Monday, December 05, 2005

Freedom/Smart Money Accounts

I just love Freedom Accounts. I like to refer to them as Smart Money Accounts, because it's just smart to save a little bit each payday to pay big bills that you know are coming.

I don't know why I've never thought of this before. I consider myself fairly smart when it comes to money. I've always saved money. I've always paid more than the minimum on my debts, and always on time, but for some reason, it never occured to me to set up accounts that are designed to pay large, irregular bills.

Now honestly, I consider the "money-will-just-show-up" way of paying your bills to be pretty silly - well actually, it's down-right immature - but I've used that method to pay my irregular bills for years. If you aren't familiar with the "money-will-just-show-up" method I will give you an example.

A few weeks or a month before an irregular bill (let's say it's your auto insurance) is due, you start wondering where the money will come from to pay this bill. As time grows shorter, you begin to look around for ways to pay the bill. Do I have enough in savings? Am I getting a birthday check this month (yeah right - you still get money on your birthday even though you're 45)? Will my Income tax refund show up in time?

If none of these ideas pan out, you begin looking at your credit card, and telling yourself it won't be so bad to charge it because the interest rate is pretty low on this card, or you promise yourself that you will pay it off in 2 months, TOPS.

So, either the money just 'shows up' (gifts, refunds, savings) or you charge it to your credit card and end up with interest to pay, sometimes for months. More debt and more debt!

Then I read about Freedom Accounts online and ordered the book, Cheapskate Monthly Money Makeover. Although I can't say I like Mary Hunt (in my opinion, she comes across as a money snob in her books), I have to give her credit for a good idea regarding Freedom Accounts.

Setting aside money to pay irregular bills like Auto Insurance, Car Tags and Registration, Heating oil, Seasonal Clothing, Gifts (birthdays & holidays), Life Insurance, and even Haircuts is just Smart Money Management.

To create Smart Money Accounts, you figure out how much money you need to save each pay period in order to pay these irregular bills, and send it, or have it sent, to some type of savings account. This way, the money is there when the bills come due.

To figure out how much you need to save, just divide the amount of the bill by how many paychecks you will receive in each prepayment period.

For example, let's say that your auto insurance is $320 (bill), every 6 months (prepayment period), and you get paid twice a month. So, you would divide $320 by 12 (2 paydays each month for 6 months equals 12). This comes out to $26.67 each payday (I rounded up).

Move on to the next irregular bill you have and figure out how much you will need to save from each paycheck to pay that one. Let's say this one is Heating oil. You usually spend $300 for the year and again, you get paid twice a month. Divide $300 by 24 (2 paychecks a month for 12 months equals 24). This one comes to $12.50 each payday.

Once you do this for each irregular bill you have, add up the totals. For our examples, add $26.67 plus $12.50 and you will need to save $39.17 every pay period to pay these bills.

To keep yourself from (accidently?) spending this money, it's best to have it deducted from your checking account every payday, and sent to a savings account of some type.

The internet has made it so easy to save now-a-days! You don't have to change banks, you don't have to use your lunch hour to drive to your bank to set this up. It can all be done easily and securely online.

I keep my Smart Money Accounts at ING Direct. ING makes it easy to open an account and I feel completely secure having my money there. They also pay a very decent 4.4% (APY) interest on your savings. That's way more than my regular savings account pays (which is a measly 0.5% at Bank of America right now).

You can just use your regular savings account for your Smart Money Accounts if you aren't really concerned about earning interest. And with most banks you can set up your transfers online, so you won't have to actually go to the bank to set it up.

Just set up the transfers somewhere and soon you will be worry-free when these bills show up again.