Divorce can be financially devastating

I recently wrote an article for Mintlife.com and Business Insider about how divorce can be a financially devastating experience. Maritalstatus.com says an average divorce can run $20,000 but that’s only the beginning.

From legal fees and alimony payments, to the division of assets and possible tax consequences, the costs can grow even higher.

The expenses of a divorce are unlikely to deter a couple that truly needs to split, but experts say you should still be aware of just how high the bill can get. It some cases, the financial consequences can set you back decades.

Financial consequences for everyone

When it comes to divorce, Hollywood and pop culture often portray the highest-earning spouse being taken to the cleaners, but the reality is, both spouses face financial damage. Nathan Cobert, CFP, of Cobert Financial Group in San Francisco, said while a growing number of spouses both work and have comparable incomes, the majority of marriages still have a primary “resource spouse” and a “non-resource spouse.”

“There’s usually a spouse who is afraid they’re going to be bled dry and another who is afraid they’re going to be homeless. It’s always a financial problem for both,” said Nathan Cobert.

The first financial burden is the separation of one household into two. While one person may remain in the home, even if only temporarily, the other has to find a new place to live. Not only are there two rents or mortgages but two cable bills, two utility bills, two health insurance bills and there is no longer the bulk savings on things like groceries. Almost overnight, the living expenses for the couple double while their combined income likely remains the same.

“It’s a lot more expensive to maintain two separate households and you’re having to do it on the same amount of income,” said Jeff Landers, CDFA, President of Bedrock Divorce Advisors in New York.

Capital gains can be a killer

Divorce can come with big tax bills. In many cases, when a couple splits, they may immediately start scrambling to claim or divide assets. It’s not uncommon for a spouse to run and clear out bank accounts, cash in CDs and sell off stocks, bonds and other investments. Blinded by emotion and fear, Cobert said they can be hit with a harsh reality when tax time comes around.

“People are not often aware that there are consequences for taking out certain assets. Spouses may want to get the money or may need it for income, but the taxes can really add up,” said Cobert.

Let’s say the couple had $100,000 of investments in a joint account. If they liquidated portfolio and the cost basis of those stocks was $70,000, they could each be on the hook for $15,000 in capital gains. If the money was in a traditional IRA and they sold off the stock and took the money before they were age 59 ½, they could be not only on the hook for capital gains but an additional 10% penalty, as well.

Spousal support quickly adds up

The granting of alimony (also known as “spousal support”) and how it is calculated varies significantly from state to state. Alimony is usually paid to the less-advantaged spouse and is often seen as a temporary measure to help them stay on their feet during the separation.

Landers said the first determining factor is the length of the marriage. Although it can vary, in most jurisdictions a couple must have been married for at least ten years for alimony to be a consideration. Other factors include how old the spouse is, whether or not they have a job, how much they earn, any other assets they have, the nature of the dissolution of the marriage, and the need.

“There is no set formula. It’s very subjective. You could be in the same state, have two different judges, and the same set of circumstances, and end up with very different conclusions,” said Landers.

Cobert also said it can vary widely, but in general, the “resource spouse” might have to pay 50% of their income minus 40% of the income being earned by the non-income spouse. Others say it often works out to ensure that both homes have around the same average income. Often, if there is a child involved, child support is the priority and is calculated first. In any case, if alimony payments are awarded, the paying spouse could have to pay a significant amount of their income to the other spouse for a number of years.

“It’s usually determined by the judge. That’s why we recommend Alternative Dispute Resolution so both parties can come to a fair agreement,” said Cobert.

Don’t forget the legal fees 

No matter how amicable a divorce may be, there are going to be significant legal fees. Attorney fees add up quickly because, when combined, the couple is paying for not just one, but two legal teams. Even an amicable do-it-yourself-divorce can still cost over $1,500 in many jurisdictions. Landers said the problem is that when a relationship deteriorates to the point of divorce, very few couples do it amicably.

“If they were able to do it amicably, they might be able to go with mediation and it might not cost a lot of money. But if they were that amicable, they might not be getting a divorce,” said Landers.

And the more a couple disagrees and fights it out in court, the more expensive it becomes. Throw in a custody battle and a fight over alimony and assets, and legal fees could easily top $100,000 in many states. Things get even worse and more expensive when the spouses stop talking to one another and communicate only through their attorneys.

Cobert said ADR (Alternative Dispute Resolution) and mediation has grown more popular in recent years as a way to more amicably and cheaply handle divorce disputes. He also recommends the couple consult with a Certified Divorce Financial Analyst who can analyze their assets and circumstances and help them proceed with the separation in a way that makes the best financial sense for both.

