With record high inflation and rising interest rates, an economic recession has been the subject of many conversations lately. Now with two consecutive quarters of a drop in GDP (gross domestic product)—the benchmark many economists use to gauge a recession—the possibility of a serious economic downturn isn’t just fodder for conversation anymore. It’s time to get serious about protecting your finances for a recession. Here’s how you can make sure you’re prepared.
Build Up Your Emergency Fund
It’s widely recommended to have enough savings to cover three to six months of living expenses. The specific amount will depend on your circumstances. For instance, in today’s uncertain economy, you might feel it worthwhile to aim for more than six months. It might seem daunting, but don’t undervalue the effectiveness of small contributions on a regular basis. You can also think about automating your savings contributions for a set-it-and-forget-it approach. Whichever way you go about it, consistent contributions to an emergency fund help to build positive saving habits that will carry into the future.
Pay Down Credit Card Debt
Focus on paying down any high-interest debt. Not only will this help you be more prepared should you get laid off during a recession, but credit card APRs are rising in response to the Federal Reserve’s rate hikes. Knocking out debt could free up critical breathing room in your budget that you could use to boost your emergency fund.
Identify Ways to Reduce Expenses
Start looking at all the ways you spend money, and identify ways you can scale back on discretionary spending (services or items that aren’t necessities—vacations, dining out, cable, spa treatments, etc.). Typically, the guidance is to spend no more than 30 percent of your net income on discretionary purchases. Think about creating a monthly budget in order to stick to this guideline and ensure you’re not overspending.
Stay Invested
It’s tempting when the market is as volatile as it’s been recently to think about cutting back on 401(k) contributions or selling stock investments. Keep in mind, however, that you’re investing for the long term. Stocks rise and fall all the time, and history has proven that bull markets (rising market conditions) last longer than bear markets (falling market conditions).
Rebalance Your Portfolio
While you want to stay invested for the duration of a recession, you might consider rebalancing your investments. Depending on your age, risk tolerance, and investment goals, it may make sense to shift more investments into growth funds, which could potentially experience greater gains when the market rebounds. Be sure to keep in mind that money needed in the short term should not be allocated to these funds as they are high risk.
Individual Retirement Accounts (IRAs) allow for a tax-advantaged way to invest your money long-term. Whether you choose to invest in a traditional IRA or a Roth IRA (or a combination of the two), you’ll defer paying income tax on the money you set aside for retirement. Follow these IRA investment strategies to boost your retirement savings and maximize the value of you IRA.
Max it Out
The maximum amount you can contribute to an IRA for 2022 is $6,000, and it is generally worth making the maximum contribution. Note that there are income limits. You can make a full contribution if your income is less than $144,000 ($214,000 if you are married filing jointly). For 2022, retirement savers age 49 and younger can max out an IRA by saving $500 per month or making a deposit any time before the 2022 IRA contribution deadline of April 15, 2023.
Make Catch-Up Contributions
As of the calendar year you turn age 50, you are eligible to contribute an extra $1,000 to your IRAs for that year, and all following years. If you weren’t able to save as much as you would’ve liked earlier in your career, catch-up contributions offer an opportunity to boost your yearly savings until retirement.
Don’t Wait Until the Contribution Deadline
It’s true that you can make a contribution to an IRA up until the mid-April tax filing deadline and apply it to the previous tax year. By shifting some funds into an IRA, you may be able to reduce your tax bill or boost your refund. However, that may not be the most beneficial move depending on your circumstances. When you wait to contribute, you miss out on potential growth. There is also the chance that you will be making an investment at a high point in the market. Contributing to an IRA at the beginning of the tax year enables the funds to compound for a longer stretch of time. You can also consider making small monthly contributions as a budget-friendly approach that will still yield favorable results.
Low- and Moderate-Income Workers Can Claim the Savers Credit
If your adjusted gross income (AGI) is below $34,000 as an individual or $68,000 as a couple in 2022, you may be eligible to claim the saver’s tax credit as well as the tax deduction for your IRA contribution. This credit is worth between 10% and 50% of the amount you contribute to an IRA up to $2,000 for individuals and $4,000 for couples.
