You don’t think twice to lock your doors, look both ways before crossing the street, or turn off your electronics when you’re not home. So why is it that so many of us are one disaster away from a financial catastrophe?
That’s where a “Safety Net” comes in. By definition, a safety net is a term used by financial planners to describe a number of different things you should have to protect your family and your finances. But a safety net should be much more than just a few extra thousand bucks you’ve got saved in case aliens take over the world. A TRUE safety net could encompass a whole lot more. Here are a few ingredients you’ll need in your Safety Net.
Insurance
Insurance is a top priority for your safety net. Although some see it as an unnecessary expense, these policies really are a must have. Just anyone who has ever had to pay their own medical bills or accident expenses out of pocket. All it takes is one accident (not even at your own fault) to put you in debt forever! It’s not a roll of the dice that you want to take.
Here are a few of the major policies you’ll want to have:
• Health / Dental Care – If your employer doesn’t provide this (or enough of it), then make it the first thing to get. Want some motivation? Just look at one of your insurance statements and see how much the cost for any doctor’s office or medical procedure REALLY was. Health care costs are OUTRAGEOUS!!!
• Auto Insurance – This is very important not just for your car, but for the possible medical and property damages you could be liable for. Most states legally require at least the minimum coverage to even be able to drive. My personal preference to spend a few extra bucks more to get several thousands more in coverage for bodily injury and property damage. Also, I usually opt for a high deductible and pay a lower monthly fee.
• Home Owners or Renters Insurance – Similar to the Auto Insurance, this policy protects both your home and processions as well as an accidental liabilities. Again, for the extra few bucks, opt for higher accident coverage.
• Life Insurance – If you were to die, who would take care of your family financially? Most employers provide a small insurance policy that would cover a few immediate expenses, but it wouldn’t be nearly enough for the long-haul. For the best coverage, a term life insurance policy can be purchased relatively inexpensively and provide hundreds of thousands of dollars in benefits that would take care of your family for a couple of years. The general rule of thumb is to get a policy that covers 10x your income. Note that Social Security also provides some limited “survivor” benefits.
• Disability Insurance – There’s a place between being healthy and death that few of us ever think about called “disabled”. If you were ever hurt or ill for any reason, Disability Insurance would provide income where you would not be able to. I will warn you that this type of insurance is a little more costly than others. Some employers offer this type of insurance, so first check to see what benefits you may already have. Note that Social Security also provides some limited benefit.
Savings (also called an Emergency Fund)
Okay, so that extra couple of thousand dollars I mentioned does rank high on the list of priorities. But that’s because there are any number of things that you could use it for:
• Job loss
• Medical emergency
• Large-scale home repairs
• A sudden car purchase due to any number reasons
• Etc, etc.
The goal to strive for is 3 to 6 months of your combined (you and your spouse’s) net (after tax) income. Basically think of it like having an ATM that you could immediately withdrawal from if you both lost your jobs.
And on that same note, you shouldn’t keep it in fluctuating funds like stocks or high-risk bonds. Consider more stable investments like high-interest savings accounts, CD’s, or money-market – things where you could get to the money in a flash if you needed it.
By the way – When you’re building your 3 to 6 month savings, be smart about it in relation to any debt you have. For example, it makes no sense to save up 6 months worth of savings before paying down a credit card with a 20% interest rate. In this type of situation, split up your money with more of it going towards the high-interest debt and less going to the savings.
Retirement
Yes, your traditional retirement accounts could also be considered part of your safety net. In a very EXTREME (and I stress EXTREME) situation, you could borrow the money. Plus, you need to be saving anyways as part of the safety you’ll need in old age.
So outside your Emergency Fund, here a few of the popular places to stash your money:
• Employer Sponsored Plan such as a 401(k) or 403(b)
• Individual Retirement Account (IRA) – ROTH or Traditional
• Annuity
• Personal Savings
Of all the options, a ROTH IRA is your best compromise between an Emergency Fund and Retirement funds. Why? Because a ROTH is the only fund you can withdrawal from where you do not pay any taxes or penalties (the principal has to be five years or older).
College Education
This last topic applies to the safety net of your children or other dependents. Speaking in general terms, a college education is always a great safety net for anyone to have because it opens the number of opportunities you have to get a better paying job.
If you have young ones, start saving right now because college costs are projected to be unthinkable by the time they will be old enough to go. Saving now will help both your financial situation as well as help keep your children out of future debt.
There are a few tax-advantaged options for saving towards this goal:
• 529 Plan
• Pre-Paid Plan
• Savings Bonds
Remember, however, that your retirement savings comes first. Although it’s not a great solution, your kids can always apply for loans and make payments on them when they start getting job. You, on the other hand, cannot take out a loan to retire and will be less able (both physically and mentally) to simply work a few extra years to offset the extra money you’ll need.
Related Posts on Financial Planning:
1) Traditional vs. Roth IRA – Part 1: The Basics
2) Help! I Just Got My 401k Packet At Work! What Do I Do?
3) When Can I Get My Retirement Savings?
My husband and I are slowly moving part of our EF into savings bonds. After a year they can be reimbursed at anytime, so a bit more flexible than CDs but still higher interest than high yield savings. We still plan to have a month in cash, but the next two months in the end, will be I. The savings bonds. Given that we don’t want all the money locked up for a year this is taking us a while, but we will get there.
Using savings bonds is an interesting strategy for building up your emergency fund. It makes sense – as long as you’re getting a higher rate of return why not?