By Erin Jones, AAFMAA Wealth Management & Trust Relationship Manager
We all know, in general, what’s required to protect our financial well-being: insurance coverage, an emergency fund, retirement savings, etc. But as our needs change with the different stages of life, so can the definition of what makes us financially healthy. So how can you tell if you’re staying on track?
Below are some simple guidelines--including mathematical formulas--to help you assess your own financial health. As you review, think about (or even make a list) of the areas where you have strengths and weaknesses. Remember, these guidelines are not set in stone, and will be influenced by where you are in your lifecycle.
Risk Coverage (Insurance)
Life Insurance: Death benefit of 10–16 times your annual gross pay; consider having life insurance on the non-earning spouse to cover household and care-taking responsibilities (if applicable).
Disability coverage: Coverage of 60-70% of gross pay. Consider adding short-term (three to six months) disability insurance since long-term disability payments typically do not start until the sixth months after disability occurs.
Property - Home and Auto: Coverage should be equal to, or greater than, Fair Market Value (FMV).
Long Term Care (LTC): Secure 36-60 months of coverage. You will want an inflation protected plan since LTC costs inflate around 3-4%.
Personal Liability Umbrella Policy (PLUP): A policy that provides $1-3 million of coverage; this is liability coverage that can help cover you from extreme financial loss due to unforeseen incidents where you are held liable. Here are some examples:
While cooking, you leave your stove unattended. In addition to damaging your property, the fire also damages your neighbor's property and injures your neighbors. As a result, you may have to pay for any repairs to your neighbor's dwelling in addition to any injury claims.
While on your property, a guest slips on your sidewalk or falls from your trampoline. The injured person could file a claim against you.
*Note for PLUP, the insurance company typically requires the maximum coverage on auto policies and homeowners policy in order for the PLUP to be issued.
Emergency & Debt Management
Emergency Fund: Maintain 3-6 months’ worth of non-discretionary expenses. If your household has two or more sources of income, then 3 months’ worth is sufficient. If your household has one source of income, then 6 months’ worth of expenses is suggested. Non-discretionary expenses are those that do not go away if you lose your job.
Mortgage Payment: The ratio of housing costs should be 25% or less of your gross monthly income; the way to calculate this is to add your monthly Principal, Interest, Property Taxes and Homeowner’s Insurance (P.I.T.I.) and divide this total by your monthly gross income.
Housing and All Other Debt Ratio: Add the P.I.T.I. to all other recurring monthly debt (auto loans, student loans, boat, credit card and any other monthly debt) and divide the total by your monthly gross income; the ratio should be 38% or less.
Consumer Debt: Monthly consumer debt should not exceed 20% of your monthly net income (after tax and other deductions from your gross pay).
What is “good” debt? Anytime the useful life of the asset far exceeds the term of the debt; examples are a 15-year mortgage or a 3-year car loan.
What is “reasonable” debt? 30-year mortgage or 5-year car loan.
What is “bad” debt? Carrying credit card (consumer) debt each month.
Long-Term Savings and Legacy
Education Funding: $1,000/$3,000/$6,000 per child per year for 18 years. The tier is dependent on what type of college you plan on your child attending; the assumption here is save $1,000/year for a public state college, $3,000/year for a semi-private university and $6,000/year for a competitive private university. (These are general guidelines, and tuition rates vary depending on state and institution.)
Retirement Savings: By age 62–65, an individual should have saved 16 times the amount needed annually during retirement. A benchmark savings ratio target is 10-12% of annual gross income if an individual begins saving before age 32; if one waits until after age 32, the amount moves to 12-15%; and if you wait until age 45 or 50, the rate increases to 15-20%. To calculate your annual savings ratio, add your employee and employer contributions (including profit sharing) and divide that total by your annual gross income.
Legacy: also known as the “Big Three”
Will: A will is a legal instrument detailing how you want your real and personal property disposed of at death; it is important to review it periodically and keep it updated.
**Individual Retirement Accounts (IRAs) and qualified accounts (i.e. 401ks) are not passed through a will; these are passed through a contract, and you’ll need to assign a beneficiary or beneficiaries to inherit the assets. If there are no beneficiaries assigned, the assets will pass through probate.
Durable Power of Attorney for Healthcare: This is a legal document where an agent is assigned to cover all health care decisions and only lasts while you are incapable of making decisions on your own; deathbed issues can also be addressed in this document.
Advanced Medical Directive (Also known as a Living Will): This is a legal document in which a person specifies what actions should be taken for their health if they are no longer able to make decisions for themselves because of illness or incapacity; this is typically for deathbed issues such as Do Not Resuscitate (DNR) and how you wish your body to be disposed of after your death.
||Short-Term Savings and Debt Analysis
||Long Term Savings and Legacy
|Life Insurance (10-16x gross pay)
||Emergency Fund: 3-6 months of non-discretionary expenses
$1,000/$3,000/$6,000 per child per year for 18 years
|Disability (60-70% of gross pay)
||Housing Ratio no more than 28% of gross income
||Retirement Savings: 16x pre-retirement income.
|Property: Home and Auto > or equal to FMV
||Housing Ratio and all other recurring debt no more than 36% of gross income
||Retirement Savings Rate: before age 32, 10 – 12%, start after age 32, 12 – 15%, start after age 45, 15-20%
|Long Term Care (inflation protection) 36-60 months *consider Short Term Disability
Good Debt: i.e. 15 year mortgage/ 3 year car loan
Reasonable Debt: i.e. 30 year mortgage/ 5 year car loan
Legacy: the “Big Three”
- Durable Power of Attorney
- Advanced Medical Directive
|PLUP (Personal Liability Umbrella Policy) $1-3M
||Bad debt: i.e. carrying credit card debt from month to month
After reviewing these benchmarks, do you think your financial health could use a checkup? At AAFMAA Wealth Management & Trust, we work with military families like yours every day, developing strategies for success. Connect with a Relationship Manager today, who can help create your path to a solid financial future.
Resource: American College Fundamentals of Financial Planning and Insurance 2011