Sunday, March 14, 2010

Most of us can't tackle all of our spending and saving needs at once. But following this outline can make it a lot easier to keep your finances on track.

By Liz Pulliam Weston
MSN Money

Here's a money secret that might keep you from driving yourself crazy: You can't do it all.

We're supposed to max out our retirement savings, pile up huge emergency funds, pay off all our debts and buy tons of insurance. Yet we've also got other bills to pay, kids to raise and, yes, fun to have.

Even in good times, many of us can't cover all the bases perfectly. Now that many are facing pay cuts, unemployment or unpaid furloughs, more of us are facing painful trade-offs on less income.

Here's what you need to know now to properly prioritize your spending and manage your money. You may not be able to cover everything right away, but as more money comes in you can work your way down the list and be reasonably sure you're getting the important stuff right.
Priority No. 1: Pay your bills
Obviously, you need to keep a roof over your head and food in the fridge. But your ability to manage all your other financial priorities will be greatly enhanced if you can get a handle on your basic living expenses.

Bankruptcy expert Elizabeth Warren recommends limiting your "must-have" bills to 50% of your after-tax income. Must-haves, as she wrote in "All Your Worth" (co-written by her daughter Amelia Warren Tyagi), include shelter, utilities, transportation, food, insurance, child care and minimum loan payments.
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Her plan leaves 30% for "wants" such as new clothes, entertainment and vacations, and 20% for savings and debt repayment.

If your must-haves balloon over 50% of your after-tax pay, you may be able to rein in your costs by trimming your food bills and lowering your home's thermostat. If not, you may have to make more painful adjustments, such as finding a cheaper place to live or getting rid of a too-expensive car.

What you shouldn't do is cut your insurance coverage. Shopping around for coverage and choosing higher deductibles are better ways to lower costs than dropping your policies altogether, since that can leave you exposed to catastrophic expenses from accidents, illness or lawsuits. What you need:

* If you have a car, you need liability coverage, at least. Comprehensive and collision insurance is a good idea on newer cars and may be required by your lender.

* If you own a home, homeowners insurance is essential. Make sure you have enough coverage to rebuild your home, plus adequate liability insurance ($500,000 is good, and more is better).

* If you rent, renters coverage is a smart buy. Your landlord's policy doesn't cover your stuff or your liability.

* Health insurance is a basic expense you shouldn't forgo if you have any choice, because a single accident or illness can bankrupt you. If you don't have or can't afford coverage, read "A survival guide for the uninsured."

* Life insurance may be an essential, but only if you have financial dependents (people who need your income to survive). Term insurance is the cheapest way to go; learn more at MSN Money's Save on Life Insurance Decision Center.

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If your income isn't stretching far enough to cover your must-have bills, read "How not to pay your bills" and consider a consultation with a bankruptcy attorney. For more on bankruptcy, visit MSN Money's "Guide to Personal Bankruptcy."
Priority No.2: Save $500
Just a few hundred bucks in the bank can eliminate expensive bounced-check and late-payment fees. Having $500 in the bank also allows you to pay for minor emergencies without adding to your credit card debt. Furthermore, there's a huge psychological advantage to having even this small cushion, as I wrote in "Want to sleep better? Save $500."

Eventually, you'll want a bigger stash to guard against financial setbacks, but $500 is a good initial goal. Set up an automatic transfer from your into a high-yield , or jump-start your savings with a windfall, such as your tax refund check.
Priority No. 3: Start saving for retirement
You may be surprised to see retirement so high on the list. Surely your credit card debt and your kids' college educations are more important.

Except they're not. You have only so many working years to set aside enough cash to last you for the rest of your life, and any delay in getting started will cost you big time. Waiting just five years to begin can reduce your total nest egg by as much as 30%.

* Facebook users: Become a fan of Liz Pulliam Weston

Stopping or reducing your contributions is another bad move. It may be hard to contribute when markets are so volatile, but it's still important if you hope to build a nest egg. (Read "Under 35? Hurray for the meltdown" for more.)

But how much should you save? In "16 favorite money rules of thumb," I suggested that you save "10% for basics, 15% for comfort, 20% to escape." If you start saving for retirement by your early 30s, putting aside 10% of your income should cover your basic expenses in retirement, while a 15% contribution rate should give you a more comfortable nest egg. A 20% rate should allow you to retire early or enjoy luxuries such as extensive travel.

Continued: What if you can't manage 10%?

Your money priorities, first to last

Continued from page 1
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What if you can't manage even 10% right now? Then:

* If your 401(k) still offers a match, contribute at least enough to get that.

* If there's no match, start by contributing whatever you can, and bump it up a percentage point or two whenever you get another raise. (See "No 401(k) match? Save anyway.")

* If you don't have a retirement plan at work, contribute to a traditional individual retirement account. You can contribute up to $5,000 a year if you're under 50 or up to $6,000 if you're 50 or older, and your contribution is tax-deductible.

