And How to Overcome Them
Like any long journey, the road toward financial freedom will have bumps and obstacles. However, having the foresight to anticipate and plan for these challenges can make a big difference. Following are five common obstacles you may face on your journey toward financial freedom, as well as strategies to help you overcome them.
#1 – Paying for college
It’s no secret that the cost of college has risen significantly over the past several decades. In fact, the average cost of undergraduate tuition in the United States has more than tripled over the last 58 years, and that number accounts for inflation. Between 2000 and 2021, tuition and fees at public, four-year universities rose by 70% on average.1 Another often published statistic is that college tuition increases at a rate of 8% per year, which means the cost of college doubles every nine years.2
All this to say that if your financial goals include paying for a loved one’s college education, it’s important to start planning as soon as possible. Failing to save in a tax-efficient manner is an obstacle that can quickly derail your long-term financial security.
A commonly used strategy is to begin saving as early as possible in a 529 college savings account, which is a triple tax-advantaged vehicle allowing you to set aside funds for future education expenses. When used to pay for education expenses, earnings in a 529 plan can be withdrawn free from state and federal taxes — and in some states, savers are able to receive a tax deduction for intra-year savings.
For example, let’s say you contributed $50,000 to your daughter’s 529 plan over several years. Due to investment growth, the account is now worth $70,000. Typically, the $20,000 of growth would be taxable, and the taxes you pay would decrease the total amount available to pay for your daughter’s college. However, if you use the full $70,000 to pay for education expenses, you can avoid tax on the $20,000 in earnings.
As an added bonus, this year we saw advancements in 529 plans that helped address long-standing obstacles for most parents/guardians. With enrollment falling 3% over the last decade for four-year college degrees, what happens if your intended student chooses not to go to college? The National Center of Educational Statistics now shows less than 39% of 18-24 year olds will enroll,3 making this a valid concern. Recent legislation allows up to $35,000 in excess 529 plan funds to be converted to a Roth IRA for the beneficiary after 15 years.
#2 – Saving for retirement
The challenge of saving for retirement can sometimes feel like an impossible obstacle to overcome. After all, most people can expect to live 20 to 30 years in retirement. That’s a long time to live off your savings.
Thanks to the power of compounding interest, it’s wise to start saving for retirement while you’re young. However, any money you save today can help improve your financial situation in retirement, and it’s never too late to start.
One of the easiest ways to start saving for retirement is typically through an employer-sponsored retirement plan, such as a 401k or 403b. At a minimum, consider investing enough to take full advantage of any available employer matching contributions, because we never want to turn down money. For example, if your employer offers a 50% matching contribution on the first 6% you contribute, be sure to contribute at least 6% so that you can receive the full value of this benefit.
Pre-tax retirement plan contributions offer the added benefit of lowering your taxable income during the year in which contributions are made. On the flip side, Roth contributions, which are made with after-tax dollars, aren’t subject to income taxes when they’re withdrawn in retirement. In plain language, you can save on taxes now (pre-tax) or save on taxes later (post-tax/Roth).
If you don’t have access to an employer-sponsored plan (or you’ve maxed out your retirement plan contributions), consider saving in an individual retirement account (IRA). A traditional IRA is funded with pre-tax dollars, which allows you to lower your taxable income during the year in which you contribute. Withdrawals are then taxed at ordinary income tax rates when withdrawn in retirement. IRA contributions are subject to income limitations ($7,000 for those under 50 and $8,000 for those 50 and older in 2024).
In contrast, a Roth IRA is funded with after-tax assets. While these contributions don’t reduce your taxable income in the year during which they’re made, withdrawals in retirement are typically tax-exempt. Roth IRA contributions are also subject to income limitations ($7,000 for those under 50 and $8,000 for those 50 and older in 2024).
#3 – Home expenses
More than ever, we are seeing a bunch of folks who are in a low interest rate home purchased at a pre-2020 price. This type of home makes for a wonderful asset, unless you now need to move. On the other hand are those spending a high percentage of their income on housing — a common obstacle on the road to achieving financial freedom. Whether you stretch your finances to purchase a larger home than you can afford or you’re faced with the cost of expensive repairs, spending a significant amount of your income on your home can make it difficult to save for the future.
When determining how much you can reasonably afford to spend on your home, consider the 28/36 rule. According to this rule, you should spend no more than 28% of your pre-tax monthly income on home-related expenses and no more than 36% on total debts, including your mortgage, credit cards, car loans, student loans, etc.
Of course, this is just a general rule of thumb. However, keep in mind the less money you spend on housing costs, the more you have available to save and invest for the future.
#4 – Aging parents
An additional detour on the path toward financial freedom comes with caring for aging parents. According to AARP research, family caregivers spend an average of 26% of their income on care-related expenses.4 Adding to the financial challenge of caring for aging parents is the fact that many family caregivers must work less or leave the workforce completely in order to provide support to an aging parent.
Fortunately, there are steps you can take to ease this financial challenge:
- Look for tax-saving opportunities. If your aging parent lives with you, you may be able to claim him/her as a dependent on your federal tax return, which can help save you money when you file. You may also qualify for a dependent care tax credit of up to $3,000 in qualified care expenses per individual. In addition, the IRS allows you to deduct medical and healthcare-related expenses that exceed 7.5% of your adjusted gross income. Qualifying expenses may include necessary medical equipment, transportation and home modifications to accommodate your loved one.
- Apply for government benefits. If your aging parent is a U.S. veteran or currently eligible for Medicaid, you may be able to receive payment for your care services. The amount available depends on your state of residence, your loved one’s particular needs and the average wage paid to home health aides in your state. You can learn more by visiting the American Council on Aging’s website at https://www.medicaidplanningassistance.org.
- Set up an appropriate estate plan. Nursing home costs can take a real bite out of your assets without proper planning. Although protecting your assets can be complicated, it’s a necessary step. A trust enables you to transfer the control of your assets from yourself to a beneficiary or the trust itself. When you transfer assets into a trust, it will lower your net worth. And with that, you may qualify for additional government assistance in picking up the costs of your nursing home stay. But it’s critical to do this ahead of time due to the five-year lookback period with Medicare.
#5 – Carrying too much debt
Debt is one of the biggest obstacles to achieving financial freedom. Anytime you owe money to someone else, you’re required to put that entity’s financial interests ahead of your own. The sooner you pay off all your debt, the sooner you can take control of your money and start working to achieve financial freedom.
Make a focused effort to pay off your debt as soon as possible, especially debt that carries high interest rates.
Two effective strategies for paying off debt include:
- The snowball method – This method involves paying off your smallest debt balance as quickly as possible, then moving on to the next-smallest debt. The benefit of this approach is it can help you gain a sense of accomplishment as you knock out one loan after another.
- The avalanche method – Using this method, you begin paying on whatever loan has the highest interest rate. Once that’s paid off, you move on to the loan with the next-highest interest rate until all loans are paid off. This approach allows you to pick up speed as you go, because each payment saves you more money than the one before.
Could you use help overcoming the specific obstacles you face on the road toward financial freedom? Creative Planning is here for you. Our experienced teams help you develop, implement and maintain a holistic financial plan to align all aspects of your finances with your goals. To get started, schedule a call with a member of our team. We look forward to getting to know you.
