By Michael Dinich
If you read a lot about how to save money, you may believe that the biggest scourge threatening your financial goals are subscription boxes, latte consumption and envy of the Joneses. Having worked within personal finance with people with modest incomes for nearly 20 years, I have learned that there are even bigger threats looking to sabotage your goals.
It is possible to build wealth with a modest income but it takes a bit more planning and time than a high-income earner. Lower earners need to be as efficient as possible, use a bit of creativity, and avoid these 10 common mistakes to become wealthy.
High-income earners make these mistakes also — and they should be avoided by all.
1. Not optimizing your tax return
One of the biggest mistakes people with modest incomes make is not creating an income tax plan and tax budget.
The common misconception is that tax planning is only for the “wealthy”. However tax planning when you have a modest income is critical. Even if you are in one of the lowest income tax brackets, income taxes can consume 10%, 15% or even more of your income.
For many families, income taxes are their third or fourth largest household expenses. One of easiest ways to free up money is to create a tax plan.
The IRS offers several tax incentives for individuals and families with modest income, such as the retirement savers credit, the premium tax credit, the child tax credit and the earned-income tax credit. Several of these tax credits are refundable. A refundable tax credit can represent free money from the government.
Note: When you qualify for a refundable tax credit, should you manage to reduce your tax bill to zero through other means, then the government could potentially pay you extra money.
Additionally, lowering your taxable income may also help with reducing the amount of income-sensitive student loan repayments, potentially help with college financial aid for you and your dependents and may reduce the amount of self-employment taxes you may pay.
Should you qualify for several income-sensitive programs, the cumulative effect could be much larger than you may think. The problem is too many people with modest incomes either put off doing tax planning or wait until tax season (mid-January to April 15) to review their taxes.
Unfortunately, very little can be done after Dec. 31 to reduce taxable income. Engaging in tax planning throughout the year will help you budget for any tax planning measures that are necessary, and strategically time purchases and deductions.
Tax planning does not need to be overly complicated. You can create a tax plan using free online tools. Simply print out a list of any income sensitive tax incentives you hope to use and compare your anticipated income for the year with the requirements for the program.
2. Paying down debt too aggressively
We have all seen the articles online: debt is bad and loan interest destroys your financial dreams .
Paying off debt is an important goal. However individuals and families with modest incomes need to be careful not to pay off debt too aggressively. Many financial gurus such as Dave Ramsey or Suze Orman would encourage you to prioritize paying down debt before saving for retirement.
While their hearts are in the right place (they don’t want their audience to become slaves to debt), the math does not always favor aggressive debt pay down. Contributions to retirement accounts could be eligible for employer matching, retirement savers credits, and lower out-of-pocket health insurance costs.
Recently, I worked with a family who was paying an extra $10,000 a year on their mortgage and neglecting their 401(k). Creating a tax plan revealed that contributing $10,000 to their 401(k) would save them over $7,500 in income taxes and health insurance costs. Now they are funding the 401(k) and using the $7,500 to pay down the mortgage and will be able to retire much sooner.
Paying down debt too aggressively may lead to more debt. Many savers with modest incomes get trapped into the yo-yo diet version of debt pay down. They pay debt too aggressively, saving too little to for emergencies and they are ultimately forced back into debt at the first hiccup.
Many individuals and families would be better served by paying off debt a bit slower. Try to get the lowest payments and interest rate possible. Each month allocate some money to paying down debt and some money toward building emergency funds. As the debt balance declines and your cash reserves grow, then increase the amount you pay on the debt.
3. Ignoring estate planning
It seems like we are constantly seeing some celebrity in the news who passed away and didn’t have proper estate planning documents. When you see a celebrity estate such as Prince or Stan Lee in the news it’s easy to question why they didn’t have proper documents.
However, everyday people with modest means have similar experiences, it’s just not deemed newsworthy. The reality is death, disability, and dementia complicate not only finances but the family dynamic.
For 20 years I have seen clients parade their adult children through the office, all of whom insist they have no interest in their parents’ finances. The overwhelming majority of people insist their estates will be handled without issues because everyone is in consensus and nothing will go wrong.
Without fail, these families end up having the biggest disasters because the combination of confidence and complacency lead to a failure to plan. Even well-intended families can be ripped apart when forced to interpret vague or nonexistent instructions about how to care for a disabled loved one or distribute an estate.
Do yourself and your family a favor and reach out to a competent estate planning attorney and discuss a living trust and any ancillary documents. Trusts are typically more money than a will, however, even if you don’t anticipate probate being costly, they are often worth every penny.
Not engaging in asset protection
When you visit the estate planning lawyer, you should talk with them about asset protection.
If you have a side hustle, small business, or own rentals, you should talk to a competent professional about asset protection and business structure.
Having the right business structure could protect your personal life savings from lawsuits and potential creditors of the business.
Over and above potentially shielding your personal assets, setting up proper business documents for your could have substantial financial benefits. Setting up a suitable business entity for your ventures can assist with building business credit and may even help with tax planning.
Building corporate credit may help remove business loans from your personal credit, improving your own credit score. Additionally, if your business relies heavily on credit, having established corporate credit helps ensure the company does not get shut down if key founder dies.
5. Buying too little or too much insurance
Often people have either too much insurance or too little.