Need some inspiration to put the money aside? Think about how hard it is to live on your current income. Now image living on about $12,000. That's the typical Social Security benefit, and it's all you'll get if you don't start saving. For more, read "Could you survive on Social Security?"
Priority No. 4: Pay off 'toxic' debt
Now it's time to tackle your credit card bills and other dangerous debts, including payday, car title and pawnshop loans.

As I explained in "6 steps to dumping 'toxic' debt," debt is toxic if:

* The lender can change rates and terms at any time, with little or no provocation.

* The standard or default interest rate is in the double digits, or higher, which typically prolongs the time you remain in debt.

* Initially easy payment terms encourage you to rack up more debt than you can comfortably repay.

The best way to pay off toxic debt is usually to target the highest-rate debt first, paying as much on that as possible while paying the minimums on your other debts. But you also could tackle your smallest debt first, just to give yourself the psychological boost of retiring a bill.
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Priority No. 5: Bolster your emergency fund
As layoffs mount, the perils of living paycheck to paycheck become more obvious, and your $500 cushion will disappear fast if you lose your job.

So focus on building up an emergency stash worth at least three times your must-have expenses. That should tide you through a typical spell of unemployment if you cut all nonessential costs. (The median duration of unemployment was 11 weeks in February, according to the Bureau of Labor Statistics, up from 8.9 weeks a year earlier.)

You might want to bolster your cushion even more in many cases. If you work in a troubled industry that's already swamped with job seekers -- say, newspapers, real estate or auto manufacturing -- your joblessness might extend for months. The bigger your fund, the better you'll sleep. (See "Why I'm saving up $15,000 this year.")
Priority No. 6: Check out long-term-disability insurance
You've probably heard it before: Your earning power is your greatest asset. Meanwhile, your chances of a disabling accident or injury during your working life are much higher than your risk of dying in the same period.

But workers' compensation will pay you only if you're injured on the job, and disability benefits from Social Security are tough to get. So long-term-disability insurance is a smart purchase if you can afford it.

The cheapest way to get coverage is usually from your employer. If your job doesn't offer it, check with any professional organizations to which you belong to see whether disability coverage is offered.

If not, you may need to look for an individual policy. These can be prohibitively expensive, so you may need to compromise by agreeing to a longer waiting period before benefits begin (such as 90 or 180 days, instead of 30 or 60) and/or by limiting the benefit period to five years instead of to age 65. For more, see "Disability insurance can save your life."
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Priority No. 7: Enhance your retirement savings
Once you're contributing at least 10% of your income to a tax-deductible retirement plan, you can consider what's known as tax diversification.

That means putting money in various retirement buckets that will receive different tax treatment in retirement.

Retirement plans that give you a tax break upfront, such as 401(k)s and traditional IRAs, will require you to pay income taxes on withdrawals in retirement.

* Your 5-minute guide to retirement

* Retirement planner

Contributions to a Roth IRA, by contrast, don't give you an upfront deduction, but you can withdraw from them tax-free in retirement.

If you can't contribute to a Roth (the ability to contribute begins to phase out once your modified adjusted gross income exceeds $105,000 for single filers or $166,000 for those who are married filing jointly), consider putting money into a taxable brokerage account. Again, there's no upfront tax break, but investments held a year or more qualify for more-attractive capital-gains tax rates.

Continued: Start saving for college

ontinued from page 2
[Related content: savings, budgeting, Liz Pulliam Weston, 401k, financial planning]

Priority No. 8: Start saving for college
You're on track for retirement, your toxic debts are retired, and you've got a decent emergency fund going. Only now should you lift your sights from your future to that of your kids.

Putting your progeny so low on the list is hard, I know. But they have other options to pay for school, including loans. Nobody will lend you money for retirement.

The best way to save is likely to be through a 529 college savings plan (though not everyone would agree). You can contribute lump sums or set up automatic withdrawals of as little as $25 a month.

* Your 5-minute guide to saving for college

How much should you save? If you're trying to pay the full freight at Harvard, one heck of a lot: $819 a month, starting at birth, according to the college savings calculator at

A more realistic goal for most families might be to save for one-third to one-half the cost of public-school education and rely on borrowing to cover the rest. That would require a contribution of $80 to $125 a month for a child who just entered kindergarten.
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* 6 steps to dumping toxic debt
* When paying off debt is a bad idea
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* Calculator: Too much debt for your income?

Priority No. 9: Save for spectacular experiences
If you've covered all the priorities and have cash left over, it's time to start putting money aside for something wonderful: a special trip, a family reunion, a sabbatical. (Yes, people take those, even in recessions.)

Because money isn't just about covering the essentials; it's also a tool for living life to its fullest.

We tend to forget that when we focus only on the bills, the retirement accounts or the tangible stuff money can buy. Yes, purchasing a new car or TV can give you a rush, but that fades fast. What lasts are our connections to other people and our memories of happy events.

Make sure you're getting enough of those.

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