“More people are using CDFAs to run the numbers and come up with optional settlements. It’s usually a lot better to try to keep it out of the courts,” he said.

There’s no reason for a parent not to have life insurance

I recently wrote an article for Quicken.com about why parents need life insurance.

It’s crazy to think we’d even have to mention this but recent survey data indicates that far too many parents go without life insurance. According to the Genworth Financial LifeJacket Study, 69% of single parents and 45% of married parents lack life insurance coverage. Gregory Fairchild, research project developer and University of Virginia Darden School Professor, said it’s a growing problem because many children have few or no options if they have to deal with the unexpected death of a parent.

Protect your family

Basically, the younger the parent, the fewer the assets, and the greater the debt, the more catastrophic it can be for surviving family members when a parent dies without life insurance. What makes things worse, is those who go without life insurance are often the ones who need it the most.

“We find that many single parents are simply too busy – or even too scared – to properly evaluate their life insurance needs,” said Fairchild.

Life insurance is essential for parents because it protects your child’s future in the event of your death. The idea is that should something happen, you don’t want your family to suffer financially. You want your loved ones to know they have enough money to pay the bills and live comfortably.

Joe Pitzl, CFP, of Intelligent Financial Strategies said the last thing you want is for family members to compound their grief by worrying about how they’re going to cover the mortgage or a child’s tuition.

“Your family and/or children are relying on your income and if you die without life insurance you can leave your family high and dry,” he says.

Mari Adam of Adam Financial Associates said one of the reasons so many parents go without life insurance is because they don’t want to think about death. It’s an uncomfortable feeling for many to discuss what would happen if they were to perish in a car crash or drop dead from a heart attack.

Others are uninformed and believe that life insurance is expensive. While whole life policies can be prohibitively expensive, Adam said term policies for parents in their 20s and 30s are dirt cheap and can be obtained quickly. ”It’s the one kind of insurance that is actually cheap. I think many people don’t have it because they don’t realize how cheap and easy-to-get term insurance is,” said Adam.

Rates can vary, but for a 30-year-old non-smoker, a $250,000, 20-year policy can be had for as little as $200 per year. That’s only $16 per month to ensure the financial security and future of your spouse and children. Adam recommends that parents avoid expensive whole life insurance and start with a term policy that offers the maximum benefit for the lowest price. Although such policies are often marketed for their “investment” benefits, Adam said you can come out ahead by buying term and investing the difference.

“You can probably talk to someone on the phone for ten minutes and get it done. It’s critical because we’ve seen people who don’t and the kids are put into a horrible situation,” said Adam.

How much do you need?

A common rule of thumb says you should have enough life insurance to cover between six and ten times your annual income. But this also depends on the size of your mortgage, any debts you may have, how many children you have, and your expectations for their future. You should generally factor in the cost of paying off the mortgage, any college tuition and expenses, and a reasonable annual income to cover living expenses for the family.

If you have a spouse, it’s not that he or she will never work again, it’s just that you want to have enough insurance to provide a cushion so that they can continue their lifestyle without your income. You’ll also want to factor in the cost of your own funeral. Because term insurance is to inexpensive, it doesn’t cost much more for additional coverage.

“It’s really cheap, you can get a million dollar policy for not much at all. The cost of obtaining more coverage isn’t much more,” said Adam.

If you don’t want to buy one big policy, another option is to create a “layered” life insurance plan with terms that will cover you for thirty years. The idea is that as you get older, you have more assets to leave behind, so you need less insurance. While you may need $300,000 in coverage when you’re thirty, you may have more than $300,000 in assets by the time you are sixty.

So, by creating a layered policy, you get more insurance in your early years and then less insurance (and saving on premiums) later down the line. Such a plan could include a $100,000 30-year plan, a $100,000 20-year plan and a $100,000 10-year plan. So, in the first ten years you’ll be insured for $300,000; between years eleven and twenty, you’ll be covered for $200,000, and in the last ten years you’ll only be covered for $100,000.

“You project your need based on today and at several breakpoints in the future. It could cut the premiums in half and maybe allow you to afford more coverage earlier on,” said Pitzl.

Marriage does have some financial advantages

I recently wrote a piece for Interest.com about how a friend with benefits is nice but a spouse with benefits is better.

People spew a lot of negative stuff about marriage these days but the reality is that if you’re already in a long committed relationship and have been living together for years, there could be some great financial benefits with tying the knot. Of course, no one would suggest marrying for money or tax savings but there are a few advantages that come with making the commitment.

Advantage 1. Two is better than one.

