About half of Americans lived in middle-income households in 2014, according to Pew Research.
This demographic includes families with incomes two-thirds to double the U.S. median household income – or those earning between $42,000 and $125,000 (with cost-of-living adjustments for expensive metropolitan areas).
America’s middle class includes teachers, firefighters, and plumbers, but also engineers, construction managers, and chefs — workers from all over the economy. The middle class provides and consumes the bulk of services that keep society afloat, driving economic growth and investment with each purchase they make.
But when it comes to money, the American middle class faces a range of unique challenges. Wages have stagnated for nearly everyone but the highest earners since 1979, and rising inflation-adjusted costs of essentials like housing and healthcare have put a squeeze on the average budget. Most middle-class families don’t have nearly enough saved to pay for college or to retire at age 65.
But, are all of our money woes the result of economic issues? Not quite. Just like every other group of earners in America, we don’t always make the smartest decisions with our money. If middle-class Americans hope to build a financially viable future, it’s up to us to make the best decisions we can, no matter what’s happening with the economy at large. Here are eight money mistakes the middle class needs to stop making to turn things around:
1. Racking up too much debt
According to a recent study by the Federal Reserve Bank of Boston, 65% of credit card users carry a balance. In other words, most Americans are okay carrying credit card debt from month to month and paying interest on it – some out of sheer necessity, but some by choice.
For middle-class Americans trying to get ahead financially, this can be a costly mistake. Remember, the average credit card interest rate is now over 15%!
“One of the quickest hacks to put more money in your pocket and take control of your finances is to set your credit card bills to be automatically paid in full each month,” says San Diego Financial Planner Taylor Schulte. With this one strategy, you’ll save money on every purchase by avoiding interest charges.
And really, consumers at all income levels are better off if they avoid debt like the plague. You don’t derive a single benefit from carrying credit card debt – only added costs, debt, and stress.
2. Not having an emergency fund
Nearly half (46%) of us would struggle to cover a $400 emergency, according to a 2016 Federal Reserve report on the financial well-being of Americans. The figure is skewed by the fact that 81% of people making $100,000 or more said they could easily cover the cost, while only 34% of those making $40,000 or less could.
Still, our lack of emergency savings is a problem. When you don’t have the cash to cover emergencies — which will inevitably occur — it’s far easier to let your finances spin out of control or get caught in a cycle of debt.
Many financial advisors suggest keeping an emergency fund stocked with three to six months’ worth of expenses, but nearly any amount you can stash away will help. With some cash stored “out of sight and out of mind,” you’ll have a buffer should you face surprise medical bills, home or car repair costs, or other expenses you couldn’t predict.
3. Not giving your retirement a raise when you get one
Retiring on time requires patience and persistence, along with the fortitude to invest steadily for up to 40 years. But if you hope to grow your nest egg, it’s important to boost your retirement contributions as your income grows. If you don’t, it can take a lot longer to build up enough cash to retire, says Seattle-based financial advisor Josh Brein.
“Consider giving your emergency fund or your retirement savings a raise at the same time you get a raise, equal to the increase in wages you’re now earning,” notes Brein. If you save $500 per month and get a 4% raise, for example, you should boost your retirement contributions proportionately.
If you’re saving in a work-sponsored 401(k) plan, it’s easy to set this up so it’s automatic. By saving a percentage of your income every year (instead of a specified dollar amount), your retirement contributions will increase automatically as your earnings grow.
4. Relying entirely on a 401(k) plan
The convenience of investing in your work-sponsored 401(k) plan can’t be understated, but using only one account for retirement may not be enough. Not only could you come up short by the time you reach retirement, but there are notable disadvantages that come with investing only in tax-advantaged accounts.
“If you only invest in a pre-tax 401(k) account, you could potentially be creating a future tax headache for yourself,” says Christopher Hammond, financial advisor and founder of Retirement Planning Made Easy. “At age 70 ½, under most circumstances you must take distributions from your qualified money — that is, traditional IRA’s and 401(k)’s. This may inadvertently lead you to pay more taxes later.”
One way around this is to invest enough in your 401(k) to get your employer match, then put the rest into a Roth IRA. This way, you’ll have access to some tax-free money in retirement and (hopefully) reduce your future tax burden.
5. Not taking advantage of Health Savings Accounts (HSAs)
If you have a high-deductible health plan (HDHP), you may be able to use a health savings account (HSA). While the rules governing these accounts are up in the air due to proposed changes to the Patient Protection and Affordable Care Act (PPACA), the way they operate should stay the same.
“HSA plans allow you to save on a tax-free basis and then pay for your current or future medical expenses,” says financial advisor Gary Dahlquist of Clarity Retirement Advisers.
In 2017, the government will let you stash away up to $3,400 for an individual or $6,750 per family if you have a high deductible health insurance plan. These deposits are deducted from your income on your tax returns, lowering the amount you owe in the process. This money grows tax-free until you need it.
“Another great thing about these plans is they can be used to pay for expenses not covered by traditional health insurance,” says Dahlquist. “Chiropractor visits, dental or vision care, including eyeglasses and contact lenses, are examples of acceptable expenses covered by the HSA.”
If you’re not using a HSA, says the advisor, you’re realistically giving up a 25% discount on your medical expenses (if you’re in the 25% tax bracket).
6. Delaying retirement savings
“A frequent middle-class mistake is to delay saving for retirement while focusing on other financial priorities first,” says financial advisor Alex Whitehouse.
For many of us, it’s far too easy to believe you’ll start saving for retirement after you pay off your student loans, buy a house, or fund your children’s college education. While these are all worthy goals, life happens, and it’s easy to put retirement savings on the back burner until it’s too late.
If you’re middle-income earner especially, you need time for your retirement funds to grow. Whitehouse recommends saving for retirement as early as possible to put the magic of compound interest on your side.
“A small amount saved consistently takes advantage of compound interest and can have a significant impact at retirement,” says Whitehouse. “Begin by saving 1% of your income and gradually increase it 1% every year for as long as possible, until at least reaching 10% to 15%.”
7. Forgetting to update beneficiary designations on retirement accounts, life insurance policies, and annuities
Do you really want to leave your life insurance proceeds to your ex-wife? How about gifting your 401(k) balance to your parents? This is the type of thing that happens when you don’t update beneficiary changes and you pass away.
“Marriage, divorce, or any changes in your family situation are reasons to revisit your beneficiary forms,” says financial advisor David Niggel of Key Wealth Partners in Lancaster, Pa. “The beneficiary designation form is a legally binding document and overrides your will. Therefore, whoever is named on the form will receive the asset over what your current will reads.”
Nigel says this may happen more often than people realize: No one thinks they’ll die young, yet it happens all the time. And when these documents aren’t updated, huge sums of money can wind up in the wrong hands.
8. Spending too much on depreciating assets
As of the last quarter of 2016, the average car payment was $506 per month and 68 months long! That represents a huge chunk of cash for Americans who are already struggling to save. But the worst part is that these payments are mostly “sunk costs.”
“The fact cars depreciate rapidly makes them a poor way to spend an extra $500 each month,” says financial advisor Benjamin Brandt of RetirementStartsToday.com.
Brandt notes that working with middle-class clients has given him a unique perspective on common money drains. “We’re enamored with the idea of impressing others with our vehicles, but that often means overspending by thousands of dollars each year,” says Brandt.
Most middle-class Americans would be better off driving older cars and investing their extra cash in a Roth IRA or their emergency fund, he adds.