Use Your Tax Refund to Contribute to Your IRA
You can use IRS Form 8888 to deposit all or part of your tax refund directly into an IRA. Provided the deposit is made by the due date of your tax return, you can file a tax return claiming a traditional IRA contribution before the money has actually been deposited in the account. In other words, if you file earlier rather than later, it’s possible to use your tax refund to make an IRA contribution you already claimed on your tax return.
Consider Converting to a Roth IRA
For some taxpayers, it may be beneficial to convert an existing traditional IRA to a Roth IRA. Expect to pay income taxes on the conversion amount, which could be substantial, so be sure to do the math before you make the leap. The funds that are moved into the Roth grow tax-free and will be tax-free upon withdrawal in the future, provided the account is at least five years old. The decision to convert to a Roth IRA basically boils down to whether you want to take the tax hit now or later. The farther away you are from retirement, the more advantageous a Roth IRA could be, because the Roth’s earnings will have more years to compound.
Running a small business can be stressful and time consuming, so it’s understandable when the financial health of your business gets neglected. Getting into the habit of reviewing your company’s overall financial health is a smart move to position your business for success now—and for years to come. Read on for an effective health checklist for your small business by focusing on three critical components: financial planning, budgeting, and investing.
Financial Planning
As a business owner you know that taxes are potentially one of the most substantial expenses affecting your bottom line. Therefore, you need to have defined business goals and personal financial goals in order to adhere to the most appropriate tax-planning strategies.
To do this you should:
Keep an ongoing list of business and personal financial goals in order of priority, and consult this list when making any new financial decisions.
Be sure you have a small-business structure that provides the most pertinent legal protections and benefits.
Reduce taxes, or file an extension, and maximize applicable deductions and credits. Strategize by timing income and expenses to your advantage, utilizing charitable gifting, and saving for retirement with a Simple IRA, solo 401(k), or SEP IRA.
Budgeting
Issues with cash flow can derail a business to the point of no return. Get ahead of any challenges by managing your budget in accordance with your business plan.
Know how much revenue it will take to cover any expenses before you can break even and generate a profit.
Consistently keep an eye on your income, inventory, credit, and cash. Modify as needed in order to cover fixed expenses and hold onto a healthy cash reserve.
When you do need financing, analyze your budget and cash flow trends to help determine the best financing options for your business.
Investing
As a small-business owner, don’t make the mistake of investing all of your money into your business. Make saving a habit so that you have enough cash reserves accessible in a pinch for both personal and business needs, but invest any extra cash inflow, and diversify non-business investments.
Additional Factor of Financial Health
In addition to financial planning, budgeting, and investing, you should be protecting your business with insurance. This could include liability insurance, property insurance, workers’ compensation insurance, health insurance, life and disability insurance, and business interruption insurance.
A financial health checklist is an important tool for aiding small-business owners in overseeing the financial condition of their company. Routinely taking stock of your business allows you to make smarter decisions for growth and success.
Although retirement planning often involves some guesswork regarding the future of the economy as well as each retiree’s individual circumstances, there are some general misconceptions to avoid in order to be sure you’re building a solid nest egg. We go through these common beliefs below so you are informed when setting goals for retirement.
The 4% Rule is Steadfast
The 4% rule has been regarded as a sound retirement distribution strategy for years. With this method, retirees withdraw 4% from their retirement portfolio during the first year of retirement. The amount then increases each year according to inflation. This method, in theory, should yield a consistent stream of income for at least a 30-year retirement. However, given market expectations—namely, lower projected returns for stocks and bonds—the general consensus is that the 4% rule be amended to 3.3%. This may seem like a small difference, but it could have a big impact on your standard of living. The difference would be even more evident later in retirement, when accounting for inflation.
You Can Live Off Social Security Benefits
Social Security will only replace about 40% of preretirement income. Given that retirees need to replace approximately 80% of preretirement earnings to prevent a significant reduction in quality of life, Social Security Benefits will fall way short of this mark. Make sure your game plan includes additional savings from investment accounts to cover the discrepancy.