Let’s face it. Whether you’re trying to lug a sofa upstairs or trying to save for a house, two is always better than one. It’s good when someone has your back and can lend you a hand. When you’re married, you’ve got two incomes and two brains working together.

Hopefully you have double the assets or at least a little more money than you would if you were single. It’s even better if you’re both on the same page about investing, saving for your future and staying out of debt. You get a lot more financial security in so many ways. Even if one spouse stays at home or is a student, there’s the potential for future earnings.

Some married couples keep their finances separate, some merge them. But in any case, you both will be working together for your common good. Through compounding, your investments can grow even faster if you’re saving twice the money. While you think you may have all of these things with a “friend with benefits,” your commitment is that much stronger when you’re married. You’re not only joined financially, emotionally and physically — you’re joined legally.

Advantage 2. You can have more health insurance options.

While more companies are offering benefits to unmarried partners nowadays, you still have the most options when you’re married. If you’re both employed at companies that offer health insurance, you then get two options to choose from. Pick the best and least-expensive coverage, then decline benefits at the other company. If you’re self-employed, having a spouse with health insurance benefits at work can be a lifesaver.

Because your only other option would be to get an individual plan on the open market, you may save 50% or more in premiums should you be insured through a spouse’s plan at an employer. Also, an employer’s plan usually isn’t going to decline you based on any preexisting conditions. Regardless of your medical history, you should get the same rate that other spouses would. How much you save will depend on the individual company plan. Some companies will cover up to 80% of an employee’s premiums but won’t cover anything for spouses.

Advantage 3. You can save big on taxes.

When you’re married, you have the option to file your taxes jointly or separately. What is best for you depends on your income, deductions and various other factors. But at least there is the opportunity that you can save on taxes. In some cases, it can add up to thousands of dollars.

Don’t listen to the talk about the “marriage penalty,” which has largely been erased by changing tax brackets and increased deductions. If you have two big earners, you could pay slightly more in taxes, but there’s not much of a difference for most people. If one spouse makes a fair bit more than the other, there could actually be considerable tax savings.

Let’s say one spouse makes $75,000 per year and the other, $35,000. As a single filer with the standard deduction and personal exemptions, the first spouse would owe $12,500 in taxes. The $35,000 earner as a single filer would owe $3,400. That’s a total of $15,900 for the both.

But if they were married filing jointly with $110,000 in income, they’d owe $15,000 in taxes. That’s $900 in savings in federal taxes alone.

And if one spouse is a stay-at-home parent, student or doesn’t work, the savings can be even greater. Let’s say you’re making $60,000 per year, your partner is making $0 per year, and you get married. The minute you get married, your standard deduction will double and you’ll drop from the 25% tax bracket to the 15% bracket. With a $60,000 income as a single filer, you’d owe $8,750 in federal taxes. But if you got married and your spouse had no income, you’d pay only $5,300 if you filed jointly.

Advantage 4. You can get a break on auto insurance.

Men, in particular, can see a massive reduction in their auto insurance premiums once they get married. Insurance companies make men in their 20s pay through the nose. But they seem to think that when you get married, you’re less likely to drive like a maniac. Your liability insurance could drop by 50% or more.

Insurance companies also provide more discounts when you combine policies with multiple cars and drivers, so the savings can add up more. In many cases, the couple may actually pay less when they come together on the same policy than they did on their individual policies. Of course, all the financial benefits of marriage assume you marry the right person at the right time for the right reasons.

Of course, just as marriage can offer many financial advantages, it can also be a financial catastrophe if it doesn’t work out. The average cost of a divorce is roughly $20,000. And that doesn’t even include things like alimony and division of assets. No one should ever get married for financial reasons or to save a few bucks. But if you’re already in a committed lifelong relationship, walking down the aisle can bring some financial security.

Save big and boost your financial security by driving your vehicle as long as you can

I recently wrote a post for Interest.com about how I’ve boosted my financial security by keeping my truck.

Sometime this month the odometer on my truck will hit 100,000 miles. 

It may not seem like a big deal for some people but surveys have found that many Americans trade in their vehicles and upgrade long before hitting this mark.

For me, hitting the six-figure mileage mark on my 2003 Nissan Frontier is only the beginning. I plan to drive it as long as possible. Certainly at least another 5 years and 65,000 miles. Hopefully beyond that.

I will buy a new truck when reliability becomes an issue or I have to spend too much on repairs. It’s not because I don’t have the money, it’s because I’ve made a conscious effort to forgo automotive luxury to boost my financial security.

Aside from a mortgage or rent, a car note can typically be one of a consumer’s biggest expenses. And if you don’t make your vehicle purchases wisely, it can be a lifelong financial drag.

