The New Year Is a Good Time to Crunch Numbers

Resolve to fix your finances this year? It’s a common goal.

“There are two things that everybody wants to do at this time of year -- lose weight and get their finances in order,” said Nick Childers, senior financial consultant with Merrill Lynch & Co. in Beverly Hills.

The beginning of the year is a great time to deal with financial goals for two reasons: Annual investment, earnings and tax statements are arriving, giving consumers a good gauge of where their finances stand. The start of the year also is traditionally the time when individuals assess where they’re headed in life.

Financial planning can be intimidating, requiring knowledge of everything from arcane tax rules to complex calculations for retirement saving. But there are shortcuts and general rules that consumers can use to get close.

Want to plan the easy way? Here’s a guide:

Construct a rough budget: Most people know roughly what they spend each month. It is infrequent costs such as insurance premiums, property taxes and vacations that can throw their budgets off, Childers said.

To do a quick and realistic budget, add the cost of these and any other one-time or infrequent bills -- such as an estimated amount for car repairs and medical costs not covered by insurance -- and divide by 12. Set aside enough money so these expenses won’t derail your budget.

Review life insurance needs: If anyone relies on you for financial support, you probably need life insurance. But figuring the right amount is tricky -- experts recommend everything from five times to 25 times earnings or annual expenses.

Here’s a simple rule of thumb: Determine how many years your survivors would need your income after your death and then multiply your after-tax income by that number. (Life insurance proceeds are not taxable.)

Using this formula, a person earning $60,000 after taxes, who estimates his family would need 10 years of support, would buy $600,000 in coverage. If the survivors would need coverage for a very long period -- say, 20 years or more -- the multiplier can be reduced slightly to reflect the time value of money, said Eric Tyson, author of “Personal Finance for Dummies.”

Pay off consumer debt: Banks will let their customers build up debt on credit cards and consumer loans until the payments exceed 20% of their income. But the right amount of consumer debt is zero, Tyson said. Why? This debt is not tax deductible and usually doesn’t reflect an investment in something that’s likely to appreciate in value.

Don’t fret over “investment” debt: Student loan and mortgage debt, on the other hand, are tax-deductible and good long-term investments. Your home is likely to appreciate. And a bachelor’s degree can mean $1 million in additional earnings over the course of a career, according to Labor Department statistics.

What about margin debt -- loans secured by your investments? Generally, this would go in the “bad” debt category. Although the cost of margin loans is deductible against investment income, it puts your assets in jeopardy because your broker can sell your stocks if the balance of your loan exceeds a set percentage of your portfolio value.

Figure savings goals: Most people need three kinds of savings -- for emergencies, for near- and mid-term goals and for retirement.

The right amount of emergency savings will depend on a variety of factors, but planners usually recommend having easily accessible savings of three to six months worth of living expenses. Someone with a working spouse, adequate health insurance and a reliable car can save less, while someone in a riskier situation should save more.

To figure how much to save for near- and mid-term goals, first identify the goal, such as banking $10,000 for your 12- year-old’s college bills. Divide the savings goal by the number of months available to reach it. The college-saver, for example, has roughly five years, or 60 months, which works out to about $167 a month.

Because even short-term savings earn something, the figure can be rounded down a bit. If this individual were able to earn 5% on his money, for example, saving just $150 a month would be enough.

Figuring the right amount to save for retirement -- even with the simplest formulas -- is a bit more complicated. It first requires a guesstimate of how much you’ll spend a month after you retire. Most advisors suggest that’s probably 60% to 100% of your current monthly budget. (Retirees whose homes are paid for can figure 60% to 70%; renters and those with long-term mortgages probably will need more.)

For instance, if your monthly after-tax income is $5,000, you’ll probably need $3,000 to $5,000 at retirement. Subtract the amount you’ll receive from Social Security and a corporate pension, if you’ll receive one. The result is the monthly amount you’ll have to pay out of your own savings.

But how much do you need to have saved by retirement to receive that much monthly income during retirement? If you expect to live 30 years after you retire, multiply the monthly amount by 210. If you think you’ll retire early -- or live a long time -- multiply by 240. The result is the amount you would need to have invested at a 4% return to guarantee the required monthly payments for 360 months or 480 months, depending which multiplier you chose.

To figure how much to save to reach that goal, subtract what you’ve already saved from what you need. Multiply the result by the figure in the accompanying chart that most closely corresponds with the amount of time you have left before retirement and the rate of return you expect to earn on your money between now and then. Use conservative estimates -- it never hurts to have too much money saved for retirement.

The result is the amount you must save each month to get what you think you’ll need in the future. If you’re not saving enough -- and can’t make up the difference on your current income and spending -- figure you’ll need to live more frugally now or learn to live on less later.

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Figuring retirement savings

To figure monthly retirement savings needs, subtract current savings from the amount needed at retirement. Multiply the result by the figure in the chart below that most closely corresponds with the amount of time left until retirement and the expected rate of return. (Details are provided in the accompanying story.)

Years until retirement:

5 years

5%: 0.0147

7%: 0.0140

9%: 0.0133

10 years

5%: 0.0064

7%: 0.0058

9%: 0.0052

15 years

5%: 0.0037

7%: 0.0031

9%: 0.0026

20 years

5%: 0.0024

7%: 0.0019

9%: 0.0015

Source: Times research

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Times staff writer Kathy M. Kristof, author of “Investing 101” (Bloomberg Press, 2000), welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes .com. For past Personal Finance columns visit The Times’ Web site at www.latimes.com.