the Roth IRA, says Barry Korb, of Lighthouse Financial Planning. "It's costing you in taxes now, but down the road, that money is tax-free. Do it while you can afford it." Keep contributing at least 15% of your gross income toward retirement savings, says Nicholas Yrizarry, of Wealth Management Group, in Laguna Beach, Cal. Once the kids arrive, you'll likely have to pull back if one spouse leaves the workforce or to pay for child-care costs. Either way, "the reality is you can't do 15% of gross income because it's not there anymore."
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Siphon off cash for a down payment. Sacrosanct as retirement accounts may be, some financial planners consider them fair game for a down payment on a first home. To justify this strategy, you need to have enough time before retirement to replenish the accounts. If you're 45 or older, don't even consider the idea. Also be strategic about which account you tap. With a 401(k), for instance, you'll incur taxes and a 10% penalty on early withdrawals. But with an IRA, Uncle Sam waives the 10% penalty on a distribution of up to $10,000 for a first-time home buyer -- although you'll still owe taxes on the withdrawal. If your spouse is also a first-time home buyer, you can each withdraw up to $10,000 penalty-free. You can always withdraw your contributions from a Roth tax- and penalty-free, but if you're buying your first home, you can take up to $10,000 of earnings tax-free, too, as long as you've had the account for at least five years.
You can usually borrow against your 401(k), an option not available with IRAs. You are allowed to borrow as much as half your balance, up to $50,000, for any reason. You generally have to repay a 401(k) loan within five years or it's considered a taxable distribution. But your employer may allow you as long as 15 years if you're borrowing to buy a home. "If it gets you into the home you want and need," says Yrizarry, "it's an effective use of your money."
Already own your home? Consider refinancing your mortgage if you haven't locked in the low rates available now. You can put the money you free up into savings.
Set a goal for college savings. Talk about a squeeze play. At the same time that you're funding your own retirement, you're also expected to stretch to cover college bills. But you could aim for, say, three years at a public school or two years at a private school and figure on paying the rest out of current income, or have your student kick in summer earnings. To run the scenarios, use the college-cost calculator at Savingforcollege.com. To meet 50% of the total cost of four years at a public university, based on the current average annual cost ($17,131) and a 6% inflation rate for college costs, you'd need to save $222 a month for 18 years, assuming a 7% annual after-tax return on your college savings fund. If you covered half of only the tuition bill, you'd need to save $107 a month.
As for which account to pump money into, your best bet is usually a state-sponsored 529 savings plan, which lets your savings accumulate tax-free. If you use the withdrawals for qualified educational expenses, such as tuition and fees, the earnings can be withdrawn tax-free as well. About two-thirds of the states also offer a tax benefit for contributing to a 529 plan. A Roth IRA is also a good way to save for college. Earnings can be withdrawn penalty-free (but not tax-free) before 59 1/2 if you use the money for college expenses.
This article first appeared in Kiplinger's Personal Finance magazine. For more help with your personal finances and investments, please subscribe to the magazine. It might be the best investment you ever make.