While a vehicle is a necessity in many parts of the country, it’s a terrible depreciating asset that has high costs and can be next to worthless by the time you get rid of it.

On strictly financial terms, you want to spend as little as possible on a vehicle and drive it as long as you can. In a perfect world, you’d pay cash for your vehicle and not borrow a dime. But that’s not a possibility for most people. The next best step, depending on the interest rate you’re paying, is to pay off your loan as quickly as possible.

I paid off the loan on my current truck in 2007, two years sooner than the five year term was up. I can not tell you how wonderful it has been having no car note for five years.

During that time, that monthly payment, which would have otherwise gone to a lender, has been going to my Roth IRA, investments and a savings account I have set aside for a new vehicle.

I can honestly say that I owe a fair part of my financial security to my lack of a car note. I consider my truck not just a thing to get around but a tool that saves me money. Because every day, week, month and year longer I drive it means more money in my pocket.

If I were to buy a new vehicle today, I’d likely end up with a $300 monthly note based on the purchase price, my trade in and down payment. So the way I look at it, I’m saving $3,600 per year by continuing to drive my truck. This doesn’t even factor in the increased cost of my collision and comprehensive insurance for a new vehicle.

It is getting older and I do expect to have to put a little money into it. I’m going to need a new timing chain, a new clutch and possibly a few other repairs in the coming years. But even if I factor in $800 for an annual repair budget, that’s still $2,800 per year, or $233 per month I’m saving.

And since I save and invest that money rather than spend it, those savings add up even more. If I can earn a 6% average return on that $2,800 per year, that means in three years, I’ll have an extra $9,500 put away. If I can manage to drive my truck another five years that’s $16,730 I’ll have saved. Even if I have to dump another $2,000 in the truck over those years, that’s almost $15,000 I’ll have saved.

Not only can that money go to more important things like my Roth IRA, daughter’s education fund and emergency fund but I’ll have far more money for a down payment on my new vehicle.

When the time comes, I should be able to walk into a dealership and easily put down $10,000 to $15,000 on a new truck. That means I’ll borrow less, have less debt and will pay less in interest.

When you buy a new car every three to four years you are literally throwing thousands of dollars down the drain. Not only do you take massive hit on depreciation but you could also have more than $1,000 in tax, title and license costs.

Unless you’re raking in the big, big bucks, constantly chasing a newer car is undoubtedly taking away from other areas of your financial life. No matter how much money you make, 99% of us are constrained by some type of financial limits. You have to recognize those limits.

I can live with a few scratches, squeaks and outdated vehicle features. I’d rather provide for my family, save for stability, travel, spend money on having fun and sleep soundly at night rather than give all that up for a nice hunk of metal in my driveway. It’s just a matter of priorities.

Why you should open a Roth IRA now

I recently wrote an article for Interest.com on 5 reasons you should open a Roth IRA now.

Aside from a checking account, it is by far the single best account to have and the best way to save. It’s an Individual Retirement Account that not only provides you with tax-free income in retirement but offers you a lot of flexibility to make penalty-free withdrawals between now and then.

At a time when Americans lack not only retirement savings but emergency savings, the Roth is great because it lets you pull double duty by saving for both in one place.

In a perfect world, you’d never touch the money in a retirement account until your working days are over.

But in these economic times people don’t often have a choice. Everything from layoffs to medical bills can put a pinch on everyone.

If you have to tap most retirement funds, it can get quite expensive.

Withdraw money from a 401(k) or traditional IRA before you reach 59½, and you’ll be hit with a 10% penalty and have to pay income taxes on whatever you take out.

If you need $5,000, for example, you might have to actually withdraw $6,500 because of those penalties and taxes.

That’s not the case with a Roth IRA.

You can withdraw contributions anytime, for any reason, without paying any penalties or taxes.

That’s one of the reasons Mari Adam of Adam Financial Associates in Boca Raton, Fla., says that opening a Roth IRA is one of the best financial moves you can make.

If you’re like most Americans, you’re probably lacking in both your emergency and retirement savings.

So if you have to play catch-up, using a Roth as part of your emergency fund lets you do both simultaneously.

“It gives you flexibility to where if you need it in an emergency or for something important, you can access the principal for any reason tax-free and penalty-free,” Adam says.

Second, a Roth can help you save for college bills and a down payment on a home. This is especially important if you’re young and haven’t yet bought your first home because you can withdraw up to $10,000 to put towards a down payment and not pay any taxes or penalties.

Some parents are using Roth IRAs to hold some of their kids’ college education funds because the contributions can be withdrawns at no cost whenever the money is needed.

