What Should You Do With Unexpected Income?

Unexpected Income from a Financial Windfall

What would you do with unexpected income received from an inheritance or insurance policy — or even a big year-end bonus at work?

While it’s not wise to rely on windfalls as part of your financial plan, you need to think ahead and understand what steps to take should this ever happen. Without a plan, it’s easier to use this extra, unexpected money irresponsibly or wastefully.

In order to plan on a windfall (without depending on it), you need to:

  • Find a trusted professional to work with
  • Establish a sensible, rational mindset
  • Take care of any pressing financial issues (or fund a financial goal)
  • Build your financial team

Let’s break these steps down into more detail.

Take Care of Tax Obligations

This is your first priority when dealing with significant amounts of unexpected income — like money from an inheritance or something like winning the lottery.

There are tax laws and codes around financial windfalls that may look a little different than what you’re used to. It’s important that you protect yourself (and your new money!) by working with a trusted, qualified CPA.

Your CPA can outline what kind of obligations you must now meet, and can provide advice on how to manage your money so you’re not slammed with a larger-than-necessary tax bill.

Get Your Head in the Right Space

Suddenly coming into a good financial situation (read: lots of money) can positively impact your net worth, and very negatively affect your mindset. You need to avoid impulsive decisions and remain rational.

Many people feel elated and excited upon receiving a financial windfall. Others feel anxious, paranoid, depressed, and stressed because of this new burden.

In either case, avoiding making decisions can help after you’ve taken care of any tax-related issues with your CPA. Give yourself space — in the form of time — from this event. Don’t suddenly decide to make big changes to your money management habits, spending, or life in general until some time has passed.

You can also help establish the right mindset by educating yourself.

Read books on personal finance, investing, and sudden wealth. Learn all you can about money and how it works. Check out financial blogs. Ask questions; seek answers. Knowledge is power.

Fund Financial Goals, or Fix Financial Problems

Once you can think about your finances in a calm, reasonable way, it’s time to think about what to do with this money. If you’re in the red, your first priority is to use extra and unexpected income to get out of debt.

No debt or financial issue to solve right away? Use your unexpected income to create a larger emergency fund. The general rule of thumb is to keep three to six months’ worth of living expenses socked away in a liquid savings account.

If you receive a windfall, however, consider providing yourself with an even larger safety net. Bump up your emergency fund to six to twelve months’ worth of expenses. Remember, just because things look great now since you have extra money does not mean nothing will ever go wrong again.

Your emergency fund can still protect you from a job loss, serious damage to your property, or a big medical bill. Don’t neglect it! Take advantage of having more cash than usual on hand to fully fund your savings for a rainy day.

Build Your Financial Team

When you start increasing your assets — especially when it happens suddenly — you need a reliable financial team to help you take care of all aspects of managing your money and wealth.

In addition to a CPA, you’ll want to look for a fee-only advisor to provide you with professional financial advice. You also want to have a lawyer who can develop an estate plan for you. (No, that’s not fun to think about. But it’s important, even if you’re young.)

When searching for financial professionals to help you, keep the following in mind:

  • Look for fee-only advisors who don’t charge commissions on financial products they sell
  • Ask about their professional credentials and their experience to ensure they can meet your needs
  • Make sure any professional is willing to work with you as a fiduciary

And Yes, You Can Splurge (Just a Little!) After Receiving Unexpected Income

It’s important to take care of practical needs whenever you receive extra money. You need to proceed with caution so that you don’t act impulsively or make financial decisions you’ll later regret.

But you are allowed to have a little fun, too!

After doing the responsible stuff listed above, create a wish list of things you’d love to buy or experience. Then take 5% of your unexpected income and pick a few things to enjoy from your list.

Have you ever experienced a financial windfall? Do you have a plan in place in case you do?

What’s Up With Your Credit Score?

Credit Score

Do you realize just how important your credit score is? It’s the deciding factor in a number of situations — strictly financial or otherwise — and it has the potential to make or break your financial situation.

It doesn’t really matter what your personal philosophy on credit may be. Fact is, many institutions place a lot of importance on that three-digit number of yours.

Fair or not, your credit score indicates how much of a risk you may be to their business.

