Budgeting Q & A. Table of Contents. Emergency Funds 2. Variable Income 2. Saving for Retirement 3. Paying Down Debt 3.

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1 Budgeting Q & A Getting Started We ve selected some commonly asked questions from over 200 submitted during September s Budgeting webinar. Although this information can help you better understand general budgeting principals, you should consult your own financial advisor for information about your specific situation. Table of Contents Click on the heading below to go that particular topic of interest. Page Emergency Funds 2 Variable Income 2 Saving for Retirement 3 Paying Down Debt 3 Basic Budgeting 4 Saving for College 6 Workplace Retirement Plan 7 IRAs 7 Mortgages 8

2 Question Emergency Funds Where is the best place to invest money for an emergency fund? As I get older, should I increase my emergency fund? Should retirement or an emergency fund be my highest priority? How long, on average, should it take to build up an emergency fund? My wife and I are planning to remodel our new house. However, that s going to blow our entire emergency fund. Is that a prudent thing to do? Can I count my retirement plan as my extreme emergency fund? I already save as much as I can each payday to put in my retirement plan. Variable Income I m in sales and get paid by commission. How do I budget when my income varies so much month-to-month? What do you do with occasional income from a seasonal part-time job? We can t tell you where to invest your money, but we can tell you that an emergency fund is not intended to be an investment. The emergency fund is intended to be money that s easily accessible for emergencies. Some place where the money will be accessible. Some considerations include a savings account or money market account. Not necessarily. An emergency is for, not surprisingly, emergencies, which don t get more expensive as we age. Rather, determine a figure that you feel comfortable having as ready cash, and aim for that in your emergency fund, regardless of your age. That said, if your income or expenses increase over time you may want to have more saved in your emergency fund. Many financial advisors suggest 4-8 months of income should be saved in an emergency fund. Both are important. But in terms of which comes first, build an emergency fund first. Then be diligent about saving for retirement. There really isn t a set time. It can depend, of course, on how large you think it should be, and how much you can regularly contribute to it. It s not unusual, however, for emergency funds to equal between four and eight month s annual income, which may help you determine how long it may take you to realize your particular fund. An emergency fund shouldn t be used for anything other than an emergency. If you feel you must use emergency money, withdraw a portion, and promise to replenish this account as soon as possible. If you blow the entire emergency fund on remodeling, you leave yourself exposed should a true emergency arise. Saving as much as you can for retirement may be a smart move for your future. But remember, your retirement plan is just that...for retirement. If, by extreme emergency fund, you mean economic hardship, then yes, consider taking out a loan from your own retirement plan. But be careful. Money you withdraw now won t be there for you when you retire. Variable income can pose special challenges. If your pay is based on a base salary plus commission, try to sync up your base pay with essential expenses, and consider your commission income for extras. Otherwise, you might bank some commission during strong months to cover shortfalls during lean ones. Variable income from, for example, seasonal work or sales commissions, can pose additional budgeting challenges. One approached is to sync up your essential expenses (food, rent/mortgage, utilities, gas, etc.) with income you can count on. Then apply variable income against nice to have expenses (vacations, dinging out, etc.). If the variable income is too large to do that, consider banking extra income during good months, and taping into it during lean months. 2

3 3 Question Saving for Retirement When you are retired, at what point do you stop saving for retirement and start spending? Two years ago, I had to use my entire retirement plan to get by. How do I know how much I need to get back up to speed, and what percentage of my check I should be contributing (on average) each month to get there? How much money should I start saving at the age of 41, even if I m putting into my company profit sharing? I m going back to school, which won t be cheap, and I haven t even started saving for retirement yet. Should I start saving anyway and budget for that, even if my contributions are small? Paying Down Debt Should I hold onto U.S. Savings Bonds until maturity or use them towards debts (i.e. credit cards)? I have $58,000 in federal student loans, $17,000 in private student loans, and I estimate I ll have to take out another $30,000 more. How urgent is it for me to pay these off? (The interest rate on my federal loans is 4%.) These days, retired is taking on new meaning. For some, being retired means going back to school, or starting a new career, or, to your question, consulting or some other incomegenerating endeavor. So, if you don t need to withdraw money, and indeed can continue to add to your account, by all means. As for how much is enough, Prudential s Retirement Income Calculator ( can customize an answer to your specific needs. You might also consider consulting a professional financial advisor to help you create a financial plan that is customized to your specific situation. Start by checking out our Retirement Income Calculator at retirement. This interactive tool can quickly help you determine how much you should save for your specific retirement goal. You ll also find a wealth of useful retirement planning information and tools on our website at Finally, considering you ve had to start over again saving for retirement, you might also consider consulting with a professional advisor to help create a new financial plan. You re right to consider more than just your company profit sharing plan as a source of retirement income. In fact, many people rely on what s often referred to as a three legged stool. That is, retirement accounts, Social Security and personal savings. How much personal savings? That, of course, depends on each individual situation. Prudential s Retirement Income Calculator can help you determine that ( This interactive tool can customize an answer to your specific needs and goals. If you can afford to save even a small amount regularly, that s a good thing to do. If not, however, investing in yourself (by going back to school) is smart. Once you land a good job, refocus on your retirement savings. With only a few exceptions (a mortgage might be one, or student loan), paying off debt is generally considered a good move. Cashing in U.S. Savings Bonds to do so depends on how these relatively conservative investments fit into your overall finances. Depending on the age of your bonds, it s possible they no longer generate any interest. To find out, and for more information about U.S. Savings Bonds, visit To be sure, it s important to pay off student loans. But you ll find that many institutions offer relatively lenient rules including low rates and long payment schedules for doing that.