You Can Start Withdrawing Social Security at 65 Years Old
When the Social Security Act was signed into law in 1935, it established age 65 as the full standard benefit age. Couple this with the fact that 65 is also the Medicare eligibility age, and Americans have long considered 65 to be the standard retirement age. However, while Medicare eligibility age remains the same, full retirement age (FRA) has since changed. Depending on a retiree’s birth year, their FRA can be anywhere from age 66 and four months to age 67. This means that if you start Social Security at 65 (before your FRA), you will be subject to early filing penalties that could slash a substantial portion of your monthly check. Be sure to check your online Social Security account to be informed of your FRA and the appropriate timeline for claiming benefits.
Saving 10% of Income for Retirement is an Adequate Goal
For decades, workers followed the rule of thumb to save 10% of their salary for retirement. However, longer life spans, lower projected market returns, and the declining value in Social Security benefits have all contributed to the need to save more. It’s important to work with a financial advisor to come up with a personalized plan for retirement goals, but at the very minimum, aim to save 15% to 20% of income.
Medicare Will Provide Sufficient Coverage for Care
Medicare often doesn’t provide enough coverage for seniors ages 65 and older. Factors such as high insurance costs and coverage exclusions contribute to the need for supplemental coverage, such as Medigap. And sometimes seniors find that a Medicare Advantage policy—the private insurance alternative to traditional Medicare—is a better fit. No matter what you ultimately decide, it’s crucial to devote specific funds to medical costs, either in a health savings account or another tax-advantaged retirement account.
Contrary to popular belief, estate planning isn’t just for the wealthy. Your estate includes everything you own, and it’s worth taking the time to plan for what will happen to it. Below we’ll go over steps you can take to be sure your money and assets are kept safe from unwanted surprises, like excessive taxes and unintended heirs.
Create a Will
This may seem like an obvious step, but according to a recent study published by Caring.com, only 33% of the 2,500 Americans who were surveyed said they have a will. If you don’t have a will, your estate goes to probate court—a process whereby state laws determine how your estate will be divvied up and to whom your assets will go. It’s a time-consuming and expensive process. To be clear, even with an established will, your heirs will still need to go through the court system in order to confirm the validity of the will.
Specify Your Beneficiaries
Name beneficiaries for your assets if you want to avoid probate court. Check to see if certain accounts like retirement funds and life insurance policies will allow you to designate beneficiaries for that specific asset. Some accounts will even permit transfer-on-death (TOD) provisions, which is a hassle-free way to pass assets to heirs. You can also check if your state allows beneficiary deeds, which allow property to be automatically transferred to a new owner when the current owner dies, without the requirement to go through probate.
It’s important to note that a beneficiary or TOD specification tops a will, so be sure to review beneficiary information after every milestone event (i.e., marriage, divorce, birth of a child).
Set Up a Trust
Trusts are established in order to control distributions from the estate to the surviving spouse and children, and to assure that assets are used in a way in which the person setting up the trust feels suitable. If you hold your property in a trust, your heirs won’t be required to go through a probate court.
Revocable living trust: You can assign parts of your estate to go toward certain things while you’re alive, and you can modify the trust after it’s created. If you fall ill or become incapacitated, your chosen trustee can take over. Upon your death, the trust assets transfer to your designated beneficiaries.
Irrevocable trust: You cannot modify the trust after it’s created, but irrevocable trusts offer tax shelters that revocable trusts do not.
Reduce Taxes with a Roth Account
Because regular income tax must be paid on distributions from all traditional retirement accounts, those with traditional 401(k) or IRA accounts could unwittingly leave their heirs a hefty tax bill. Converting those accounts to Roth accounts can help to reduce taxes considerably for heirs. While a Roth’s converted amount is subject to regular income taxes, withdrawals—whether by you or your heirs—are tax free.
Gift Your Money While You’re Still Living
As of 2021, the IRS permits individuals to gift up to $15,000 per person per year. If you’re looking to bypass estate taxes, gifting can bring the value of your estate down. The money is also tax-free for recipients. Just be careful not to give away assets that appreciate in value. The taxable amount of these assets, such as stocks or a house, is adjusted upon the owner’s death. Therefore, it may be favorable to transfer certain assets after death rather than before.