It’s crucial that you know how your credit score can affect your financial plans and bills, how credit scores work, and what your credit score is actually comprised of.

How Having a Good Credit Score Can Help You

Good credit means more opportunities and better financial positioning in a variety of situations.

You’re more likely to qualify for the really great rewards credit cards if you have good credit. Those cards could provide cash back or points you can redeem for expenses like travel (rather than paying with your hard-earned cash). The better the rewards, the more stringent the requirements for the card. If your credit score isn’t above 700, you run the risk of being denied.

Interested in purchasing real estate, either for yourself or in the form of investment properties? Having a good credit score will make it easier to qualify for a mortgage with favorable terms and a lower interest rate — which saves you money over the life of the loan.

The same goes for any type of loan you’re interested in taking out. The better your credit score, the more favorable the terms of the loan will be for you.

You’ll also benefit from lower insurance rates, as most insurers are now using your credit rating to help them evaluate you as a property and casualty insurance client.

How Having a Bad Credit Score Can Hurt You

Soft inquiries are common from many companies these days. While that won’t have any impact on your score, it will influence how these companies see you.

Did you know inquiries can be made when entering a cell phone contract, or when you go to set up your utilities? All sorts of companies, big and small, want to know how responsible you are — and the easiest way (to them, in our current system) to do that is to check your credit report or score and make an assumption based off that number.

They are in the business of making money, and if you can’t pay on time, they don’t want the risk.

There are even some employers that are checking the credit reports of would-be employees, especially if they will be handling cash. If that sounds crazy, consider the fact that there are dating sites that exist that require users to share their credit score range. (Experian even wrote up a blog post about it!)

Let’s not forget about insurance, either. Companies can look to your credit score to determine whether or not to give you a policy. This is true for auto and homeowner’s/renter’s insurance. In their eyes, a lower credit score means you may be more likely to file claims.

Besides that, you’ll be subjected to higher interest rates on loans and lines of credit across the board. This makes loans and debt even more expensive for you — especially when considering big loans like mortgages.

How Credit Scores Work

The basics: you have 3 FICO scores from the 3 credit bureaus: Experian, TransUnion, and Equifax. They are separate companies and have their own ways of calculating your score, which is why all 3 may be different.

The best overall FICO score you can have is 850, and the lowest is 300. Your credit is considered excellent if your score is above 750.

Good credit is a score between 700-749 (the median FICO score is 723). Fair credit is 650-699; anything below that, and you could be in trouble.

It’s best to try and keep your credit score above 700 to reap the most benefits of having a good score.

What’s Your Score Made Of?

Now that you know what constitutes a good and excellent credit score, let’s go over the different sections that make up your score:

35% is your payment history. So pay on time, every time. Make this a priority! If you have a hard time remembering due dates, you might want to opt-in to automatic payments. At the very least, you should set reminders for yourself.

If you have a really good track record and make one late payment, it’s worth asking your lender if they’ll forgive you. In most cases, they’ll agree to sweep it under the rug especially if you pay in full.

Otherwise, payments made after 30 days will stay on your record for 7 years. (Yikes.)

30% is the amount you owe. Having a lower balance is always going to look better on your credit history. It indicates that you’re responsible with your money and know how to manage it. The more debt you have, the higher the risk you are for lenders.

15% is the length of your credit history. This is why starting early with credit is recommended, and why closing accounts is not.

10% is any new credit that you’ve recently been approved for. When applying for a loan or a new credit card, lenders will do a hard inquiry. This has the potential to lower your score by a few points.

(If you’re looking to apply for a mortgage, it’s generally recommended that you not open any new lines of credit until you’re approved.)

10% is the type of credit you have. Do you only have student loan debt? A car loan? A mortgage? Credit card debt? Lenders want to see what kind of experience you have with credit.

And remember, just because you know you’re responsible with credit doesn’t mean you should ignore your score and report. Pull your credit report once per year and check for errors or discrepancies. You can also use a service like Credit.com or CreditKarma.com to periodically check your actual credit score.

3 Steps to Financial Independence

Achieve Financial Independence and Freedom

Here’s the great thing about financial success: the keys to achieving it for yourself are based on some pretty simple, easy-to-understand concepts.

Spend less than you earn. Save (and wisely invest) as much as you can.