4 4 Question Is it worth it to refinance a car loan? I am trying to clear up some credit card debt and thinking about using a debt consolidation program. Do these programs hurt your credit score at all? What is your opinion about transferring one credit card balance to another credit card account? Is it smart to take out a loan from my 401(k) to pay off high interest loans? How do you feel about taking out a home equity loan? Basic Budgeting You say it s never too late to start a budget. Even at almost 60? Should home improvements be included as a continuous budget category? How often should I review my budget? What percentage of my paycheck should I set aside for savings? Generally no. Car loans tend to be short (5 years or less), and it s unlikely you ll be able to recoup the costs of refinancing. That said, crunch the numbers. If the interest rate is such that you can recoup the refinance costs within the life of the loan, consider it. Applying for a debt consolidation loan to pay off other accounts shouldn t raise or lower your credit score significantly in the short term. While it does mean you ve taken on new debt, credit agencies look at your credit history as a whole and will note that your other accounts have been paid off. In the long term, if you make the payments on the new loan consistently for a year or two, it should ultimately improve your credit score. You can adversely affect your credit rating if you turn to a debt management agency to negotiate a settlement with your creditors for less than you owe. This appears on your record as a failure to repay what you ve promised. Some agencies may also allow your accounts to go unpaid for months before they settle, which also hurts your score. Depending on the particulars, a balance transfer from one high interest rate card to one that is considerably lower can be a smart move. Be sure to review the rules, however, including how long the low rate is in effect, and how high that rate can climb in the future. Smart as it is to want to pay off high interest loans, borrowing from your 401(k) may not be the best plan. To avoid penalties, you ll have to put the money back in your plan, of course. And all the time the money is out detracts from the potential tax-deferred compounding you could be realizing. Before you borrow from your retirement plan, first consider other ways to reduce high interest loans, including economizing or perhaps even taking on part-time work. Generally, a home equity loan or line of credit enables you to borrow up to 80% of the equity value of your house. But remember, you are putting up your home as collateral. Miss your payments and you could lose your home to foreclosure. Furthermore, if housing prices fall--as they have over the past few years--you could end up owing more on your home when you sell than it s worth. Home equity loans are best used for improvements that can be expected to increase your home s value. For more information, visit: mortgagesloans/a/homeequityloans.htm Absolutely. If you think of a budget and a spending plan, that is, a blueprint for living a comfortable lifestyle within your means, it s never too late for that. Although home improvements are the kind of expense that can be postponed when money is tight, budgeting for them can help insure you ll have the funds to make steady, continuous progress on your goal. When you set up your budget you will likely need a certain period of trial and error, trying to reconcile how much you are spending to how much you are making. Once you get to that point, however, re-visit your budget as often as you need to remain comfortable that it s working. For some, once a month, perhaps for others less often. One rule of thumb has been at least 10%. However, lengthening life spans have meant that retirement is getting longer. And, depending on your age and how much you have saved so far, stretching to 15% or even 20%, if possible, is a good goal.

