2020 taught us to expect the unexpected. Millions of people are adjusting to a new financial reality after pandemic-related shutdowns and economic devastation.
“If 2020 was a year of reacting to negative circumstances, then we can make the theme of 2021 to proactively strengthen and protect our financial lives for when the next negative circumstance comes along. Because there will be something else that comes along,” said Drew Feutz, certified financial planner at Market Street Wealth Management Advisors.
There are some ways you can prepare your money for the next challenge in the new year. Here are three financial goals to set for 2021.
1. Establish a solid financial foundation
If 2020 knocked your finances for a loop, now is the time to rebuild and get back on solid footing. This may require a financial tune-up, a major overhaul or completely starting from scratch. Feutz recommends making sure you’re on top of the basics, including:
- Organizing your financial accounts, knowing how to access them and using secure passwords.
- Knowing your net worth, including the value of all assets and liabilities, and tracking it as it changes.
- Creating or updating a household budget.
- Making sure you have every type of insurance you need.
- Establishing alternative income streams, like a side hustle or passive income.
- Paying off debt.
- Saving for retirement.
Handling the basics will help create a solid financial foundation and allow you to build wealth in the future. “Work through the steps to make sure that you have this financial foundation in place before worrying about the ‘hot’ investments that you see on TV or that your friends are telling you that you need to buy,” said Feutz. “Once you have the foundation in place, then you’ve given yourself permission to play. Unfortunately, too many people get this backwards.”
If you don’t know where to start, consider hiring a professional for advice. Here’s how to tell which type of financial adviser is right for you.
2. Adjust your emergency savings plan
Even if you saved the commonly recommended three to six months’ worth of expenses, that might not have been enough to get you through 2020. While it’s possible that you don’t need to save as much as you thought, it’s more likely that you need to save more.
Rebuilding a depleted emergency fund should be a high priority. Getting a good handle on "pandemic spending" may have taught you that you need more or less than you thought, said Daniel Kenny, certified financial planner at FI-nancial Planner. If that’s the case, you could potentially reduce your emergency savings goal a bit, he said.
The minimal growth provided by a traditional savings account won’t come close to keeping up with inflation, and even high-yield savings accounts aren’t as strong as they used to be. Some experts suggest investing your emergency fund, but remember you’ll want easy access to cash in case of emergency.
3. Open an FSA or HSA
The United States health care system was already expensive and confusing to navigate, and that was before a global pandemic. Even people with decent health insurance may be spending a lot out-of-pocket for medical expenses.
If you want to be better prepared for routine checkups and medical emergencies alike, consider signing up for (or increasing your annual contribution to) a flexible spending account or health savings account.
Flexible spending accounts
FSAs are tax-advantaged savings accounts offered by employers. Contributions made to the account are tax-free and can only used for eligible medical expenses. You will need to determine how much to contribute at the beginning of the plan year. The annual contribution limit for 2021 is $2,750.
“Typically any funds you don’t use by the end of the year will be lost unless your employer allows a carryover,” said Ryan Firth, certified public accountant and president at Mercer Street. That's why it’s a good idea to predict the right amount to contributuded. Used funds typically go back to the employer, who can use it for administrative expenses, reduce employee contribution amounts for the following year or awarded as a cash refund to all employees. He noted that if your plan does allow a carryover, the limit to carryo ver has increased to $550 for 2021 and 2022.
Health savings accounts
Health savings accounts also let you use tax-free funds for eligible medical expenses and is an investment product that earns interest. They are only available to people with a high deductible health plan. Here’s how to open a HSA. Unlike FSAs, funds in HSAs can be carried over year to year. The annual contribution limit for HSAs in 2021 is $3,600 for an individual.
HSAs are “perhaps the most tax-advantaged savings vehicle available because contributions are tax deductible for federal income tax purposes [and] earnings grow tax-free for federal tax purposes,” said Firth.
The best way to use an HSA is to pay for medical expenses out of your pocket, then request reimbursement from the HSA later, said Firth. That way, the money stays in your HSA plan longer and has a greater growth potential.
If you were financially blindsided in 2020, this year is an opportunity to right the ship using the lessons you learned. Revisiting your overall financial plan, prioritizing emergency savings and working to reduce future medical costs will leave you better prepared when the unexpected occurs.
Image: Getty, Dougal Waters