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All that happened in 2020 caused many people to reassess every part of their lives, especially how they preserve their own financial health.
Family budgets shifted last year, with fewer trips to restaurants and movie theaters and fewer vacations. Because of these lifestyle changes, your family may be fortunate enough to now have more savings on hand than usual.
If that's the case, here are eight considerations to help you understand how to create a budget plan for 2021, how to cut expenses on the family budget and how to put those unexpected savings to good use.
1. Build Your Emergency Fund
The rule of thumb for an emergency fund is to save a minimum of three months' worth of expenses. However, if 2020 taught us anything, it's that the unexpected can happen, so there's no harm in being over prepared.
If you can, try to build your emergency fund to at least six months' worth of expenses. For example, if your household expenses total $3,000 a month, aim to have $18,000 in your emergency fund to give your family a greater financial cushion.
2. Pay Down High-Interest Debt or Student Loan Debt
Paying down debt is an important part of understanding both how to create a budget and how to cut expenses on the family budget.
If you have a high-interest credit card or personal loan debt, it's wise to set aside room in your budget to pay it off every month. Look at your additional savings and figure out how much you can allocate toward this debt each month.
Also, consider paying down student loans. While there is a moratorium in effect until Sept. 30, 2021 on student loan payments and the interest the loans accrue because of the pandemic, you shouldn't feel deterred from paying down the debt if you have extra money to do so. Since these federal student loans aren't accruing interest at the moment, it can be a good time to pay down a larger share of the principal balance you owe and help accelerate your timeline for paying off student loan debt entirely.
3. Max Out Your Self-Employed Retirement Plan or 401(k)
For 2021, the IRS stipulates that you can contribute up to $19,500 to an employer-based retirement plan or 401(k). If you have a self-employed retirement plan, such as a 401(k) or SEP IRA, you can contribute up to $58,000, depending on your compensation or earned income. If you have additional savings, consider contributing extra to retirement, especially up to what your employer matches if you have a 401(k).
4. Invest in a 529 College Savings Plan
The average cost of college now ranges from about $10,000 to $35,000 a year for public and private institutions.
That is a huge sum for most families — but luckily, you can start saving now by investing in a 529 college savings plan. You can choose to invest in the options offered by the plan. The investments will hopefully grow over time — giving your family access to more money to pay for college than you'd have by just putting money into a savings account or CD — but may also lose value.
Depending on your state, you also could get a state tax deduction, up to a certain limit, for your contributions. Just keep in mind that you can only withdraw money for a 529 to pay for qualified education expenses. Otherwise, you'll face a 10% penalty on the earnings you've withdrawn. Additionally, it's important to note that investments do not guarantee growth and have the potential for both gains and losses.
5. Open a Traditional or Roth IRA
You also could invest in a traditional or Roth IRA, even if you have a 401(k) plan through your employer. For 2021, the annual contribution limit for IRAs is $6,000. If you open a traditional IRA, you could qualify for federal tax deduction depending on your income, since you'll contribute to this account with pre-tax dollars that will be taxed once you begin to make qualified withdrawals at age 59½.
With a Roth IRA, you invest after-tax dollars, so there are no tax deductions. Some find it worthwhile to invest in a Roth account because you'll have access to tax-free dollars in retirement once you turn 59½, as long as you have held the account for five years. Withdrawals are tax-free before this time as long as your circumstances qualify.
If you're under age 59½, you can have the flexibility to withdraw up to $10,000 of what you've contributed penalty-free if you're disabled, if you've inherited this account or if you plan to use the money for a down payment on your first home or to cover college or adoption costs.
6. Get Life Insurance
If you don't already have life insurance, it's certainly something to consider. This can be a complimentary part of your budgeting and long-term financial planning, just like investing in retirement or debt repayment.
Term and whole life insurance are the two main types of life insurance. With term life insurance, you pay a monthly premium, but benefits expire after a set period, such as a 20- or 30-year term. With whole life insurance, benefits never expire as long as you continue to pay your premiums as scheduled, and there's a cash value component that you can withdraw from while you're still alive. However, a withdrawal may generate income tax liability, reduce the account value and death benefit and may cause the policy to lapse.
Whole life insurance typically comes with higher monthly premiums than term life, so consider talking to a financial representative or professional to determine which policy will best meet your family's needs.
7. Increase Your Charitable Contributions
While you can leverage your savings to increase your retirement contributions or to pay for future education expenses, you also can use it to give back to your community and causes that matter to you.
Many nonprofit organizations and food banks are struggling right now as many of their donors face economic hardship and uncertainty. If you have any extra to give, consider contributing to a local or national organization that means something to your family — or even to someone you know locally who is in need. You could even have your kids identify a group or organization that should receive the donation, giving you the opportunity to teach them a valuable lesson about the importance of giving back.
8. Set Aside "Fun" Money
It's been a difficult time for many people, so if you have additional savings, set some aside for activities your family can enjoy together.
While it may be hard to go on vacation now, we may return to some sense of normalcy in the near future. So, save some of this "unused" money for a meaningful or enjoyable short-term goal, such as a future family vacation, a dream kitchen remodel or buying a bigger family car.
If you're blessed to have extra savings, take advantage of it to bring a little more joy to your own family, to give back or to improve your long-term financial health.