5 5 Question Would you recommend using a certified financial planner? Can I view the course at home? Should I create separate accounts for each savings category? Do you suggest paying off high interest credit cards (i.e. 20% APR) before starting to save for retirement? Shouldn t your budget be based on NET pay instead of GROSS pay? I m having trouble estimating my monthly grocery, dining out, entertainment and shopping expenses. Any good idea how to estimate those? How can you possibly budget for medical expenses? I just had my first child. How should I change my budgeting? Because many people can benefit from professional advice, it s worth considering contacting someone trained in personal finance. Start by looking online or in your local Yellow Pages. Or ask friends and relatives for a reference. Be sure the one you select has the proper credentials, such as CFP (Certified Financial Planner), RFP (Registered Financial Planner), or ChFC (Chartered Financial Consultant). Also consider visiting the FINRA website ( to do a Broker Check on anyone you are considering. Absolutely. You ll find it on our education website at along with the attachments that support this presentation. You can also view past webinars from this site. To be sure, your emergency fund should be in a separate savings account that is devoted to true emergencies. And you likely will want to have, if you don t already, a checking or money market account for everyday bills. As for any other savings goals (vacations, car, new bike or computer, etc.), that s up to you. You may want to set up separate accounts just keep things straight. But if you do, be sure to check out first whether there are any minimum deposits and/or fees associated with the accounts. You may want to pay down high-interest rate debt (such as credit card debt) before you focus on saving. Aside from simply getting out of debt, paying them down will keep your credit score and debt-to-income factors healthy when applying for a loan. Our worksheet refers to gross income and not net income because your overall income is likely to be a combination of both. Your salary may or may not be gross (i.e., you may have taxes taken out already, or you may receive cash, such as with tips or gratuities) and your true net income isn t known until after you have paid income taxes for the year. In addition, rent, alimony and other income is generally received as gross and then claimed as taxable income on your federal income taxes. A good rule is to mark down the actual income you receive, for purposes of creating your budget, while remembering that you may have a tax impact in April. Don t include any income tax refund as reliable income for purposes of your budget. That money should be considered extra income. On the other hand, if you expect to owe taxes at the end of the year, consider including that obligation in your budget. First of all, these aren t all the same type of expense. Groceries are a necessity. But entertainment, dining out and shopping are the types of expenses that can be postponed during a pinch. So, for groceries, keep a journal for about a month of what you spend to get a good idea of your average weekly expense. Extra money you might have left over each month can be used for dining out, or other discretionary expenses. Because medical expenses can vary widely, and you don t know in advance if, or when, you may be sick, medical expenses can pose a budgeting challenge. One approach is to make sure your emergency fund is large enough to cover unexpected medical costs, and to be diligent in building your emergency fund back up. Another approach is to set up a savings account solely devoted to medical costs, should they arise. Well, for one thing you may want to start saving for college now. And of course, you may also want to adjust such budget expenses as groceries and clothing. Plus,you may need more life insurance, and don t forget toys!

6 Question Savings accounts no longer pay much. What s the best investment in such difficult economic times? Savings accounts are not intended to be a money-maker like an investment in stocks or bonds. Savings accounts are intended as a safe place to accumulate money (save) with low risk and high accessibility. If you are looking for a return on your savings, consider other alternatives, such as bonds, stocks, and mutual funds. Can you recommend some retirement or investment planning software? How do you factor for large purchases, such as a new bike or computer? Saving for College What s the benefit with saving for college through a 529 Plan as opposed to a regular savings account? Is it smarter to consolidate student loans or pay them off separately? What is a 529 plan, and how do I enroll? Do you recommend paying off a house with a 15-year mortgage over saving for my children s college education? One good place to start is Prudential s own website ( where you ll not only find retirement calculators, but life insurance and higher education calculators as well, along with FAQs, investment guides and a link to help you find a financial advisor, should you need one. You can set up a specific savings account for large purchases. For instance, there are vacation clubs where you can contribute each week towards a monetary goal. For something like a computer, consider your emergency fund. But be sure to replace those withdrawals as soon as possible. The biggest advantage is that 529 savings have the potential to grow tax-deferred, and when withdrawn, are tax-free if used for qualified education expenses. If the funds are not used for qualified education expenses, however, there is a tax penalty in addition to income tax on the earnings. Generally, student loans are low-interest debt with liberal payback rules. So it may be hard to consolidate them into a better arrangement. Then again, it depends on the loans, and the rates and conditions of the consolidation you re considering. Because the devil can be in the details, you may want to share your particulars with a trusted financial advisor. Named after section 529 of the Internal Revenue Service code, a 529 plan is an education savings plan (run by a state or educational institution) in which contributions have the potential to grow tax-deferred and, if used for certain qualified educational expenses (such as tuition, books and other supplies), money can be withdrawn tax-free. Every state now has at least one plan. And in most plans, your choice of school is not affected by the state your plan is from. For more information about college savings, take our online tutorial: You can learn more about 529 plans in particular at Not necessarily. If you can t afford to save for a child s education and pay off a 15-year mortgage at the same time, consider a 30-year mortgage that allows you to make extra payments against the principal whenever you have the wherewithal to do so. 6