They can also tap the earnings and the 10% penalty is waived if it goes to cover a qualified higher education expense. This includes college tuition or expenses for you, your spouse, your child or grandchild.

A Roth IRA is also one of the greatest tax breaks you’ll ever get from Uncle Sam because your earnings can grow tax-free and be withdrawn tax-free in retirement.

Think about it: Your money can grow for decades, and you’ll never be taxed on it.

At 59½ years old, you can start withdrawing from this jackpot when all your friends with traditional IRAs have to pay taxes on every dollar they touch.

If you’re 30 years old and max out your Roth IRA to the current limit for 30 years and average an 8% return, you’ll have $608,000.

If you used the 4% rule, that would provide $24,000 a year, tax-free.

If you were in the 15% tax bracket, and had to pay taxes on your withdrawals, it would be about the equivalent of $30,000 per year.

Of course, contributions to Roth IRAs must be made with after-tax earnings.

This is one of the biggest differences between a traditional IRA and a Roth IRA.

With a traditional IRA, contributions (up to the $5,000 limit or $6,000 if you’re over 50) can be deducted from your earnings, lowering your income tax bill for that year.

But unless you’re in a higher tax bracket, you really wouldn’t see much savings with a traditional IRA anyway.

If you’re in the 25% tax bracket and contributed $5,000 to a traditional IRA this year, you could save up to $1,250 in federal income taxes.

But would you actually save and invest that difference?

Probably not. If you’re like the majority of Americans, it would be absorbed into your annual spending on things like dining out, clothes and cell phone bills.

With the Roth, you won’t save any money in taxes now, but you’ll be able to grow that money for decades and never pay taxes on any of it.

Finally, with a traditional IRA, you must start making withdrawals by age 70½.

There is no such requirement for Roth IRAs. You’d be lucky to be in this situation, but you can hold this tax-free money indefinitely and pass it on to your heirs.


Be smart with inheritance money

According to the AARP, one fifth of all baby boomer households have received an inheritance and the average inheritance is $64,000. Another 15% are expected to receive an inheritance in the future.

While inheritances are usually financial blessings, financial advisors say that many recipients don’t manage them properly. A study by Ohio State University’s Center for Human Resource Research found that adults who receive inheritances typically only save half of it.

I recently wrote an article for Quicken.com about smart ways to spend your inheritance. Susan Bradley, CFP and founder of the Sudden Money Institute, said that whether it’s an inheritance, lottery winnings or a settlement, many people blow money that they didn’t have to work for.

“It’s likely a once-in-a-lifetime opportunity to make your life more secure and enjoy a little more financial freedom. You have to use it wisely because once it’s gone, it’s gone,” she said.

The first thing you should do when you receive an inheritance is sit on it a while.

Bill Hammer, a Certified Financial Planner and co-founder of the Hammer Wealth Group, said age isn’t always a factor. He has seen 50-year-olds “make 20-year-old decisions” when they receive large sums of money from inheritances. Hammer said the first step to avoiding making bad knee-jerk decisions is to simply sit on the money for a few months.

“Most people will have that money spent in their mind before it even hits the account. Don’t do anything with it initially. It’s a psychological thing. People make better decisions when they wait a few months,” said Hammer.

Bradley said because people don’t have to work and sweat for inheritance money, they often view it as easy money and are more inclined to blow it.

“It’s likely a once-in-a-lifetime opportunity to make your life more secure and enjoy a little more financial freedom. You have to use it wisely because once it’s gone, it’s gone,” she said.

Next, consider paying down any high interest debt you may have.

Mari Adam, President of Adam Financial Associates in Boca Raton, Fla., recommends you first put the money in a safe interest-bearing FDIC-insured account until you’ve had time to plan how you’re going to allocate and use the money. Although you’d be taking on some risk, another option would be to park it in a brokerage account and invest in some dividend-paying Blue Chip stocks.

If you’re struggling with high-interest debt such as credit card debt, one of your first moves should be to allocate at least a part of your inheritance to pay it down. Carrying a $5,000 credit card balance at a 15% interest rate can cost you up to $750 per year in interest. If you inherited $20,000 and paid off that balance, you’d be saving yourself the interest every year.

“Having less debt is always better. When you pay down debt you’re getting a guaranteed return on your investment,” said Hammer.

You should also consider paying down any high-interest student loan debt or a car loan, assuming the rate is above 6%.

While it might be tempting to pay off a mortgage, Hammer said it may not be the best use of the funds, especially if you’re paying 4% or less on a fixed loan. That’s because you may be able to earn more on your sum by investing it.

