Free from the shackles of debt! Now what?

If you've spent years in debt but finally managed to pay it off, it can be a little overwhelming. Here's a three phase plan for starting with a blank slate.

A few weeks ago, I put out a call on Twitter and on Facebook for detailed posts that people would like to see. I got enough great responses that I’m going to fill the entire month of July – one post per day – addressing these ideas.

Lois on Facebook wants to know about starting from scratch. “After two years of living just on basic needs in order to get rid of 60k in credit card debt – yea! we did it! But what is the best strategy for starting over (we have do have 1k emerg. fund).”

Congratulations on your positive financial changes! It feels really good to be free from the burden of debt.

You’re facing a problem that many people face when they reach debt freedom. They’ve been in debt for so long and burdened by constant debt payments for so long that they’re unsure what to do when they’ve been freed from those shackles.

For people in your situation, I would recommend a three phase plan for continuing forward in your financial journey.

Phase 1: Retirement planning
This is absolutely the next thing you need to focus on. By retirement planning, I mean having money available to you when you reach the point in your life where you want to step away from work and enjoy the years you have remaining in your life.

My usual advice to anyone is that they should shoot to have 25 times their annual living expenses in retirement savings on the day they retire. That seems like a huge number, but it’s an achievable one.

The key is to start now. A good rule of thumb to use is, if you haven’t started contributing to your retirement, start contributing a percentage of your income to retirement that’s your age minus fifteen. If you’re 30, contribute 15% per year. If you’re 40, contribute 25% per year. If you’re 50, contribute 35%. This isn’t a perfect solution, but it’s one that’s going to get you as close as possible to a path to be able to retire at a reasonable age. In truth, if you’re approaching fifty and haven’t started saving anything for retirement, you’re either going to need a pension or you’re going to be working until at least seventy to maintain your standard of living.

Phase 2: Protecting yourself from falling back into debt
Once you’ve got retirement savings lined out, you need to use your remaining extra money to prevent yourself from falling back into debt. This comes in a few big pieces.

First, build up a bigger emergency fund. Try to save two months of living expenses for each dependent in the household. This will help you deal with almost any crisis that crosses your path.

Second, start saving for any known large expense that’s coming. For example, you’re going to have to eventually replace your car. Start making car payments now, except put those payments into a savings account. This way, instead of having to pay interest to the bank on a car loan, you’ll collect interest that you earn yourself on the savings account.

Finally, make sure you and your partner have adequate life insurance. I usually suggest getting a term life insurance policy so that you’re not left destitute if your partner dies. Shop around and look for the best deal you can find. Try to get one with a benefit equal to at least five times that person’s salary – and preferably more.

Phase 3: Establishing long term goals
If the above things are well in hand, you’re building a strong financial backbone for yourself. You should start thinking about your long-term goals at this point.

Is your goal to retire as early as possible? If so, ramp up your retirement savings as high as you possibly can.

Is your goal to go back to school? If so, open up a college savings plan (also known as a 529) and start socking money into that.

There are lots of goals that people have – and many of them require some significant savings in advance. Now is the time to start doing that.

Good luck.

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