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Many people have heard about Roth IRA’s and wonder, what’s the difference and should I pay attention to them? The answer is yes, and we’ll explain why in layman’s terms. There are rules, tax benefits, and limits and we can break them down to get a sense of what might be beneficial for your individual situation.
Continue reading “What's a Roth IRA and Why Should I Care?”
Whether starting a new job or making selections in your employer’s annual benefits enrollment, you may have the opportunity to select a Health Savings Account. Health Savings Accounts (HSAs) are rapidly growing in popularity across the country for both employers and individuals and it’s important, particularly for young professionals, to understand what HSAs are and why you should consider them.
HSAs are relatively new as they were established and signed into federal law in 2003. The purpose of an HSA is to help reduce healthcare costs and to incentivize individuals to save for healthcare costs both now and for the future. Think of an HSA as a Healthcare 401k and Checking Combo Account. HSA’s have considerable benefits; it can reduce your tax liability, reduce your overall healthcare costs and increase your investable assets. Before choosing an HSA, we recommend a few qualifications to consider:
If you answered yes to both of those questions, you may want to consider an HSA. One of the biggest differences between a traditional HMO/PPO plan and an HSA is the deductible (the specified amount the insured individual pays for a claim prior to the insurance company payment). In a traditional health insurance plan, the insurance company picks up most of the tab for healthcare expenses, even for routine visits or basic general care. Since HMOs are essentially paying out first-dollar for smaller health claims, they charge much higher insurance premiums. The HSA on the other hand changes that relationship by pairing with a High Deductible Health Plan (HDHP), which shifts the responsibility of smaller health claims from the insurer to the consumer (us) and picks up larger expenses after the deductible is reached.
Let’s use an example to hash that out:
Leslie has an HMO plan. She gets the flu and visits the doctor. A few weeks after that visit she receives a bill. The visit was billed at $400 and insurance network discount brought it to $200 and the insurance company paid $150, leaving the patient responsibility of $50.
If Leslie had an HSA plan and visited the same doctor, she would receive the same bill of $400, the same discount to $200, but this time, the patient responsibility would be $200, not $50.
So now you’re saying, wait a second, I don’t want to pay $200 if I get sick, that’s nuts!That’s where we need to step back and understand the bigger picture and five reasons to consider HSAs.
Health Insurance premiums are much lower with High Deductible Health Plans. Health insurance can cost thousands of dollars per year, so cutting your insurance premiums can lead to significant savings. If you obtain insurance through your employer, your insurance premium is paid to directly to the health insurance company, typically deducted directly from your paycheck. Those premiums are paid regardless of whether you have health expenses or not. So if you’re healthy, paying high insurance premiums can be an inefficient use of your hard-earned dollars.
The savings from the reduced premiums can go to your HSA pre-tax. Just like a 401(k) you can contribute a set amount (pre-tax) to be withdrawn from your paycheck and transferred to your Health Savings Account to cover the expenses when you do visit the doctor. HSAs have an outstanding benefit that you cansave money with pre-tax dollars and spend on healthcare expenses with pre-tax dollars, which gives you more spending power with your savings. In the HMO example above, Leslie paid $50, but with after-tax dollars. It would be more like $62.50 (assuming a 25% tax rate)
Not only can you reduce your insurance premium and save in a tax-sheltered account, but HSA’s also give the ability to invest your savings in the stock market just like a 401(k). The 2016 IRS annual contribution limits for HSAs are $3,350 for individuals and $6,750 for families. These savings can be invested for long-term growth using the power of compound interest. Over several years, one can build significant healthcare savings that grow tax-free.
Employers pay a large portion of the cost of healthcare for employees. Shifting from an HMO/PPO to an HSA with a High Deductible Health Plan saves employers significant costs. Often times they will share a portion of those savings with employees and help you fund your HSA’s. Many companies will give $500-$1000 annually to help with the high deductible. That is literally a tax-free bonus every year.
The HSA belongs to you, the money in the savings account belongs to you. It stays in your account year after year, so there are no ‘use it or lose it’ provisions. In fact, if you set this up with an employer, the account will stay with you even if you leave your employer.
Health Savings Accounts can be intimidating, particularly with the uncertainty of a high deductible. Health plans have an out-of-pocket maximum, which is an upper limit on the amount individuals will have to pay for covered health expenses in a given year. Evaluate whether the combination of employer contributions, individual contributions, and emergency savings can reach that upper limit. If you are relatively healthy and have a strong emergency fund, an HSA can be a very beneficial additional savings and investment vehicle.
Be sure to speak to HR or your benefits representative to understand the specifics of your plan.