“If the spread is very close, you should just pay down the debt. But if you can make 8% on your money and your mortgage is at 4%, you might want to hold off on paying it down,” he said.

If you don’t have high interest debt, or if you’ve got some money left over after paying it down, save for your retirement and your child’s education.

After paying down debt, a wise use of inheritance funds would be to put it towards your own retirement or your child’s education fund. Because of the long-term power of compounding, a large supplemental contribution can have a big impact later down the line. Bradley said while saving consistently over time is the key to having enough for retirement, a lump sum surge can make things so much easier.

“If you’re typically putting away $100 per month towards your child’s education fund and inherit $20,000 and put $10,000 towards that, you have advanced years in those savings,” she said.

Let’s say you were to take $5,000 of inheritance money and put it in a Roth IRA. If that were to grow at a modest 6%, it would be worth over $16,000 in twenty years and more than $28,000 in thirty years.

Hammer said that while it’s critical to save for your child’s education, it should come after retirement funding. That’s because while you can always use Roth IRA retirement funds to put towards education, you can’t use education funds to cover yourself in retirement. If you need to pull money out of an ESA or 529 plan, you could be hit with a 10% penalty and taxes. Contributions to a Roth IRA can be withdrawn at any time for any reason without penalty.

“If you’re not sure, I’d err on the side of retirement and start putting away money there,” said Hammer.

Finally, if you’re determined to have a little fund, consider investing it and splurging off a small portion of the earnings.

There’s nothing necessarily wrong with enjoying and playing with some of your inheritance money if you’ve taken care of high-interest debt and other financial priorities. If the amount is large enough, you could invest most of the money then use a portion of your earnings for fun.

For instance, if you were to inherit $200,000 and could earn a 5% return on it, that would generate $10,000 per year in income. It’s not enough to quit your job but it could certainly provide a little extra spending money during the year.

Better yet, reinvest half of that and enjoy an extra $5,000 per year in “fun” money. That annual or monthly distribution you take would also grow as your original sum and reinvestments. In the fifth year of your investment, it would be producing more than $12,155 in annual income.

“You want to try to leave [the principal] as a cushion that you can use your entire life,” said Adam. “You can hopefully earn dividends and draw income off it indefinitely.”



How much should you be putting away every month for retirement?

When I recently wrote about knowing your retirement goal number, I received a lot of feedback via email, blog comments and comments on Linkedin.

Some were positive, some were negative. Some implied that there are jut too many factors to calculate that number. While that might be true it shouldn’t stop anyone from at least trying to figure out how much you need in retirement. Even if that’s 40 years away and so many things can change between now and then, having a number gives you a goal to aim for.

Most importantly, having that number lets you work backwards to figure out how much you should be putting away now every month towards retirement.

Where do people start? And how can a regular Joe or Jane sitting at home come up with a rough number to find out how much they need to be saving now?

I recently wrote a story for Interest.com that breaks that down into four step system to calculate your monthly retirement savings.

Step 1. Estimate how much you’ll need per month in retirement

Start with you income. You’ll want to have an average of how much you make annually throughout your working life.

You might be making $40,000 a year now, but by the time you retire 20 years from now, you might be making $70,000 a year.

So, your average annual income might end up around $55,000 a year.

When you retire, you hopefully will have paid off your house, won’t be supporting kids and will have fewer expenses than you do now.

But most experts agree you need to replace at least 60% of your pre-retirement income to continue your lifestyle.

That’s $33,000 a year, or $2,750 a month in today’s dollars.

But you’ll also have to account for inflation, which typically runs 3% a year. So, to have the same purchasing power of $33,000 in 25 years, you’ll actually need $69,000 or $5,750 a month.

Step 2. See how much you can expect from Social Security.

Now that you have an estimate of how much you’ll need every month, see how much you might get from Social Security.

Visit the Social Security benefits estimator to estimate how much you’ll receive.

It will give you three numbers based on whether you plan to start collecting benefits at age 62, 67 or 70.

The longer you wait to start collecting, the more you’ll get per month. If you collect at age 62, you could receive up to 45% less than if you wait until you’re 70.

Of course, a lot depends on how much you pay into the system. As your income rises over the next 10, 20 or 30 years, so will your benefits.

You also have to remember that things are a little shaky with Social Security. If you’re under 40, a lot can happen between now and retirement.

There’s a good chance they’ll raise the retirement age or reduce benefits. They could do both. It’s likely that the system will also pay a smaller cost-of-living adjustment.

Take a look at the four changes that might be in store for Social Security that I recently wrote about.