Save and invest what you can, consistently and over time, and you will achive financial independence. Sound too good to be true? Check out this post from early retirement expert Mr. Money Mustache. It’s appropriately titled, “The Shockingly Simple Math Behind Early Retirement.”

Note the savings chart he shares with readers there – or check out a copy below:

Savings Rate

The point is that the math behind the idea of becoming financially independent is really simple. So why aren’t more people kicking back on the beach with a fruity umbrella drink at the age of 35 or 40?

Because taking that consistent action and saving 20%, 30%, or more of your income for more than a few years takes good planning and serious dedication. It’s hard work, in other words. You’ve got to be highly motivated and driven to your goal of financial success.

And we can help you with the planning part. Get started on the path to financial independence with these three steps to take action on now:

Take Full Advantage of Employer-Sponsored Retirement Plans

If your employer offers you a 401(k) plan with a company match, take advantage. Any employer-sponsored retirement plan is going to provide one of the easiest ways for you to reach your goal of financial independence. That employer match is free money on the table.

Not enrolled? Get yourself signed up immediately. Then contribute at least enough to your account to secure that match. If your employer offers to match up to 3% of your contributions, you need to contribute at least 3% of your earnings to that account. If they offer a partial match beyond 3%, take advantage of that as well.

Every time you earn a raise, make sure you bump up your contributions. Or make a plan to increase your contributions by 1% every 6 months or every year.

Remember, securing the match should be the minimium. Work toward putting away at least 15% to 20% of your gross, before-tax income. Ideally, you should work towards maxing out your 401(k) each year.

Don’t have this type of plan? If you work a public service job, you may have access to a 403(b) plan instead. If you’re at a small company, your option may be a Simple IRA (which functions in a similar way to a 401(k)). Ask the individual in charge of human resources about your options for employer-sponsored retirement plans, and then get signed up.

Self-employed? While you may not have access to an employer-sponsored plan, you can still take care of your own retirement with a variety of accounts for people who work for themselves. You can choose from a Solo 401(k), SEP IRA, or Simple IRA. Speak with a financial professional to determine which account makes the most sense for your situation.

Balance Your Invested Accounts

Why all the focus on 401(k) plans (and similar retirement accounts for those who don’t have access to 401(k)s)? These accounts are advantageous and should be the centerpiece of your retirement planning because they’re tax-deferred.

This means that you don’t pay taxes on your contibutions in the year you contributed – you will owe when you withdraw your funds, but you get a tax break today. This is huge, because if you owe less in taxes today you can save more today, too.

And financial independence is all about what you can save today. The sooner the start, the more time you’ll provide your investments to compound. The magic of compound interest is why someone who’s saving 50% of their income will reach financial independence in just 17 years – rather than working for 40 years or more.

So tax-deferred retirement accounts offer a big benefit: they give you the opportunity to reduce your tax burden in the present in order to contribute more money to your nest egg. But there are other tax-advantaged accounts you should utitilze, too.

While 401(k)s are tax-deferred, a Roth IRA is funded with after tax dollars but the earnings in the account grow tax-free. The second step to financial independence is to balance your tax-advantaged retirement accounts and utilize both types.

Roth IRAs are extremely beneficial in saving for retirement because all of the earnings in your account accumulate completely tax free. And what that means is that when you retire, you can pull money out of the account and thumb your nose at the IRS because you owe them nothing.

Take that money you didn’t have to pay in taxes thanks to the deductions your 401(k) allowed you for this year, and fund your Roth IRA with your savings! For 2014, those under 50 can contribute $5,500 for the year. Those over 50 can contribute $6,500.

Aim to max out your Roth. That means contributing about $450 per month to this account.

Save, Save, Save

The final step toward financial independence? Save as much as possible.  In fact, aim to be a “hyper saver,” or someone who saves at least 20% of their gross income.

Embrace your inner tightwad and make sure you’re not spending money on frivolous things that don’t get you any closer to your goals — or aren’t really in line with your values. Value experiences and people over things (and then stop spending so much money on things just to impress other people).

Oh, and remember: invest wisely!