7 Question Workplace Retirement Plans If we are enrolled in a retirement plan, do we include the contributions on the worksheet/budget? I have taken out a loan on my retirement plan. Can I still make monthly contributions while this loan is outstanding? When I retire, will I be taxed on retirement plan withdrawals? IRAs What is a Roth IRA, and what advantages does it have over a traditional IRA? From a tax perspective, what is your opinion about putting money in a 401(k)/403(b)/457 plan vs. a Roth IRA? Where can I go online to learn more about Roth IRAs? Yes. You should definitely include retirement savings as part of your overall budget. Your plan administrator is the best source for information about your specific plan. But you might just as likely ask yourself should you make contributions if you have an outstanding retirement plan loan. You usually have a maximum of five years to repay a retirement plan loan (unless you re borrowing for a first home, which allows a longer payback). If the loan is not repaid on time, it s considered a premature distribution, and could be subject to heavy taxes and penalties. Furthermore, the longer it takes to repay your loan, the longer that money isn t benefitting from tax-deferred growth potential. For more about the pros and cons of borrowing from your retirement account, visit: basics/4714.asp Generally, before-tax contributions and earnings are considered taxable income. In fact, if you withdraw prior to age 59 1 /2, you may be assessed an additional 10% early withdrawal penalty. If your plan offers a Roth contribution option, contributions are tax-free when withdrawn. Earnings are also tax free if certain conditions are met. The biggest difference (it may or may not be an advantage) between a Roth IRA and a traditional IRA is that, provided you follow the rules, withdrawals from a Roth IRA can be income tax-free. Another key difference is that generally traditional IRA contributions can be deducted from current income in the year you contribute (income limits apply), while Roth IRA contributions are made after-tax. Although it s important that you consult your own tax advisor for specific information, generally employer-sponsored retirement plans, such as a 401(k), provide an immediate tax incentive because contributions are generally subtracted from your taxable annual income. Roth contributions are not tax deductible, but earnings can be withdrawn tax free. (Some employers are beginning to offer Roth contributions within traditional retirement plans, by the way.) Which is better? That depends on a number of factors, including your investment time frame and whether your employer s plan provides for an employee match. For more help deciding, visit The Internet includes a wealth of information about Roth IRAs. And of course, your own personal finance advisor is a good resource for whether a Roth IRA makes sense for you. Prudential has information about Roth IRAs on its PREP website ( and be sure to check out our Roth tools and calculators at Another great place for general background information, is 7

8 Question Mortgages How do I figure if it s worth refinancing my mortgage? Do you pay the principal or the interest if you want to pay down your mortgage by making extra payments? As a percentage of my monthly income, how much should I be paying on my mortgage? Should I pay extra against my principle with only five years left on my mortgage? What is a reverse mortgage? My wife and I are planning to remodel our new house. However, that s going to blow our entire emergency fund. Is that a prudent thing to do? Great question! And experts differ in their answer. Generally, you want to remain in the house long enough to recoup refinancing costs, which of course will differ from situation to situation. Even then, however, you may not want to refinance if, for example, you can recoup the costs in three years, but you are sure to move in 3.5 years. That said, interest rates remain at historic lows, so this may be a good time to refinance. This link can take you to a site with more information, including a calculator to help you decide: should-i-refinance.html Additional payments to your mortgage should go against the principal. As the principal declines, so, too, will the amount of interest you owe on the remaining loan. It wasn t long ago when it seemed like home values could only go up. Not so today, of course. And many financial advisors warn against buying more house than you can afford. Moreover, how much you can afford is impacted by so many things, including your other financial obligations--current and future--and frankly your sleep at night instincts. Many lenders still estimate about 28% of gross monthly income. But for more information about this, see... Don tbiteofftoomuchhouse.aspx With only five years left on your mortgage, the majority of your payment already is likely being applied to principal. And that may mean the income tax benefits of mortgage interest may not be an issue. It may come down to whether you simply want to be free of your mortgage. That said, without knowing what other obligations you may have, it s difficult to say definitively. This is a good question for your financial or tax advisor, who should have a good idea of your overall financial situation. A reverse mortgage is a special type of loan that lets you convert a portion of the equity that built up over years of home mortgage payments into cash that can be paid to you. Unlike a traditional home equity loan or second mortgage, no repayment is required until the borrower(s) no longer use the home as their principal residence or fail to meet the obligations of the mortgage. For more information about these unique home loans, you can view our article on PREP at For more detailed information, visit: and An emergency fund shouldn t be used for anything other than an emergency. If you feel you must use emergency money, withdraw a portion, and promise to replenish this account as soon as possible. If you blow the entire emergency fund on remodeling, you leave yourself exposed should a true emergency arise. 8 Neither Prudential Financial nor any of its representatives are tax or legal advisors and encourage you to consult your individual legal or tax advisor with any specific questions. Securities products and services are offered through Prudential Investment Management Services LLC (PIMS), Three Gateway Center, 14th Floor, Newark, NJ PIMS is a Prudential Financial company. Prudential Retirement s group variable annuity contracts are issued by Prudential Retirement Insurance and Annuity Company (PRIAC), Hartford, CT, a Prudential Financial company. Prudential, the Prudential logo, and the Rock symbol are service marks of The Prudential Insurance Company of America, Newark, NJ, and its related entities, registered in many jurisdictions worldwide /2010 RSMP712