To be safe, you might want to anticipate receiving 10% less than what’s stated on the estimator.

So, if the estimator says you’ll receive $3,000 a month when you turn 67, let’s change that to a $2,700 monthly benefit.

Step 3. Find your gap and how much you need to fill it

You need to find out how much of a difference you have between what you can expect with Social Security and what you need in retirement.

In the old days, Social Security benefits might have covered most of your needs, but today you’ll be lucky if it covers half.

Sure, you might be able to pinch pennies and scrimp by on your Social Security payment, but is that really how you want to spend your golden years?

In the example above, you’ll need to come up with approximately $3,000 a month of your own money to meet your retirement goal’s monthly income.

That’s still a lot of money, but it’s better than trying to come up with the full amount.

This is when you need to take advantage of the 4% rule.

It says you can take out 4% of your savings the first year of retirement and the same amount, adjusted for inflation, each year after that.

In theory, your money should last 30 years.

Using the 4% rule, to come up with $3,000 a month or $36,000 a year, you’ll need to have $900,000 socked away.

That’s a whopping number, but remember you have 25 years to reach that goal. And even if you don’t meet it (you likely won’t), you’ll still want to come as close to that number as possible.

It won’t be the end of the world if you don’t make that number.

Since Social Security will be covering almost half of your retirement income, failure to make that goal will have a smaller impact than you might imagine.

Say you only end up with $600,000 by the time you retire. That’s a whopping 33% less than you were aiming for, but it will only represent about a 16% reduction in your retirement income.

In any case, you want to get as close to your goal as possible. Saving regularly, often and early can help you grow your nest egg through compounding.

Step 4: Work backwards to figure out how much you need to save each month.

Finally, take that big number and deduct for any retirement savings you already have. So, if you have $40,000 socked away already, you’ll aim to put away $860,000 by the time you retire.

If you have 25 years to go and assume that your fund will grow at the historical stock market average of 8% a year, you’ll need to put away $7,500 a year.

That’s $625 a month.

Of course, all of these variables could change, especially your return.

If you socked away $625 a month and averaged a 9% return, you’d end up with over $1 million. Or you’d have $724,000 if you averaged only 7%.

Interest.com’s Savings Goal Calculator makes these kind of calculations easy.

Just remember that a lot of things can change over the years, but you need to have a target to work with.

Earn 6% to 18% by lending money to strangers

I recently wrote an article for Interest.com on how peer-to-peer lending offers double-digit returns with some work and a little risk.

Ordinarily, the idea of loaning money to perfect strangers would sound absurd. But in today’s environment of pathetically-low interest rates where your only safe option is to earn 2% in a CD, you might want to take a look. Every saver out there is looking for alternatives these days.

Basically, through web sites like Prosper.com and Lendingclub.com you can invest in short-term loans to borrowers seeking money for everything from home improvements and eye surgery to paying off credit cards and starting a business.

At these sites, the investors (potentially you in this case) are the lenders and can earn anywhere from 6% to 18%, even taking into account losses from bad loans that are never repaid.

Loans range from one to five years and borrowers are assigned a credit score to gauge how risky their loan might be.

At Prosper, credit ratings range from AA to HR.

As of February 2012, AA loans, which have a weighted average credit score of 808, have an actual loss rate of only 2.41% and a seasoned return of 5.18%. But those high-risk HR loans, which have an average credit score of 668, have an actual loss rate of 11.04% and a seasoned return of 17.71%.

Since most note defaults occur at five to nine months of age, Prosper uses “seasoned returns” to define those aged 10 months or more.

Lending Club uses “net annualized return” as a measure of return and includes notes three months and older.

At Lending Club, those returns currently range from 5.83% for Grade A notes to 12.4% for Grade G notes.

If you have $20,000 to invest and would rather not go through the hassle of picking loans, Lending Club will offer you a preselected pool of 800 notes.

According to their site, every single investor with 800 or more notes has had positive returns. Almost 92% of them have had returns between 6% and 18%.

The cool thing about these sites is that instead of investing in just one loan, you can spread your money across multiple loans to spread and minimize your risk.

Instead of loaning your $1,000 to one single person, you might loan $50 to 20 different borrowers.

You can also lend to people in different rating categories. You might have 35% of your investment in AA loans, another 35% in B loans and then 30% in higher-risk D loans.

By spreading your investment, you’re minimizing the risk. So, if some of your loans default, and it’s highly likely that a couple will, you won’t lose all of your principle.

The idea is that the losses you suffer in the higher-risk categories will be offset by the more reliable payments in the low-risk categories.