Any type of insurance, such as life insurance, disability insurance, property and casually, liability insurance is a rainy-day precaution. Effectively, it’s a waste of money until it’s needed. Yet everyone wants to view it through economic lenses.
Higher-income earners and those with more modest incomes often have many different risks, and various capacities for dealing with those risks. As such, they will need to think about insurances differently.
An event that would cause a financial inconvenience for one type of professional may be economically devastating for another. Recently, a colleague of one of my clients was vacationing with his family. He tripped and broke his leg. He is a truck driver and has been out of work for over four weeks. Since the injury wasn’t work related, he was not covered by employer-sponsored disability.
The same injury that puts a truck driver out of work and exhausts his emergency savings would have minimal impact on an IT professional, programmer, or someone who works at a desk.
It is imperative that individuals with modest incomes review what risks they may face and ensure they maintain adequate insurance.
Each year you should consider all your insurance policies, check the limits and deductibles and ensure they are within what you can handle financially. Be sure to cross-shop your insurance with various insurers to make sure you are not overpaying for coverage.
Having more insurance than you need can be costly. With that said, not having insurance when you need it can be even more devastating.
6. Taking advice from the wrong people
Everyone has their own way of managing finances and will have an opinion on how you should manage yours. Usually the advice is to do it just like them. Social media and the internet have afforded these opinionated people not only the ability to share these opinions with the world but also get paid to do so.
The upside is people now have access to all kinds of financial information; however, it also leads to a lot of noise. The noise makes it difficult to ascertain ulterior motives, as well as the accuracy and relevance of the opinions.
We are now living in the era of fake news, fake followings and fake experts. Recently, Drew Cloud, the media’s darling student loan expert, turned out to be a concoction of a student loan servicing company. Corporations pay “influencers” to promote their products, and there is a whole cottage industry of people who sell fake reviews and social media followings.
Consumers of financial advice need to be hypervigilant about who they turn to for information. Make sure anyone you are considering listening to is who they claim to be.
7. Making decisions based on other people’s goals
Everyone wants to know they’re making the right decisions with their finances. They often turn to friends, family, co-workers, or neighbors for advice. However, there is no one size fits all silver bullet financial plan.
Everyone has different financial goals and resources. Using someone else’s financial plan could be the lead to ruin. A plan needs to be customized to consider your health, your goals, and any risks that you face.
Your neighbor with no kids and a sizable pension may be able to be much more nonchalant about market risks than someone who has a family to support and is responsible for producing their own retirement income.
8. Failure to develop a backup plan
No matter how well you plan, life has a way of tossing us curveballs.
A high-income earner with a high savings rate who has been saving for a few years likely has the safety net of being able to take a lower paying job if the economy cools. Modest income workers tend to be more at risk when it comes to changes in the labor market.
Business may cut back on hours or overtime, or even lay off people in response to a recession. Those with more modest incomes may not have the same ability to discount labor to remain in the workforce and be successful.
The best course of action is to develop a backup plan. Keep your resume updated and work on professional development. Investing in yourself is one of the best investments you can make. It increases your income in good times and helps provide security in bad times.
The best time to pursue any certifications or additional training you may need to re-enter the labor market is before you are forced to.
9. Allowing family to derail your plans
It is possible to save for retirement on modest incomes and even retire young enough to enjoy retirement. However, the family can be an impediment to reaching your financial goals.
The best financial help you can provide your loved ones is to encourage them to have a healthy relationship with money and develop a financial disaster preparedness plan.
During the financial crisis we learned it wasn’t the market downturn that caused so much devastation. Instead, it was the collateral damage.
The stock market was in free fall, banks were cutting lines of credit or refusing to lend, and businesses were cutting back on spending. The labor market was poor, and many adult children or grandchildren were turning to their parents and grandparents for financial support.
Encouraging your family to develop a financial disaster preparedness plan can help eliminate the need to liquidate your investment at an inopportune time.
Teach your children about money and saving, encourage adult children to maintain an emergency fund, save, and to get proper legal documents including prenuptial or postnuptial documents.
10. Being overconfident
A little bit of worrying is actually good for your finances. When you are overconfident, you often ignore precautions.
Preparing for every situation is impossible. However, you can and should make the most of what could go wrong. The best planning starts with asking what could go wrong with the plan and developing safety nets to ensure you are protected.
Ask yourself, what would happen if you were injured and couldn’t work? How would death or disability impact the household income? What would happen if your hours were cut or you were laid off? If you had to enter the labor market, what would you need? Are your certifications current, and reflect what employers today would be looking for?
Should the market decline, how it would affect your short-term goals? How would it change your long-term goals?
Having answers to what could go wrong is not about working until age 70, as Suze Orman may suggest. Instead, being prepared allows you to retire sooner and provides you with sleep insurance that you know if something goes wrong you will have a plan to deal with it.
Making modest money work for you
It is possible to pursue your financial goals on modest income. However, there is less margin for error.
Making modest money work requires planning ahead for contingencies, focusing on opportunities to free up extra money, and making sure you’re not led astray by the new hottest financial Pied Piper.
Focus on your goals and what you need to do to achieve them, and don’t worry if the path to your financial goals is different than others.
Michael Dinich is the founder of the Your Money Geek blog and writes about personal finance, taxes and geek culture .