Sunday, November 22, 2015

Roth IRAs and Emergency Savings a Clever 2-in-1

Sometimes, I feel like I'm being pulled in too many directions when it comes to deciding what to do with my money.  It feels like there is not enough money coming in to contribute to all of the places that I need to be.  I've paid off all of my credit card debt, but I still have student loan debt that I'd like to eliminate.   I haven't obtained an 8 month emergency savings account yet, and I'm concerned about saving for retirement.  I feel like I have to choose, but I'm torn.  On the one hand, the more debt I have, the more income I need, so eliminating that will free up some money.  On the other hand, my retirement isn't going to pay for itself, and right now, I have 30 years until I retire.  That makes this the perfect time to allow my money to really compound and grow for retirement, but if I delay contributing, I will just end up having to save EVEN MORE money later in order to catch up.  Still there is a THIRD side to my conundrum.  If I don't have a properly stocked emergency savings, any disaster that comes upon me will require me to wrack up a credit card balance.  I REFUSE to let THAT happen!  So, what's a person to do?

Kill two birds with one stone, that's what.  Open a Roth IRA and start contributing the max (or as much as you can).  In 2015, as long as you are earning income, and make less than $116,000 (or $183,000 if married) you can open one.  You are allowed to contribute $5500 per year ($6500 if you are 50 years of age or older).  That's $458.33 per month.  If you can pull it off, the benefits will be tremendous.

Now, I'm sure a few of you are confused about how this relates to your emergency fund, right?  In a Roth IRA, you are allowed to withdraw any money that you contributed without a penalty.  You just have to be sure that you don't dip into any of the interest that it earns.  The interest earned in your Roth IRA must be left very well alone.  Well, actually, there are circumstances where you can also take the earnings, but that is considerably more complicated.  My recommendation is to simply leave that part alone.

So, if you are strapped for cash, but feel the need to do SOMETHING to start saving, I recommend opening a Roth IRA and funding to the max (or as much as you can).  This can double as an emergency savings as long as you only withdraw the contributions (not earnings).  You are to avoid having to do this at all costs.

Part two of this strategy is to consider where you will open it.  If you open it at a discount brokerage, you can invest in a manner that will likely grow your money much more quickly, but if you need access to the money, it will take longer (3-4 days) for them to transfer the money to your bank account.  My strategy is to open a Roth IRA savings at my local credit union.  Right now, the interest rates are terrible, but I can get the money into my checking account the very same day that I call them.  In a true emergency, this is a bonus.  I will only fund this one up to 1 month of my expenses.  Then I will switch over to funding one at a discount brokerage to maximize my money's growth.

Eventually, I will be able to fund both of these things separately, but until then, this is a good strategy.

Update:  It is also important to note that you can contribute to your IRA for the PRIOR year all the way up to the day that year's taxes are due!  For example, I am writing this update in Feb. of 2017.  Right now, since I haven't maxed out my IRA for 2016, I can make a contribution, and have my financial institution apply it to the 2016 tax year.  This is perfectly legal.  If you didn't contribute to it at all last year, you can use this strategy, and it will allow you to take the Retirement Savings Credit, which could be a HUGE benefit on your taxes!

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