4 Steps to Coming Out Ahead When Buying a Car

Buying a Car

Unless you live in a city with great public transportation, a vehicle is necessary in order to get around. However, that doesn’t mean you have to buy a brand new car – or pay top dollar for one. Cars don’t make the best investments because they start to lose value the moment you drive it off the lot.

Be smart about this purchase, and be ready to negotiate to get the best price.

Negotiating with dealerships isn’t what most people would call fun, but it’s a necessary part to coming out ahead. If you do your research beforehand, you’ll come in prepared and more likely to pay less than the advertised cost. By collecting data on prices in your area, you’ll be able to set yourself up for a great round of negotiating.

How do you go about collecting that data, though? Start with the tools and advice shared via the Money Guy, of course! Use these 4 steps to become more knowledgeable and increase your chances of a successful negotiation at the car dealership:

Step One: Decide On a Car

This is arguably the most difficult step in the process. There are a lot of options (and a lot of temptation to buy something you don’t really need).

First, make a list of what you need in your car. These are your priorities. You can make a list of wants, too — but think of these as bonuses, not must-haves.

If you’re at a loss as to what makes and models are the best choices, do some research by using Consumer Reports and Edmunds. Both of these sites are great resources and will give you unbiased reviews.

Once you’ve narrowed the list down to 2 to 3 cars, visit a local dealership and take those cars on a test drive. Settle on the one that impresses you the most, but leave after that. It’s important not to fall in love and want to drive the car off the lot right then and there.

You still have research to do.

Step Two: Shop Around

Now that you know what car you want, take a look at your chosen manufacturer’s website to find out what kind of inventory the dealerships around you have. This is usually found under the heading “shopping tools” on the website.

You’ll be required to enter your zipcode to view the inventory. While you can enter your zipcode in at first, you should expand your search to dealerships within a 30 to 60 mile radius — they might have better prices.

Hopefully, a few of these dealerships will have the exact car you want. It’s okay if their prices aren’t listed; you’re just trying to find out who to contact when you know the price you want to pay.

Step Three: Determine the Price

Now that you have a good idea of what’s out there locally, it’s time to do the heavy lifting regarding pricing. To find out what the going price is on the car you’ve selected, go to CarsDirect.

This website is basically a one-stop-shop for cars. They offer “insider tips” that will help you with your research. Look at the “Prices & Deals” tab on the make and model of your choice, as well as the “Reviews.” They also have a “Compare” option that might be useful if you’re still back and forth with which model to choose.

After this, go to the forums on Edmunds. Why? It’s a great place to stop and listen in on what other people are saying about the car you’re interested in. (A little market research never hurts.) Choose the make and model of the car you have in mind, and browse the forums.

You should see topics like, “[Make and model] Prices Paid and Buying Experience.” This is great information that you can use when it comes time to buy.

The goal here is to become more knowledgeable on the car you’re looking to buy than the salesman. You want to have the upper hand so that negotiating is a breeze.

Step Four: Contact the Dealership

If you don’t like negotiating, this may be a tough step. But if you’ve done your research (and you have, if you’ve followed this guide), then you’re prepared and capable of working out a deal.

Use the fact that you’re ready to buy to your advantage. When you call, let the person on the other line know that:

  1.  They have the car you want on their lot.
  2. Two to three other dealerships in the area also have the same car…
  3. …so you’re showing up to the dealership that can offer you the best, rock bottom price, with a check in hand.

You want to communicate your expectations and let them know you’re serious.

Why call over visiting in person? You have more leverage over the phone than you do face-to-face, and there’s less temptation to “give in” to the salesman over the phone. It’s harder to physically walk away than it is to end a phone conversation.

Stick to your guns. If the price quoted is too high, let the sales manager know what you’ve found in the course of your research. If all goes well, you’ll soon head down to the dealership to pick up your new car for the price you wanted to pay.

Tools for Buying Used

Edmunds is a great place to look as far as research and reviews go. You can check out Autotrader for listings in your area, and Kelley Blue Book (KBB) for information on pricing. (KBB is especially great if you’re also looking to sell your car.)

There’s nothing to buying a new (to you) car so long as you do the research ahead of time and know what you want. Don’t be enticed by any of the offers that come your way before you are ready. Remember that cars depreciate in value, and there’s no reason to pay more than necessary for one.