Let’s face it, for many investing is a difficult topic. The financial services industry has done an excellent job creating lingo and products that seem overly complex. Part of it is to justify their services; ‘If this investing stuff is too complex, give me your money and I’ll handle it for you!’ Technology is changing that dynamic and people are starting to realize that investing, particularly retirement investing, doesn’t require a Ph.D. in Math or Finance. The first step is to understand why investing is important and then to develop an openness to learning over time. This is not a forum for specific investing advice, but rather to discuss why investing is essential to reach our long-term financial goals.
Before we get into the reasons to invest, let’s make sure we are all on the same page what we mean by investing.
Now that we’re all on the same page, let’s talk about why you need to be investing!
Money is a resource, and like fire, it can both build and destroy. In order to be financially successful, we have to learn how to use our financial resources to build. There are really only three things you can do with money and how much of each you do can make all the difference in the world.
Spend – We do it every single day. We use our money to acquire products or services that we believe are of equal or greater value. The problem with spending is that most things decrease in value over time, so after we part with our hard-earned money, we’re left with a product or service that is immediately less valuable. If you use too many of your financial resources to purchase items that decrease in value, you cannot build wealth. This is why keeping up with the Joneses is so poisonous; it’s a race to the bottom.
Give – Interestingly enough, studies have shown that giving actually brings more and longer-lasting happiness than spending. You likely still remember the feeling of joy when you gave someone a great gift they really appreciated or truly helping someone in need. Giving also forces discipline with our finances, when you give money away, you become keener on how you manage the remaining funds. Giving is a very important aspect of personal finance and is a driving force for many to build wealth.
Save – There are different types of saving, but the idea is that you are using your financial resources with an expectation or goal of increasing its value in the future. That can take the form of a savings account, investing in the stock market, buying real estate, or even lending. This is the primary way to build assets and thus build wealth.
If you are under the age of 50, it’s likely you do not have a pension and the future of Social Security is very uncertain, it may not even exist by the time we would be eligible for it. We also know that advances in health and technology that we are likely to live longer lives. We will need funds to provide for ourselves for a longer period of time without the financial assistance from business or government. If that’s not scary enough, let’s say you want to retire at 65. You work from age 25-65 (40 years), during that time you need to save enough money to live without new income for potentially 25 years (ages 65-90). People are having enough trouble building 6 months of expenses for an emergency fund. How about building for 25 years (300 months) of expenses or more? Putting a few dollars in a savings account here and there isn’t going to get the job done. You need a plan and you need to start as early as possible.
When planning for the long-term future, people often forget to account for inflation. This can be a big mistake and can have serious consequences. Inflation is the increase of prices or the decrease in purchasing power over time. For example, 20 years ago one could go to a gas station and purchase gas for less than $1/gallon. As of this writing, it’s about $2.30/gallon, so a $20 bill that was more than sufficient in 1996 would not fill the gas tank today. Inflation (typically 2-3% per year) is like an ocean tide that is continuously raising the financial sea level. If the sea level is ankle-deep today and you stand still (don’t invest or grow the value of your assets), the tide of inflation will continue to rise and eventually you will be completely submerged. Like quicksand, standing still financially is actually sinking because inflation decreases the value of yesterday’s dollar. The only way to counteract inflation is to make sure your long-term savings are earning more than inflation.
So far we have given you some pretty dire news, spending won’t help, you’re all alone and the winter of inflation is coming for your assets! The good news is that you have a force of nature available that can fight the good fight and help you win and reach your financial goals, her name is compound interest. However, there are two sides of compound interest coin and you have to be on the right side to win.
If you have ever paid the minimum payment on a credit card, paid student loans, car loans or a mortgage, you have experienced being on the wrong side of compound interest. When you borrow, the investment the lender made earns interest that compounds and you pay them more in the future. This is why debt can kill wealth; your financial past is stealing from your financial future.
The right side of compound interest is much more appealing. When you invest, the earnings on your investments compound such that your future earnings also earn interest for you in the future.
Let’s use a simplified example. You save $500/month every month for 30 years. After 30 years you would have saved $180,000 cash. Now let’s say you invested the same $500/month every month for 30 years and it received 9% interest annually, it would total over $850,000.
The difference between the $180,000 and $850,000 is the power of compound interest. Compound interest is the sunlight that provides the energy to your investment seed to grow and harvest. The two major ingredients for compound interest to be effective are regular payments and time.
While saving is important, especially building the foundation of an emergency fund or short-term goals, investing is a necessity to build real wealth. Imagine a 15-year-old family member after watching a NASCAR race said to you they don’t want to learn how to drive. They explain that “It’s too technical, too dangerous and I’m not a car person!” You would probably explain to them how not learning to drive can negatively impact their quality of life. You would also likely explain to them there’s a huge difference between daily recreational driving and professional racing. The same applies to investing, excuses like, ‘I’m not good at math’, ‘it’s too complicated’, or ‘it’s too risky’ no longer hold. There is a huge difference between day-trading and retirement investing, technology has made investing accessible to many more people and because of headwinds like inflation and government uncertainty, in our opinion, it is riskier not to invest.