Lenders have pointed out this downside: Borrowers with the highest credit rating often pay off their loans early.

So, while you may have had a pool of 36-month notes earning 6.6%, half of them could end up paying it off in a year, dragging down your total return by a few points.

P-2-P lending could be risky but may be worth it considering you can make a lot more than you would in a CD. If you need to back out and get your money, you can sell your notes on a market platform at each of the sites.

You’ll also have to first make sure you qualify to become an investor.

At both sites you must be 18 years of age and have a valid Social Security number and checking or savings bank account. The minimum investment to open an account is $25.

Lending Club has “State and Financial Suitability” conditions. You must reside in one of the 28 states where peer-to-peer lending is legal, have a gross annual income of at least $70,000 and a net worth (not including your home) of at least $70,000.

You may also not purchase notes in an amount in excess of 10% of your net worth.

Read the full article at Interest.com.


8 tricks up your auto dealer’s sleeve

Interest.com recently ran my article highlighting 8 tricks up your auto dealer’s sleeve.

One of their top tricks is to prey on your lack of information:

There’s nothing a dealer loves more than an uninformed consumer who’s going to negotiate a purchase based on nothing more than the car or truck’s sticker price.

You need to work from the wholesale price the dealer paid and the average transaction price, which are usually thousands of dollars less than the sticker price.

You want to be the smart buyer who pays a little less than the average transaction price, not the one who pays a little more.

Edmunds.com or Kelley Blue Book are the places to find the critical information you need.

Another one of the most common tricks is to lure you into a deal with low monthly payments. You need to run the numbers on your own and understand that a low monthly payment does not always mean it’s the best deal because they could be doing it by extending the terms:

Don’t tell them, because they’ll use that number to sell you a more expensive car or truck than you may have wanted and maximize the dealership’s profits on your sale.

The salesperson will figure out the most you can possibly spend by dragging out the payments for as long as possible and still hit that payment.

He or she will then show you cars and trucks in that price range, which is often higher than what you wanted to spend, while reassuring you that this fine vehicle is within your budget.

Let’s say you came in to buy a compact sedan that cost about $20,000 but let slip that you could afford a payment of $450 a month.

The salesperson immediately recognizes that a 60- or 72-month loan would allow you to buy a $25,000 midsize sedan and your payment would still be about $450 a month — and that is what he or she will try to sell you.

The bigger sticker price, and longer loan, both mean more money for the dealership.

For the full scoop on the 8 tricks up your auto dealer’s sleeve, read the full article here.

Why you want to start an emergency fund today

I recently wrote an article for Mint.com on why you need an emergency fund.

An emergency fund is simply money that you keep for when stuff happens. Go through life long enough and bad things will happen. The air conditioner unit in your house could break down and you may need $2,500 to replace it. You may need $430 for a new alternator in your car. You may wake up with a tooth pain and need an $800 root canal procedure. Or even worse than all of these things, you could lose your job and be out of work for two months.

William Hammer, Jr., CFP, Vice President of Wealth Management for Vanderbilt Partners, said an emergency fund can prevent an emotional struggle from becoming a financial one.

“It’s not that the odds of something terrible happening are that great. It’s that the hardships could be devastating if you don’t have the money. An emergency fund is a piece of mind,” said Hammer.

Most financial experts say you should aim to have six months of living expenses put away. That’s often unattainable for many people so aim for three. And if you can’t do three then do what you can. The point is that you always want to have something put away for emergencies. Keep this money in a high-yield online savings or money market account and have it tied to your checking account so you can access it when needed.

Mari Adam, Certified Financial Planner and president of Adam Financial Associates, said while six months is ideal, it can be a little out of reach for most people. She said three might suffice for many and if you can’t meet that, then “something” is always better than nothing.

“Even one month is better than nothing. You need to have something put away to handle emergencies. Some people say they can’t save up six months worth, so they get frustrated and quit,” she said.

You’re not alone if you don’t yet have an adequate emergency fund. According to a 2011 survey by the National Foundation for Credit Counseling, 64% of Americans don’t have enough cash on-hand to handle a $1,000 emergency. Start one now because when you don’t have funds in place your only option may be to turn to debt.

“Most people will turn to credit cards or a home equity line of credit, if they’re lucky enough to have one when you consider where home prices are at,” said Adam Koos, CFP, President and Founder of Libertas Wealth Management.

The problem with relying on debt is you start accruing interest on whatever problem you had. If you’re tapping a credit card with a 20% interest rate to cover that $1,000 car repair and carry that debt for a year, that problem will now cost you $1,200 instead. Koos said you can “be your own credit card” by saving up the money to begin with.